The regulatory mood around digital assets in 2022 and beyond

By Michael Magrath, Vice President, Global Standards and Regulations, OneSpan

 

Put simply, digital assets are unique digital representations of financial assets, the ownership of which is registered securely on a blockchain. This includes cryptocurrencies, stablecoins, NFTs and digital asset tokens. With global financial institutions investing in cryptoassets, consumer ownership of cryptocurrency skyrocketing, and cryptocurrency even becoming legal tender in some countries, digital assets are now playing a significant role in the global financial ecosystem.

Like with any emerging technology, regulation in this area has for many years lagged behind the pace of innovation. However, this is now changing as regulators rush to protect investors, fight crime and establish their jurisdictions as fintech hubs. With this in mind, what regulatory changes can we expect key European players – France, Germany and the UK – to make in 2022 and beyond?

 

Michael Magrath, Vice President, Global Standards and Regulations, OneSpan
Michael Magrath

Confronting the growing role of digital assets in global money laundering

From drug trafficking to ransomware, we cannot ignore the fact that cryptocurrency enables serious organised crime. Crypto allows bad actors to easily receive bribes and ransoms, as well as disseminating the proceeds of their crimes – all without being identified and apprehended. This pressing issue was highlighted by the European Commission’s EU Strategy to Tackle Organised Crime 2021-2025 report published earlier this year. The authors noted that: “only 1% of criminal assets are confiscated. This has been aggravated by the increasing use of financial channels with more limited oversight than the banking sector, such as virtual currencies.”

Given this startling figure, it’s no surprise that EU member states are closely examining the role of digital assets in criminal activity – so, what steps are they taking?

In April this year, the French Ministry of the Economy and Finance published a decree designed to strengthen the country’s existing mechanism for freezing criminal assets. The new decree aims to eliminate the use of anonymous digital assets in illegal activity. At its core is an expansion of the scope of customer due diligence requirements for payment and e-money institutions, and a requirement for digital asset service providers to identify customers before permitting a transaction.

In addition to member states’ individual efforts, the EU’s proposed Regulation of Markets in Crypto-Assets (MiCA) legislation proposes a detailed regulatory framework for digital asset issuers across the bloc. It’s worth noting that the legislation doesn’t apply to central bank digital currencies, issued by states and regulated by central banks, but other cryptocurrencies, including utility tokens and payment tokens do fall within its scope. In the three years since MiCA was first put forward, there remains a lack of clarity in several key areas. Currently, it’s expected that a single licensing regime for cryptoassets will be in place across all member states by 2024.

Outside the EU, the UK Treasury published a consultation on amendments to its 2017 Money Laundering, Terrorist Financing and Transfer of Funds Regulations in July 2021. The amendments seek to implement a Travel Rule for the cross-border transfer of cryptoassets. The Financial Action Task Force’s Travel Rule requires both financial institutions Virtual Asset Service Providers (VASPs) (cryptocurrency exchanges)—to collect personal data including names and account numbers for both senders and recipients in wire transactions exceeding 1,000 USD/EUR. Secondary legislation is expected to be introduced in spring 2022.

 

Boosting security standards for exchanges and custodians

Money laundering isn’t the only pressing concern and increased scrutiny has been placed on exchanges. Though undoubtedly the most high-profile, the recent Coinbase hack was not the first to successfully target crypto exchanges and custodians. In fact, research shows that an estimated $1.9 billion worth of cryptocurrency was stolen by hackers in 2020. This eyewatering figure demonstrates that the security standards of digital asset exchanges and custodians must be significantly improved to protect investors.

The German Federal Financial Supervisory Authority (BaFin) has established itself as a pioneer in regulating digital assets – and has already taken significant steps to boosting security standards among cryptocurrency exchanges and custodians. Germany was one of the first countries to allow financial institutions to custody cryptoassets. This was classified as a financial service back in January 2020. German law states that all entities seeking to custody cryptoassets, and those engaging in the trade of cryptocurrency, must apply for BaFin authorisation. The German Banking Act considers all crypto custodians and exchanges to be financial institutions, so they must adhere to stringent anti-money laundering rules.

In the UK, the Financial Conduct Authority (FCA) will soon require cryptoasset exchanges and custodians to submit an annual financial crime report. As part of the FCA’s Extension of Annual Financial Crime Reporting Obligation policy, the number of firms required to submit to financial crime reporting is expected to rise from 2,500 to around 7,000. The requirement will go into effect from 30 March 2022.

Though it’s heartening to see increased regulation in this area, custodians and exchanges need to go above and beyond the bare minimum of what is required by law. This is the only way to cultivate lasting consumer trust, which is currently at an all-time low.

 

Offering clarity on licensing and consumer protection for financial institutions

With the value of digital assets soaring, it’s no surprise that banks and financial institutions are keen get involved by creating exchange traded products linked to cryptocurrencies. Essentially, crypto exchange traded funds (ETFs) are securities that track the price of a cryptocurrency, like Bitcoin or Ether, but can be bought and sold on a regular stock exchange.

As interest in such products continues to grow, there are increasing calls for more to be done to clarify how banks and financial institutions are allowed to license the purchase of cryptoassets.

Both Germany and France have approved the sale of exchange traded products linked to cryptocurrencies. In fact, just last month, Europe’s first UCITs-compliant bitcoin ETF was listed on the Paris stock exchange. It’s the first product of its kind to be made available to retail and institutional investors across the EU.

It was a desire to protect retail investors from the high volatility of cryptocurrency markets that led the UK government to ban ETFs of crypto products back in 2020. Given that many countries, including Germany, France and most recently the US, have approved exchange traded products linked to cryptocurrencies, the UK’s cautious position makes it an outlier in this area. And considering that retail investors can legally trade ETFs of volatile commodities like gold and oil, many have branded the UK’s outright ban as heavy-handed and disproportionate.

Overall, it’s clear that there’s a palpable sense of urgency among regulators to create a fair and enduring legislative framework governing digital assets. In 2022, we can expect regulation to increase in both complexity and rigour. To ensure that this brings stability, protects investors, and doesn’t stifle innovation, key industry players should collaborate with regulators, rather than resisting external oversight.

To discover more about the regulation of digital assets, download OneSpan’s Global Financial Regulatory Report here.

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