Cryptocurrency is, arguably, still in its infancy compared with some of its more established peers in traditional finance. In fact, for many in the traditional space, cryptocurrency remains little more than an interesting tech project that does not qualify for inclusion under the term “finance.”
Living on the fringes of finance has had its advantages, though. Since the founding of the first-ever cryptocurrency, Bitcoin, in 2009 crypto has existed outside of the regulatory framework that governs traditional finance. This is a complex world that has evolved over decades in the face of unfolding crises and whose rules dictate who can and who cannot access different financial products or asset classes.
Ultimately, regulation is designed to protect consumers, however, it is often onerous for providers and users alike. While shielding savers and investors from bad actors, regulation also needs to promote competition and encourage innovation, and for many, crypto’s self-exemption has been key to its growth. The rapid innovation we have seen over the past decade has seen crypto expand into a truly global force whose $1.5 trillion market cap now exceeds the GDP of Spain.
The Sheriff comes to town
As this avant-garde of digital finance has exploded, however, regulators have become increasingly interested in cryptocurrency. Most notable is the US watchdog the Securities and Exchange Commission (SEC), which in 2018 stepped in to effectively ban Initial Coin Offerings (ICO’s) following the spate of malicious activities that colored crypto’s first big boom. Since then, the US regulator has been among the most active among its peers, with every month seeming to bring a new rule around customer identification and taxation.
While very active, though, the SEC is by no means alone. In 2019, global money-laundering watchdog the Financial Action Task Force (FATF) recommended its members apply the organization’s infamous anti-money laundering “travel rule” on Virtual Asset Providers (VASPs). This requires cryptocurrency platforms to pass customer details between each other for certain types of transactions, as regulated financial institutions are required to do.
This has seen a spate of countries including Switzerland, Gibraltar, and Japan implement customer reporting rules that have placed a large and growing burden on cryptocurrency providers. Of the 128 jurisdictions the FATF oversees, 52 now regulate VASPs, and six have banned them.
Centralized giants in the firing line
These new requirements are catching many crypto firms in the centralized space off-guard, most notably the world’s biggest cryptocurrency exchange by volume, Binance. In recent weeks it shocked the crypto world by suspending withdrawals (i.e. off-ramping) in British Pounds (GBP) and Euros (EUR).
This follows the UK regulator, the Financial Conduct Authority (FCA), banning Binance from undertaking any regulated activity in the UK, which is effectively any activity involving GBP. According to the watchdog, Binance failed to register with the FCA after not meeting its anti-money-laundering requirements.
With a 24-hour trading volume of more than $21 billion globally, it is likely that Binance will find the firepower it needs to comply with the FCA’s rules — eventually. In the meantime, however, many of its British and European users will be forced to take their business elsewhere, particularly those that have relied on the platform as one of the few places to on and off-ramp fiat currency.
DeFi is no longer a regulation-free haven
As the centralized giants have been struggling under the weight of the regulator's gavel, the world of decentralized finance (DeFi) has opened up a new pathway for many. This space, in which users can participate without providing any personal details to many exchanges and protocols is, for some, the full realization of crypto’s original dream. As such, activity and assets in DeFi have swelled — from almost nothing in 2019 to over $100 billion today across numerous blockchains.
DeFi is not immune, however. Indeed, the FATF’s travel rule captures wallet providers in the decentralized space who are now obligated to provide customer details to requesting centralized exchanges. This is in theory, at least — in reality, this would not be possible for many DeFi operators, such as the entirely trustless MetaMask and Uniswap, for example.
The European Commission has also taken a growing interest in DeFi. The bloc is now reviewing submissions from a consultation it launched in 2019 to consider extending many of its current financial rules to the DeFi space. This includes the open briefings on ‘Markets in Crypto Assets’ (MiCA) throughout the bloc, as well as the regulation of stablecoins as securities, a mantle picked up recently by the Bank of England who has suggested that stablecoins ought to be regulated the same as the fiat currencies they are pegged to.
Smart crypto providers are preparing
As stablecoins form the very backbone of DeFi and its yield generating opportunities, should this regulation come to pass in its current form, we will see vast swathes of the DeFi space fall under the most stringent rules of global regulators. For those platforms unprepared for such a change, this could be a hammer blow that puts an end to their businesses entirely.
This is why it is absolutely essential that cryptocurrency providers of all shapes and sizes and in all corners of the marketplace take action now. We must all ensure we are lining up our products and services to be fully compliant with global regulations to support the growth of the ecosystem and bridge the gap between traditional finance and crypto for the common good.
If cryptocurrency is to find the mainstream adoption that it and the world deserves, it must be regulated. For significant numbers of new users to enter the market their assets and information must be protected while trust in service providers must be high. This places regulation front and centre as a critical next step in the evolution of cryptocurrency and one all crypto providers should be ready to take.