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We may be in the middle of a crypto winter, and digital assets might have lost two-thirds of their value. But that’s not stopping regulators preparing for a future crypto bounce-back. James Wood looks at what to expect – and what new regulations mean for payments.
Regulators need to prepare for the Crypto Spring
Last year, over 220 million people worldwide used cryptocurrencies, including some 18 million people in Europe.
In a January 2023 study, Spherical Insights said it expected payments with crypto to reach $2.2 billion annually by 2030 – a four-fold rise over current figures – and that payments at point of sale (POS) would be the fastest-growing segment within this figure.
As has been widely reported, Visa, Mastercard, PayPal and CashApp (formerly Square) all handle crypto payments, while two-thirds (64 percent) of global merchants surveyed by Deloitte last year said their customers have significant interest in using digital currencies for payments.
“Crypto is far from done – and regulators are getting ready for the future.”
The implication is that crypto is far from done. Indeed, at time of writing, Bitcoin (BTC) had risen almost $4,500 or 27 percent since the start of 2023 to hit $20,500, with some analysts, including Bank of America, targeting values of between $30,000 and $50,000 by the end of this year.
After the FTX scandal, regulators are stepping up their efforts to align crypto with other tradeable assets. And while similar principles exist across geographies, there are significant differences – with implications for the payments business.
Global principles: FSB and BCBS
In October last year, the Financial Stability Board (FSB) published a proposed framework and recommendations relating to the international regulation of crypto.
This framework sets out guidance for national-level regulators as to what is expected as a minimum. The fundamental principle governing the FSB’s approach is best described as “same activity, same risk, same regulation.”
In practice, this means – for example – that trading in crypto should only take place via registered and regulated entities; and that, in payments, identification of all parties and adequate AML, Counter-Terrorist Financing (CTF) and KYC checks should be in place.
None of this should come as a surprise; last Spring, the Financial Action Task Force (FATF) announced that its “travel rule” would be extended to crypto.
This means that, as for cash and card transactions, all companies must screen, record and communicate the information of both sender and recipient for crypto transactions that exceed $1,000 or a certain amount designated by FATF member states.
“At a global level, regulation is driving users towards stablecoins and CBDCs.”
Elsewhere, the Basel Committee on Banking Supervision (BCBS) published its final rules on the treatment of crypto-asset exposures in December 2022. These rules help determine the cost of holding and managing crypto for financial institutions globally.
Most significant among the new rules is the decision that crypto assets not backed by cash, securities or linked to a fiat currency (“stablecoins”) will be subject to the same treatment as very high risk assets.
This means banks holding more risky crypto assets now need to increase their capital reserves to cover any potential losses – effectively increasing the cost of holding such assets.
Key take-away: at a global level, regulators are encouraging financial institutions towards stablecoins and other crypto forms backed by solid assets. In payments, the implication is that Bitcoin, Tether and other established crypto are likely to become more popular.
The US: land of the SEC –or CFTC?
On January 3, 2023, a joint statement from the Federal Reserve, Federal Deposit Insurance Corp. and the US Comptroller of Currency raised concerns about the risks posed by digital assets, such as scams, legal uncertainties around custody and misleading statements. In a warning to lenders, they said it’s important that risks that can’t be controlled aren’t allowed to migrate to the banking system.
This statement forms part of a wider “turf war” between the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) over which body should be regulating crypto.
Space does not permit a description of the debate, though it’s clear all parties now agree crypto is a security, rather than an asset – making holding crypto in the US subject to more stringent guarantees from an institutional perspective.
As regards payments, the Biden administration issued an Executive Order in March 2022 outlining a whole-of-government approach to managing risk associated with crypto.
This move recognised the systemic importance of crypto as holdings in the US approached $50 billion in value, and confirmed a number of moves by separate Federal agencies, including the Financial Crime Centre (FinCEN) mandate for all digital asset companies to be compliant with AML and sanctions requirements, and the decision to treat stablecoins as payment instruments – requiring their operators to register and be regulated like banks.
Key take-away: payment regulations famously vary between states in the US. However, there appears to be consensus with global regulators on the status of crypto as a security, and the regulation of digital asset firms as banks.
Expect further guidance at a Federal level to emerge during 2023.
EU: MiCA in play
The EU’s fifth Anti-Money Laundering Directive (AMLD5) covered certain crypto assets under the term “virtual currencies”, but did not provide a harmonised approach, meaning various regulatory regimes exist for “virtual currencies” or crypto assets.
In 2020, the Markets in Crypto-Assets (MiCA) regulation was proposed by the European Commission for implementation by the end of 2024.
MiCA creates a harmonised set of rules for products and services and legal certainty related to crypto assets throughout the European Union.
MiCA aims to lay down uniform rules for the operation, organisation and governance of issuers of asset referenced tokens and e-money tokens and crypto asset service providers.
There will also be investor protection rules for the issuance, trading, exchange and custody of crypto assets.
In addition, measures to prevent market abuse will aim to ensure the integrity of crypto asset markets. In June 2022, the EU Council President and European Parliament reached agreement on MiCA, ruling that crypto asset service providers will require authorisation to operate in the EU.
Key takeaway: Expect MiCA to provide better consumer protection from fraud and scams, as crypto asset service providers will be liable if they lose assets and fail to protect investors’ wallets. Like the US, MiCA also treats stablecoin issuers as banks to be supervised by the EBA.
Question marks remain over the implementation schedule – notoriously slow – and on the implications for POS transactions, though equivalence between crypto and other instruments such as cash and cards looks likely.
Meanwhile, in the UK …
In October 2022, the British House of Commons voted to make cryptoassets a regulated financial instrument, bringing crypto into the existing provisions of the Financial Services and Markets Act 2000.
The implication is that crypto-assets will be treated like other forms of financial asset.
The new legislation, which includes stablecoins, is included in the Financial Services and Markets Bill, which is expected to receive Royal Assent in the first half of 2023.
The Government intends to make the UK a global hub for cryptoasset technology and investment and will consult further with industry on its the proposed approach – however, it has already confirmed the need for digital asset firms to register with the FCA and adopted the FATF “travel rule” into UK law.
From September this year, firms will be required to collect beneficiary and originator information for transactions with an ‘elevated risk of illicit finance’, as defined in the legislation.
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