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June Webinar 2022

This webinar dives into a global perspective of regulations and cryptocurrency with our advisory experts. They discuss digital assets and the global outlook on cryptocurrencies and the regulations that control them.

Our speakers discuss the world of digital assets and regulations is rapidly evolving all over the world. Join Kayvan Alikhani, Jeffrey Smith and James Phillips to get the latest definitions, trends and perspectives on:
– The state of regulations and cryptocurrency + digital assets in the US
– Contrasting views of current trends and regulations in the EU and UK
– Other international views on digital assets
– Best practices to managing shifting regulatory landscapes

Download the presentation deck with details here!

*Read the full webinar transcript below.

Regulations and Cryptocurrency

Speakers: Kayvan Alikhani(Compliance.ai, Jeffrey Smith (LawVisory), James Phillips (disruptive technology innovation strategist)

INTRODUCTION

Well, good morning, everybody. Thank you for joining us for “Regulations and Cryptocurrency” webinar today. Just a quick reminder, we will have a q&a if we have time, (we may not have time.) If we do have time, please go ahead and put your q&a questions into the q&a box below. If we don’t get to them during the webinar, (we have a lot of content to cover), we will follow up in an email with the on demand recording, as well as the answers to your question. So, just make sure you stick them in the box and we’ll do our best to get through all of the questions. I also wanted to give you a preview of our upcoming webinars that are coming up in the next few months: In July, August, September, October (we are having them monthly through the end of the year), so keep an eye on that. You can also see them on the compliance.ai events calendar and of course, we promote on social media. Now I will leave it to Kayvon Alikhani, co-founder and CEO of compliance.ai  to kick us off. 

Kayvan Alikhani (Kayvan)

Thank you so much Ronjini. I’m very, very happy to have Jeffrey Smith, (founder of “LawVisory”  with extensive experience in cybersecurity and legal tack) and James Phillips, (disruptive technology innovation strategist) has extensive experience in compliance, risk and regulatory reporting within the UK/EU in general, (and globally, as we’ll hear today as well.) In today’s webinar, we’re looking at digital assets and cryptocurrency. Where are we going to level-set on? What do we know about cryptocurrencies? How do we define digital assets? We’re going to look at the views within the EU versus the UK and compare/contrast how they are viewed (both from a trending and regulatory landscape.) We’ll compare the United States with the UAE. Which has taken (I, in fact, learned through this preparation) an amazing amount of progress. In terms of adopting and embracing digital assets, how it compares in contrast with the United States. What are the best practices to be “in-the-know” as a compliance team? With the regulatory landscape that impacts your organization specifically, as it relates to digital assets and regulations. What do we mean by “digital assets” in the world? Gentlemen, can you help us level-set a definition of cryptocurrencies, DeFi (decentralized autonomous organizations) and NFT’s (which Bill Gates commented on yesterday) as well? Go ahead, please.

Jeffrey Smith (Jeff)

Yes, I’d be happy to do that. Thanks, everybody, for joining us. Hopefully everybody learns a lot from this presentation that we’re doing. What we want to do is differentiate some key terms here. As you’ll see, the regulations and legislation (that is either out or coming) addresses these areas, so it is important to understand the differences. So let’s talk about cryptocurrencies. Cryptocurrencies are fungible, and digital stores of value, as well as a means of exchange (primarily.) Decentralized finance, on the other hand, is what we think of when using traditional finance (in terms of lending and facilitating transactions involving stores of value, such as money.) In this case, it’s done digitally, in a decentralized manner, and it is faster and cheaper. Stable coins, which we’ve heard a lot about recently, are a type of cryptocurrency that is designed to facilitate lower volatility and less changes in the price of a particular digital asset. Non fungible tokens (NFT’s) are really something different. They’re viewed as contrary to cryptocurrencies, they’re non fungible, (one of a kind), such as a piece of art. They can also identify or represent a certificate of title or ownership, such as a real estate deed or ownership of a collectible. They are even now being viewed as potential commodities for regulatory purposes. Another term that we’ll be talking about, is “decentralized autonomous organization” (or DAO). This is a mind-blowing concept. Even more mind-blowing than some of the other things that we’ll be talking about, simply because it’s like a company. Imagine a company run by a board of directors and its shareholders. The company itself is not legally recognized by any particular legal jurisdiction. It exists in the form of a computer program. Therefore, it exists in jurisdictional ”no man’s land.” Hopefully that helps to lay the foundation for what we’re going to be talking about. So, let’s talk about cryptocurrencies. There are currently over 18,000 types of cryptocurrencies as of March 2022, (there may actually be less as of today, with all the changes that have happened.) They should not all be viewed the same because they are not. It would be like saying, “one technology stock is just like every other one,” but they’re just not. There are a few basic categories here that you can break them down into , but they are actually more. Utility coins (tokens used to allow for exchange of services, oftentimes.) Fractional ownership interests (similar to securities) also exist. Something similar/more traditional like having stock in a corporation. Rather than stock, you actually get some type of coin or token to represent that ownership. Stable coins are a type of cryptocurrency that are designed to minimize volatility and to “peg a price” of a particular token to, let’s say, the dollar or gold. Proof of Work coins are those similar to Bitcoin, where they are minted and created by way of a “proof-of-work” methodology, which involves computers solving complex computer programs and puzzles. They use a lot of energy to do that, whereas proof of stake is less energy intensive. A lot of it is done through the staking of these particular assets, (as opposed to being solved through computer programs.) There are also hybrids, which are very interesting. There’s a coin out there called “D cred”, which is a hybrid of both proof of stake and proof of work. It also has a DAO component mixed into it. There is a voting that can take place by certain owners of the coin. The common element to think about (and all of these digital assets really involve) is the usage of blockchain technology. Also a transparent and immutable transaction Ledger (in the form of a blockchain or multiple blockchains) that we’ll be talking about.  Let’s talk about DeFi or “decentralized finance,” this is very much the future. Imagine your bank or any type of financial institution existing on a peer-to-peer basis, totally decentralized, and having no insurance intermediaries of any kind. It’s just being run through computer programs. That’s what we’re talking about, when we talk about “DeFi,”  lending platforms. The sky’s the limit on these things. Once again, they utilize blockchain technology, and in some cases, multiple blockchains. What we’ll see very soon, I think, is the movement of transactions across multiple blockchains.  Anything that has previously been done through traditional finance, will also be able to be done through DeFi. Oftentimes, it’ll utilize smart contracts, as well as pallets. The best way to understand the difference between a smart contract and a pallet, (which is a more evolved version of computer technology) is that a pallet is a placement of a bunch of smart contracts together, and further customizing it. It’s like custom building a home versus using a prefab home. That’s the best way to understand that.

Kayvan

So Jeff, as we’re looking at this (going back to my research days, 2017-2019) tracking and writing and presenting on crypto, how mature are we today? If you were to say low, medium, high or crawl, walk, run from a DeFi perspective? Where do we think we are? Is this more of an experimental phase or is it an actual adoption? Are there reference points you’re gonna be talking about later on DeFi? 

Jeff

Yeah, I would say we’re still very early. However, we’ve had some substantial advancement. This is the most rapidly evolving technology and the most quickly-adopted technology we’ve ever seen in our history. We’re going to move very, very quickly from crawling to probably walking. I think we’re sort of in the in-between stage right now. So yeah, much more to come, but it’s a very exciting time.

Kayvan

I already have a question for you on this. How do you see DeFi in relation to solving or creating potential fair lending issues? Either as a good thing or a bad thing? Right?

Jeff

Yes, these particular products and protocols are highly complex right now. Ultimately, everything DeFi, everything digital asset related and imaging decentralized has the ability to create democratization around all sorts of wealth, including finance. Absolutely, this has the power to radically transform the entire world and probably have the biggest transitional effect we’ve ever seen, as far as shifting wealth from the super wealthy and institutions to anybody that wants to get involved. However, due to the complexities and lack of regulation, there needs to be education and understanding. People need to be really careful about what they’re doing and they need to understand what they’re doing before they do it. There’s huge promise on this, yes. 

Kayvan

Then there was another question which I can imagine. We saw “CeFi” (centralized finance) in contrast to DeFi. So basically, the adoption of this is: “Me. I’m controlling it, it’s my marketplace, you guys are joining” versus decentralized where no one is the owner, and everybody’s up here. We saw some of the largest financial institutions in the United States try the CeFi approach. Would you say DeFi is kind of a response to the fact it didn’t get the level of traction that was expected or simply another flavor of adoption of blockchain/cryptocurrencies by financial institutions?

Jeff

Yes, I think that the centralization model will continue to be pushed by the traditional financial sector because they’re going to want to control it (and monetize it) as best they can, because that’s how they’re designed. They are designed to maximize profits and shareholder value, right?  Whereas the decentralized focus is about autonomy. It’s about disintermediation. Ultimately, decentralization will “rule the game” and they will win the game, simply because it’s cheaper and faster.

Kayvan

And maybe more fair? <laughs>

Jeff

It could certainly be. Yeah, I think that the market forces will drive the winners but it’s going to be quite the battle in the meantime.

Kayvan

Great questions and keep the questions coming. Please, go ahead Jeff. So, you have risks. What do we see in the form of regulatory concerns with that framework in the backdrop?

Jeff

As we’ve seen, in recent weeks and months, there’s a lot of risk. This is the piece that really needs to get worked out for this to flourish even more. There are few restrictions and regulations currently, in most jurisdictions across the world. (We’ll talk about some of these regulations soon.) There’s a lot of anonymity here. Now, there are ways of working through that, because most of these blockchains are public and there is transparency. However, there needs to be easy ways to identify who these individuals are, they’re behind these addresses, etc. Because it’s an open source system we have the risk of people getting into this business creating bad products.  They are, in essence, computer programs and with computer programs come bugs. With the lack of testing, there can be a lot of problems. One of the biggest and most interesting things about this space we’re talking about is an entire industry that will work outside of regulation and governmental control. It’s going to have to self-regulate to ultimately optimize its value, which I think will happen at some point, possibly through DAO’s, etc. There are currently no insurance or reserve requirements, as we see being applicable to banks. These types of things, once again, may exist through self regulatory steps. We’ve seen market crashes in this space considerably. 

Kayvan

Yes.

Jeff

We could see more, because this is an evolving technology. There’s a lack of disclosure. Disclosure needs to be enhanced considerably. There was a $3.2 billion loss from Security Acts in 2021 alone, and we’ll see more. 

Kayvan

It’s interesting because anonymity, in many ways, has been the driver for the adoption of Bitcoin (or those types of currencies.) It’s kind of at odds with bringing it to KYC (Know Your Customer) and now has visibility into who that individual is, who initiated and resulted in the removal. The other aspect that we observe and are interested to see is the “right to be forgotten.” The idea of, maybe, now you have to remove that information from what you have in the form of the ledger, which is now in contradiction with a lot of the principles for blockchain. I remember some of the other crypto makers were very much up in arms about the consequences of the GDPR regulations in that regard. So, you’re talking about KYC. Of the 18,000 currencies that you referenced, maybe a small fraction would today (out of the box) be in compliance with KYC. Would you agree with that?

Jeff

I would say, probably. There’s a lot of different litmus tests to use regarding compliance. Most jurisdictions have their own flavor of it. But I would say generally, KYC needs to be improved. There needs to be technology developed to allow for that. I have seen most people that are getting into the business understand the need. They are trying, but there just needs to be better tools for that. 

Kayvan

All right, let’s talk about stable coins.

Jeff

So this has been in the news in a major way. Obviously with the collapse of Luna Terra, this has been catastrophic. An entire ecosystem, hundreds of billions of dollars have basically just evaporated. Due to many reasons (this isn’t intended to go into the details of what happened, but it’s definitely something to research.) In essence, these are designed to create stability around value, so that somebody can use these coins as a means of exchange. It can also be a store of value, but something predictable. We’ve seen a lot of success in these, (including USD coin, tether, etc.) We’ve seen some failures too, massive failures with algorithmic based coins. The idea is that these get pegged to the US dollar, a particular fiat currency, or gold. In the future, I think what we’re going to see are these pegged to certain rarity assets, which will be very, very interesting. If you think about it, what is truly rare? Take a famous painting, there is one of a kind. That is truly rare. The stability of the value could quite possibly be enhanced through pegging these to certain rarities, collections of rarities or pools of rarity, so to speak. It’ll be interesting to see how this develops. 

Kayvan

Can you summarize what’s good and what’s bad about what we’ve said so far? Go ahead, please. 

Jeff

Yeah, absolutely. It creates price stability, that’s super important. Volatility is a real challenge in this space. It avoids the need for people to have to go through traditional “banking rails”, which is expensive, time consuming, and very inconvenient. So, speed obviously, efficiency is good. The cons, of course, are that we have some centralized versions of these, which is sort of defeating the purpose in some ways (arguably.) There’s obviously auditing that’s required, (which is probably a good thing) to make sure that any reserves are actually there to backup, some of these stable coins. There’s just a huge lack of regulation currently. I think people are definitely rising to the occasion. They’re going to start regulating these. Then the amount of money and wealth found in stable coins is absolutely massive. So there’s a lot of potential risk there from a systemic perspective, in my opinion. I know some people would disagree, but I think that risk is there.

Kayvan

Very good. Let’s talk about NFT’s. I honestly am baffled sometimes. I still don’t get it. My daughter laughs at me when I say that, but what are your thoughts on this and can you help provide a definition? How would you compare/contrast that to what we’ve learned so far?

Jeff

Yes and I’m going to hit this relatively quickly (just to be efficient), but NFT’s hold some of the greatest promise of ALL in the entire digital asset space. The reason is: an NFT is a representation of “ownership” of “anything.” You can transfer the ownership of anything through an NFT. You can fractionalize that interest through NFT’s. We’ve seen the use case of art (which has been massively successful) and has empowered artists around the world. We’re also starting to see it being used for utility purposes. For instance: if you want to sell your house and you want to use NFT’s to do that, you can do it. You can create a chain of title (and in something like provenance in the art community) probably more effectively through NFT. The uses are just beginning to scratch the surface. This has huge potential.

Kayvan

If you could, talk about how it’s evolved over time.

Jeff

Absolutely. This is very exciting. The first mention of it was around 2012, I would say, with Colored Coins-which is basically a concept of certain types of Bitcoin that become one of a kind. It creates nonfungible Bitcoin, in essence. Then you had a work of art from a digital artist that was created in 2014. Now, arguably, some would say that there were some digital artworks created beforehand, but they weren’t necessarily referred to as NFT’s. Then in 2016 Liquidiarity Exchange actually filed its first patent in this space that covers all the display and transactions of 3d NFT’s that they refer to as “rarity bits” (also referred to as the “virtual marketplace”), but we now know it as the Metaverse. In 2017 you had Crypto Punks, Crypto Kitties, Decentraland, Board Eight Yacht Club, which had this combination of art, but also a gamification and certain types of benefits that come along with it (like membership). Then in 2021, you have this massive sale of Beeple’s entire collection that he created over the first 5000 days of his being an artist and being focused on this for like $69 million, a massive transaction. In 2022, now you’ve got the first indictment on this from the Southern District of New York, looking at NFTs as a type of security, involving insider trading. They creatively brought it under notions of wire fraud and illegal…

Kayvan

Money laundering.

Jeff

Yes, so I would watch this very closely. It’s gonna be interesting to see what happens with this. 

Kayvan

I’m sure there’s going to be another webinar coming soon in 2022 about more.

Jeff

 DAO’s or dollars?

DAO’s, I think, are going to be very contentious. In essence, these are organizations that are truly decentralized and autonomous, the title says it all. Imagine a company that is not subject to any legal jurisdiction or regulation of any kind, anywhere. You have people who can own these entities in a decentralized manner and who can vote on certain decisions (or actions) that can be taken by these DAO’s. The promise of these are massive: that you can use them for venture capital, you can use them for charitable purposes. It’s actually used currently for DeCred, to decide which types of programming projects will be funded. They’re usually connected with a massive treasury. In DeCred’s case, they have a huge treasury, and they fund computer programmers’ projects all over the world. In some of the poorest places in the world, you have people that are now doing well financially because they’re able to create computer programs and be paid for that out of these treasuries. So it’s a really promising area.

Kayvan

James, as you’ve been looking at the backdrop, tell us what you’re seeing in terms of both the European regulatory landscape and also adoption. What are we seeing? Where are we seeing it in Europe and then focus a little bit on the UK as well.

James Phillips (James)

Okay, Europe and the UK. This slide and the next talk about the evolution and current state in the second slide of the European regulation, which is best encapsulated by talking about MiCa markets in crypto assets. First of all, that was tabulated as a document, 160+ pages of regulation. It becomes a mandatory regulation that will become managed legislation across all of the EU member states. That’s distinct to anything that’s existed before. I think Jeff touched on it, to the extent that there was any regulation that captured anything to crypto or operating in that space, it was mostly under KYC and AML Rules (which did exist as a distributed level within Europe). This is an attempt to bring it all together as a regulation. It deals with the issuance, application, and provision of services around crypto assets and gives definitions, properly and cleanly, for the first time around crypto services, assets, asset providers, the administration of those in custody and how trading platforms should operate. It’s part of, again, a major European initiative around digital operational resilience as well. That includes (obviously) being able to provide ongoing services to anybody in that market, without them just falling over and leaving anybody exposed. On the next slide, I’ve got the current situation.. 

Right now this is crystallizing, it’s gone through a number of stages. The icons I put on the top of the slide are the European legislative bodies. European regulation starts in the commission. It’s a massive civil service that coins the initial templates of the regulation that then goes by a council, (which is the heads of state as it were) or at least their committees. I can’t imagine the individual heads of states are looking at this in any detail. Then you have the European Parliament, which is a step it’s got to now. Parliament has adopted, in mid March, the current draft and the significant thing about it, albeit that it now brings a legal framework for crypto assets, generally, and what the Europeans are calling “asset reference tokens.” That’s stable coins, (as have been spoken about before) and is looking to bring e-money tokens into the payments regulation sphere. It doesn’t include a ban on Bitcoin. So “Bitcoin ban” was the big thing that’s been buzzing about. As to whether or not it would be a big issue and knocked out of scope of European regulation, because of the issue, of course, of the environmental impact of the amount of energy used by proof of work consensus mechanisms. Where we are at the moment is a compromise. It’s gonna be replaced within the text as it is now being negotiated by requiring there to be some form of alignment with the emerging European taxonomy regulation, (which is the sustainability regulation that the European Union is introducing as well,) so that there can be quantitative measures against whether something (not just crypto assets) is a sustainable item or not. So, that’s a massive taxonomy that’s been written down for the first time, in a major jurisdiction. It’s got quite a long glide path- 2025- before we see the light of day on that. There are going to be works in progress along the way, but you get the point: the bitcoin is not banned and proof of work coins are not banned. However, they are certainly in there, subject to some compliance, which will push things towards green rather than brown crypto, which I think is the next slide. (if I remember rightly). We’ll just tag on to that one. You’ll see the points I’m making here, I want to draw this out, because it’s really born (this European debate) out of whether we look at proof of work as having been good or bad. We’ll look into what’s going on in the UK in a moment. As far as sustainability and crypto is concerned, everybody recognizes the extent to which bitcoin is one of the primary users of electricity. We’ve all heard the quotes, I’m sure, about small to medium sized European economies, (I think it was the Swedish Financial Services Authority) and the environmental people there that put forward one of the proposed changes to the legislation, noting that Bitcoin was going to use just the same amount of electricity as they were using as it stood in Sweden already. So just as a measure, they’re very, very large. 

Kayvan

This was for one cryptocurrency alone, right? 

James

Just one transaction. A transaction that is good to heat your house for a month.

Kayvan

That’s just from one bitcoin though, one of the 18,000 currencies that we talked about earlier.

James

There are lots of different measures on this, yes. Let me just mention now some of the kinds of things that are coming out of this then around the roots. There is a push there, you can find rankings of the energy efficiency of cryptocurrencies, there are a substantial amount of publications around this. It is sort of market driven, if you will, so if the regulation emerging in Europe is going to give “rewards” (for want of a better expression) to a greener crypto rather than the browner one, people are gonna go that way, right? So in the codified in the taxonomy, you’ll be able to see what the score is. Pretty much similar to energy ratings on a domestic appliance, right? Because you can see the sort of scales on those. You’re not going to buy the one that’s bad (if you get a choice) if everything else is equal. The thing is, not everything else IS quite equal. If we look at the different types mentioned already, obviously there is the “proof of work” which is the principle one, the classic one that’s been around since 2009. So as at least bitcoin is concerned. Aetherium is based around proof of work right now as well. NFT is principally based around the Aetherium code. The NFT’s have got the “brownness” on them at the minute as well, because they’re using an expensive proof of work process to get their ledger validated. So you move on to alternative approaches such as the proof of stake, which is different. This is where individuals with stakes (that is to say, with a holding) putting that up as collateral, they’re getting to become volunteered on a random basis, randomly generated by the computer to become the validator of the next block. So rather than it being done by a competitive mathematical process, it is chosen randomly by a computer for “enough” (after a certain amount of trips) and becomes “Yeah, that’s good and valid.” It’s a far less heavy way of doing it. There are other mechanisms, there are people looking to “farm” literally empty spaces on people’s hard drives, there’s mechanisms of actually giving up (there’s lots of other ones around this) and hybrids across all of these. They really are factorily different,  I think that’s what’s interesting. IFO, version two, where it goes to proof of stake, will be about a 100th of the power consumption of Bitcoin as it stands. There are some things out there that are around 10,000 times as.

Kayvan

Yes

James

But the problem with them: maybe they don’t have the scalability or the security that some of the more recognized and “understood” ones do. Very grand, but if you can’t use it at scale, because it’s so slow, or it needs to be distributed resourcefully, it doesn’t actually apply. We will find inevitably, just as the petrol engine has evolved to become a better one and the electric engines, no doubt, are evolving to become better ones: there will be a better way of doing this. There will be some future which is highly effective for everyone. Okay, that was a few touches on Europe. I think the next slide is around UK. A little bit less obvious, (or easy) to find a single regulation emerging in the UK. Just the way it works. You will eventually end up with a policy statement from the PRA around anything that needs supervising and similar items from the FCA. So the PRA is the Prudential supervisor here and the FCA is the behavior governance supervisor. Both have a role to play in bringing these together. Actually, in Europe, there is a kind of equivalent around regulations and directives, but I shouldn’t go into that myself. In the UK, we will end up with an outcome. In the meantime, however, I think it’s important just to note, we’ve landed somewhere (now quite heavily in first quarter this year) after what has been about a three or four year process through a collaborative effort between HM Treasury, (which is the government), the Bank of England and the FCA. This is task force related, it’s collaborative, it’s consultative with the industry to get to the point where they’ve now landed. That landing consisted of an announcement  in mid-March, as you see there, around the outputs from the discussion. That’s the third point of the discussion paper and new forms of digital money. That’s everything that Jeff just mentioned, plus central bank digital currencies, which he didn’t mention, but they’re one of the things that’s in that new form of information. There’s a big discussion paper on that being made public. The first point, which is the financial policy committee, published its findings and recognized, full well, that it was based mostly on 2020 data. So not much use really, (because of course, things have changed so quickly), that the system, as it stands, didn’t necessarily provide a systemic or material risk to the financial system. If you look at how fast things have grown, or how substantially, they’re gonna become, if they haven’t really interconnected, then that systemic risk is becoming very real. That was recognized in this paper in March. Then you’ve got the FCA reminders, regulators, and firms: that’s everybody who’s currently trying to sell you a cryptocurrency( or run an exchange of similar.) Then importantly, (and I’m gonna dwell on this a little bit), you’ve got the DSC from the supervisory regulator, which is a letter to anybody who’s thinking about getting exposure in a crypto asset and how that should play on their books. 

One of the things that the DSC do, (it’s a UK tool.) The regulator writes to the CEO, chief executive and a regulated firm, it says, “This is what we’re looking at. It’s not rules, not regulations, it’s behavior, it’s best practice, it is expected. It’ll become codified.” In the meantime, (or sometimes it’s done the other way around) things are codified. Then they’re reminded through a DSC. It says, “Look, we’ve written it down, you aren’t doing it. Do this.” So amongst many things, it’s looking for a strong risk control. In the absence of a codified regulation, the regulators here are looking for strong risk controls. That means it’s going to be in the view of the board and most senior executive management. Everybody’s going to sign anything off having to do with the crypto asset exposure. (I’m talking about institutions now, not individuals). The institution has to have this attitude within themselves. They’ve got to look at their own risk framework. Thinking about an institutional investment into this is going to become a real thing, a big thing. Then they’re looking at the financial risks around it, but overall, it’s volatile assets and prudential risks around the level of capital liquidity they have, for the operational risks, (not the least of which is the collapse of, let’s say, the infrastructure.) You remember the Europeans were looking to digitize finance, infrastructure regulation, and the reputational risks. They were supposedly dabbling in too many cryptocurrencies and muddled it all up. My windmill of looking at how each of these things require more monitoring, refreshing models that you’re already using, change tolerances (or much more aggressive tolerances, more importantly), and they do loads of stress testing around : “Should we or shouldn’t we do this?” Or “what if this happens, what if that happens?” That’s one of the themes within the UK rollout point. 

 All the abbreviations: market risk, credit risk, counterparty credit risk, corporate rate, operational risks, etc, on its core, is regulatory capital (for a better description). Then you’ve got down to the bottom: pillar two is all of the internal capital adequacy processes,( I’m sure you have a US equivalent to that) all the internal methodologies. 

The actual capital requirements and the stress testing is also called out by the DSCO, to see if you’re gonna get involved with using crypto in your finances as an institution (not to sell or be a broker in). But if you’re running it on your books, you need to look very carefully at the capital requirements. No surprise because none of this is calibrated yet. Nobody quite knows to what extent a crypto asset could be used as an actual “financial asset” to offset the risk elsewhere, given its volatility. Everything is scored at about 100% for capital charge, just a quick glimpse into the impact on the financial institutions. 

I think the main thing here is that the featured lobe with little red ring around UK is to be a global hub, not the only one (as I’m quite sure Jeff is about to tell us), when we look at the other global implementations of this. There was a big launch around this chancellors making a speech around this to be a global hub crypto, a crypto asset, technology. Lots of business, lots of jobs want to be here, I think fair enough, the UK financial system massively understands its reputation. With very strong and robust resources here, it’s exceptionally well-connected, it’s highly likely to be an effective hub. But there are plenty of other people “banging on the door” to get to that claim. Actions around this include (I think I’ve mentioned those briefly) The one I want to pick out as the second bullet is the “crypto sprint” in the middle there and wacky things like the Royal Mint being asked to coin an NFT. It starts to materialize some of the things that have been talked about. The crypto sprint, I will mention just as a UK flavor, it’s been particularly the flavor of UK regulation where innovation is evolved to involve, in a highly collaborative way, the industry at large and that means academics. It means regulators, it means lawyers, it means vendors, it means players, (institutional and retail) where appropriate representation will come into those groups and assist regulators. Work out what could impact regulation. That was done with about, I think it was 100, maybe 200 players in that process about four or five weeks ago, and the results have been bigger. That’s it, so I think we’ve just got a few things to think about.

Kayvan

One thing, can you clarify what DLT stands for? I forgot.

James

Using typical ledger technology. 

Kayvan

So just ledger technology.

James

Yes, generic codification key techniques for crypts or whatever else. Yeah, so issues and indeed timeline. When is this all going to be coming? I mentioned that the European sustainability taxonomy is 2025, but that’s not the same timeline as MiCa. MiCa will probably be 2022 to see some final text and 2023 by the time it’s in live and UK regulations. I think like 2023 to 2024, potentially for some of it. So it’s all in place. I think the thing I missed (because I forgot that I put it there), I mention it now, the famous thing “looks like a duck quacks like a duck walks like a duck” and all that. The point is, the gist behind the DSC around this, is if you’re in a regulated business, great. If you’re not in one, you’re going to be in one or you’re doing something which is going to be. You should be regulated, behave like one. Good, you’re in a much better chance of getting a far better outcome when it comes to being regulated, because you’ll know the rules by then, you’ll get ticked off appropriately. So the FCA for example, right now in the UK, is going through a registration process and rejecting vast numbers of registration applications from crypto asset providers because of their lack of maturity, not a sort of bad actors. They just don’t really know what they’re doing. You know, so it’s really a massive learning curve everywhere. Learning curves, the green question I mentioned. The FCA registrations mentioned as well, how to behave properly and do things before you’re regulated. The current regulations are clearly not good enough. They’re just to do with anti-money laundering or whatever they may be. It’s not really going to cut it and we have to go forward, that impacts regulation regulators resources, too. You’re looking at their dedicated crypto officers. regulators don’t have enough skilled staff or the industry right so the whole thing is becoming quite a gunfight to make that all go together. “Kapow from UK!”  but I do wonder whether or not, it may be quicker elsewhere. Whether regulations are coming down the pipe everywhere this quarter, like we’ve seen. Okay, that’s it for me.

Kayvan

Yeah, well, that’s a great way to end it. “Kapow” from the UK. So is it “kapow” elsewhere or not? I see people jogging or running. Jeff, you were talking about the rate of adoption. Can you help provide a comparative contrast now that we saw for the UK, specifically between the United States and the UAE?

Jeff

Absolutely, yes, this is a race. Let me explain why this SHOULD be a race. This is one of the greatest opportunities that any country has at capturing market share, in order to be able to benefit its people. At the same time this is a global marketplace. Whoever drops the ball on this, or misses the boat on this is going to be losing tremendous resources for their people, quite frankly. Let’s talk about what the USA is doing as compared to the UAE. I think you’ll see a stark contrast here. We have 50 states in the union, right? All of them have a different opinion on this, as you can imagine. These are very politically polarized. The problem is that we have something that really needs unified treatments. With regulation comes certainty, and with certainty, comes stability and predictability. That’s the environment needs and what the business people in the environment want. But that’s not what we have at all, as you’ll see. 

You’ll see every state has a different opinion. Even the opinions of the states change as the political environment changes, or as they learn from their mistakes. New York is a perfect example of this. They’re sort of back and forth on this, right? Most of the people I know,( and I know a lot of people in this space, and I work in this space, and I advise clients in this space), people are wanting to get out of the US right now. And they’re definitely wanting to get out of New York, which was for many, many years, the center of finance throughout the entire world and the envy of everybody in terms of its capital markets. But unfortunately, that’s going to be a thing of the past unless things change. 

What we have is from the regulatory framework, is all the states, right? We have FinCEN, which was one of the first people into the game. They were trying to deal with the fact that they thought they were called “cryptocurrency,” so they must just all be currencies, which we now know is not the case. Right? So it’s a misnomer. But the way they tried to treat this is the same way that they regulate money transmitters, so that they could look into it and regulate things from an AML perspective. That was the whole point. It was really the US Treasury and FinCEN that got into this first. Then you have the IRS getting involved. How are they going to treat these digital assets from a tax perspective? Totally up in the air. Still tons of questions. Commodity Futures Trading Commission, they have something to say about it. They’re a totally different regulatory agency. SEC, a totally different regulatory agency, everybody has a different say. These agencies fight over regulatory jurisdiction, because they all want to be able to flex their muscles and want to justify their budgets. It’s a bit of a hodgepodge. 

Let’s talk about the SEC. They basically have the power to regulate securities. They’re going to want to look through the lens of security when determining what something is. If they see a cryptocurrency, an NFT or if they see something in the device space, they’re gonna want to say it relates to a security, therefore they can regulate it. That’s ultimately the approach. The regulators are starting to talk more. Let’s discuss the SEC, what they’ve been doing. They’ve been taking mainly an enforcement approach, which is basically “Let’s scare everybody half to death.” They choose to comply, but people don’t know what to comply with. That’s the problem. They have ramped up their enforcement resources at an unprecedented rate.

Kayvan

We’re seeing the results in our enforcement action reports. Definitely, yes.

Jeff

Yeah. It’s tremendous. So that’s the approach.

James

It’s “Let’s scare everybody to death in the UK” as well.

Jeff

Then you have the CFTC. Their job is to regulate derivatives. A lot of people get confused and they say their job is to regulate commodities but that’s actually not the case. Their job is to regulate derivatives as they relate to commodities. So futures contracts, etc, and swaps. They actually did get in the game relatively early. They put a stake in the ground and said that they have regulatory authority. They’ve had some enforcement actions and have definitely tried to do their part. But once again, this regulatory confusion is just creating confusion around “who’s responsible for what?”

NFT’s, what are they? Well, guess what the SEC is gonna say, “Well, we think that there’s some time securities.” The CFTC is going to say, “Well, sometimes we think that they’re going to be commodities” then they’re going to use the Howey Test, (which is the best test they have as to whether or not something’s an investment contract.) If that something is an investment contract, it’s security. You have to look into things like, “is there an investment of money into a common enterprise, with an expectation of profit from the efforts of others?” That’s the test but it’s still a very squishy, gray case-based analysis. There’s actually new legislation that’s being proposed trying to work through some of these issues that we’ll talk about. What they’re trying to go after here with this new legislation, (which leaked out, by the way,) what they’re trying to figure out is, what do they do? What’s funny about this, and I’m sure people are laughing at this, but you have to understand the absurdity of this. One of the things they’re trying to do is trying to say, “Well, if you’re a DAO, you have to register, okay?” Or if you are a decentralized  finance exchange, you have to register. What people aren’t getting is that nobody owns these things. Yes, they’re decentralized. Who’s going to register? Nobody’s going to register? You can’t? So how do you regulate something that, in essence, as a body, can’t be regulated? This is good. This is one of the ultimate tests. I think it makes the legislation sort of fall flat on its face, right before it even gets going. So this is going to be a big challenge.

Kayvan

What the UAE is doing about all this. Now that you saw the ( let’s call it, “blob”) in the United States. Let’s take a look at another country. Go ahead, please.

Jeff

Right. And yes, the UAE, obviously, has been trying to find its way in this space as well.  I think they’re taking a more pragmatic, practical approach, as we’ll see.  First up was the financial services regulatory authority (FRSA) of Abu Dhabi. Looking at how to regulate things within a free zone and they obviously sort of took an SEC approach in that, “if it looks and feels like a security, and it’s going to be regulated as such.” Therefore, if it’s a private type of offering, you obviously have exemptions for wealthy people. If it’s a public offering, it needs to be registered, like an IPO.  That was their first attempt at doing this and that was understandable. 

They work through that process. It works from a certain standpoint, but more was needed. There needed to be more of an approach from the government:  they were wanting to facilitate business and give that sort of “clarity” to companies and businesses, (which is what businesses wanted and needed), but that’s not what they’re getting. 

Dubai, as they often do, they have a desire to be the best of everything, right? Everything Dubai does, they sort of go in with this mantra, and I think that’s set by the leadership to be the best, whatever it is. In October 2019, they created another free zone, the Dubai International Financial Center at the IFC and released the first part of a regulatory framework for digital tokens because they wanted to attract people to Dubai. That’s been working pretty well.

Then you had the Dubai multi commodity center that was also trying to look at things from a commodities perspective. Then you have the Securities and commodities authority. In September 2019 the UAE, FCA and the Dubai World Trade Center authority agreed to a framework that allows the Dubai World Trade Center authority to approve and license financial activities relating to crypto assets. Now we’re starting to see a little bit more clarity and intentionality around this process. All of a sudden they want to license people and they want to facilitate business. Then in 2022, you have Dubai really rising to the occasion and just basically saying, “Look, we want to be the center of the world when it comes to digital assets. We want all the business to come here, right? Do business in Dubai.” Now this has finally arrived. Dubai is saying to the world, “we’re going to give you the clarity you want, we’re going to regulate this in an appropriate way, but we’re gonna allow the growth to happen.” So you have this friendship now between the government and the crypto universe.

Kayvan

How has it worked out?

Jeff

Well, it’s obviously very early on, but it’s working well. You have tons of growth in this space. Dubai multi commodity centers have registered a record 665 new companies, but 16% of those were in the digital asset space. This is just the beginning: the big players are all moving and setting up their headquarters there. There’s a reason for that, right? The government is jumping into the metaverse. You have the digital twin city, which is a virtual world. You’ve got Vietnam based “RFOX” opening Metaverse-types of businesses in Dubai. You’ve got Emirates involved and the UAE-based luxury real estate developer Daymak accepting payments in crypto. There’s a huge grocery store chain accepting crypto payments as well. 

So like I said: Binance, Kraken, Bybit, crypto.com, FTX are some of the biggest whales in the business (biggest exchanges). They are all there now. They handed out 30 licenses and passed new laws for crypto exchanges to operate in the cities. 

Kayvan

Like WICO. 

Jeff

Yeah, when you look at this, the UAE is…

Kayvan

 Thirty-five percent.

Jeff

Yes, 35%. As compared to the US which is only 20%. We know that this 35% is going to be growing tremendously. 

One of the things that it’s important to know is that the government of the UAE has basically stated (in short order) that they want 50% of all transactions to be engaged in through cryptocurrencies. In Dubai, they also want to do all real estate transactions through blockchain technology. They are very leading edge. The Middle East is one of the fastest-growing cryptocurrency markets in the world, making up 7% of the global trading volumes. At the same time you’ve got the UAE being third in the world (sorry, in the Middle East rather), second to Turkey. Turkey is nine times the size. Okay. So this thing is basically just taking off like wildfire and we’re just beginning.

Kayvan

Well, I wanted to see if maybe we could open up a poll: These mounting regulations (specifically as it relates to crypto and digital assets)-How are you managing that as an organization? I know we’re close to the end of time, maybe get this poll and open it up to q&a. If there are any questions, otherwise, try to wrap it up because we only have a couple minutes left. 

We’re just “winging it” right now, (I’m looking at the results as they’re coming in.) 

<Pause for Poll Responses>

Some of our closest friends are spreadsheets.

Decks being implemented.

We have gone fully digital. That’s amazing. 6% respondents and some others “winging it.”

I love that first answer. Seems like Microsoft Excel demands too big a mess, (too strong) and continues to be the way to track these (of course). Leveraging automation and AI to bring that tracking of what’s happening. 

You just saw this two-page list just from state-level players in the United States and the varying opinions and regulatory changes that they’re taking into consideration. You have to, now as an organization, be aware of those, keep track of them and then adopt/adjust accordingly. Or as we heard from Jeff: skip town and go to UAE, I guess that’s one other solution to that challenge. But, ultimately bringing it together in a framework. Integrate what you’re doing from a “compliance” perspective into that of “risk management and governance.” Compliance study, (as I mentioned briefly, when Jeff was talking about enforcement actions) has been one of the most popular reports. Our product users are trying to keep abreast of “who’s fine, what were the violations, what were the penalties, what are the pitfalls, what should I avoid?” Within which jurisdictions? Due to the rules and regulations: what are the “actual regulators” thinking? That’s where they’re putting their emphasis on. And of course, understand that comparison/contrast across different jurisdictions (from a regulatory landscape) becomes essential. And frankly, I cannot imagine how it can be manually accomplished anymore. So with that, I know there were a lot of questions during the presentation itself. We’ve got a couple of minutes left. If there are any other questions, be happy to have James and Jeff field them as well. Ronjini, have you received any questions beyond the ones that are already embedded into the session?

Ronjini Joshua

No other questions, just a comment talking about Dubai and their less-structured tax base, as James was walking through.

James

As I mentioned, one of the most interesting things I’ve learned from engaging with the PRA, sorry, the SCA, specifically here in 2017 (on one of their sprints, which is around a particular avenue in reg tech/ regulatory reporting). Some of the people I met there have now, funnily enough, ended up in Middle Eastern regulators, the ones that Jeff’s been mentioning. The “thrust and drive and build” is very obvious and you’re now seeing the result a few years later. The consequences of, perhaps, a lot of recruitment in that way,from other mature regulators. They’re bringing in some of the practices as well. Not just having an open view, but also bringing in the skills and practices for other established regulators elsewhere that are perhaps less “fleet to the foot.”

Jeff

Yes. I would say from a tax standpoint, absolutely. Dubai is trying to position itself as being the most tax-friendly. Yeah they just want people to come. They want entrepreneurs to be there and build wealth. They’re willing to give them that incentive to come there: by not having to pay high taxes, which is an interesting policy. And ultimately, it seems to be working in terms of recruiting people, to the UAE, for sure.

Kayvan

Absolutely. I want to thank you both and tell the audience that we are going to have a more in depth version of what you just heard, upcoming in our September ITL event. I’m sure the marketing team is going to keep you abreast of that. The agenda for that event, it’s a two day event, multiple tracks and crypto currencies, crypto related regulations, and “how do you deal with it as a compliance scheme?”  is going to be one of the tracks to be covered during your ITL as well. Thank you so much, everybody. Ronjini, do you want to bring it to a close?

Ronjini Joshua 

We are going to have an on-demand version of this webinar. Because we have so much amazing information here in this deck, we’ll also be sharing the deck in a post-event blog. It’ll go out to anybody who registered for this. Please feel free to share it with colleagues. But we’ll have that ready early next week and send it out. It will also be posted on our website. So this was the abridged version of the presentation. Thank you so much, everybody. Thank you.

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