March 25, 2024

Balancing Innovation with Regulation: The Crypto Compliance Conundrum

The crypto industry has matured by leaps and bounds since the ICO craze of 2017, where crypto projects played “fast and loose” with traditional legal and regulatory tenants on a global scale, often completely overlooking or outright ignoring warnings from lawyers and regulators that they were putting their projects in harm’s way. Many founders and market participants proudly proclaimed that this asset class was different, and could not (and would not) be bound by the same restraints as traditional fiat assets or commodities such as silver or gold, and truly believed they were untouchable, outside the reach of governments and regulatory bodies alike, due to the technical design of cryptocurrency, regardless of application and implementation.

The events which rocked the crypto world in 2022 and propelled us from the 2021 bull market into a deep crypto winter shed light on the need for comprehensive yet sensible regulation. Led by the collapse of household names such as FTX, 3 Arrows Capital, Celsius, Voyager, TerraLuna, and others due to rampant fraud, hacks, de-pegging of assets that were not sufficiently backed, issuance of bad debt and their resulting bankruptcies, the industry was shaken to its core, as industry icons became pariahs.

On the heels of these industry altering events came a much-needed wake up call for market participants, as regulators clamped down on projects operating in the digital asset universe and the industry matured, with institutions such as BlackRock, Fidelity, Invesco and others foraying into the space, offering spot Bitcoin ETF’s to the masses and hastening mass adoption and acceptance of digital assets as a viable and sustainable asset class for retail and institutional investors alike.

Regulatory bodies have responded in kind on a global basis, some working with digital asset companies to develop “regulatory sandboxes” to foster growth and creativity in an increasingly technology and AI driven society, developing sensible regulatory guardrails such as MiCA and the 5th AML directive, both of which are already in play, albeit in a grace period, as companies enact new policies to come into compliance. This is in stark contract to the SEC’s hotly debated “regulation by enforcement” policy and addition of lawyers and resources to their Crypto Assets and Cyber Unit, leading many companies to move offshore to avoid the fractured US regulatory landscape entirely or monoliths such as Coinbase and Ripplelabs fighting protracted battles in court over the classification of their companies, assets and product offerings, positioning themselves as “champions of the industry” with varying results.

While the entry of tradfi entities into the space has helped legitimize it in the eyes of more risk adverse retail investors and institutions alike, the regulatory landscape will continue to evolve in 2024. Anti Money Laundering, Know Your Customer and Know Your Transaction guardrails will be an integral part of all crypto ecosystems, whether it be a centralized exchange, decentralized ecosystem, defi protocol, zero knowledge/privacy protocol, mixer, bridge or any other technological development which had previously lived in a grey regulatory area. Projects will have to re-evaluate their legal, compliance and risk infrastructures in order to provide a high level of compliance and transparency to their users, and those failing to do so will be forced to cease operating across large swaths of the globe, or shut down their operations entirely to avoid prosecution.

In sum, 2024 will have a profound impact upon the crypto industry from a regulatory perspective, as the focus on anti-money laundering, crypto custody and tokenization of assets in an effort to legitimize the space takes center stage. While the regulatory guidelines for this nascent asset class will undoubtedly shift as crypto becomes more mainstream, it will be fascinating to see how sensible regulation proposed by myself and my colleagues is put into practice by US and global legislative and regulatory bodies and the lasting impact these directives will have on the global digital economy moving forward.

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