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The cryptocurrency industry is getting so big and enabling so much risk-taking that governments around the globe are taking notice.
Bitcoin traded above $50,000 Monday; its total value now exceeds $900 billion, more than all but a handful of companies. Digital currencies called stablecoins grease ever more trading and issuance. Giant crypto exchanges in Asia offer 100-to-1 bets, often serving traders in countries where their products aren’t legal.
After years of relative inattention, regulators and lawmakers are scrambling to catch up—but it won’t be easy. They aim to rein in a rebellious industry that has adopted the tech world’s blueprint for aggressively deploying new products to quickly amass users—while often leaving regulatory compliance as an afterthought.
Some of the largest crypto firms are under increasing pressure. In recent weeks, Binance, the world’s biggest crypto exchange, was barred from or warned about offering certain crypto investments in the U.K., Italy, Germany, the Netherlands, Japan and Hong Kong. It said Friday that all new users would have to provide an identification document and photo of themselves to verify their identity. BitMEX, another large exchange, paid $100 million to settle a U.S. regulatory investigation related to claims of illegally selling derivatives and lackluster anti-money-laundering compliance.
Yet few industry participants expect the crypto world, emboldened by a surge over the past 18 months in the value of and interest in their products, to suddenly change its ways. Regulators are scrutinizing the industry as never before, but so far coordination appears limited and key jurisdictions are pursuing widely divergent approaches.
“This is a land rush,” said Preston Byrne, a partner at Anderson Kill P.C. who has advised technology companies, including those focused on crypto. “There are those in crypto who believe, rightly or wrongly, that moving fast and breaking things is the right approach. So far, that approach seems to have built some pretty impressively enormous companies.”
The flashpoints include investor protection, compliance with rules to combat money laundering and terrorist financing, access to banking and payment infrastructure and tax evasion.
Making the task more difficult: Crypto is a global market, but the U.S., Europe and China have taken different approaches to oversight. U.S. watchdogs have wrung fines from crypto projects that dodged investor-protection rules, while Europe is working on specialized rules that will take time to implement. China has cracked down, but exchanges have set up shop in nearby places that are friendlier.
Hong Kong has been one such haven, but one of the city’s fastest-growing crypto entrepreneurs says he would pull up stakes and go elsewhere if he had to.
“We would love to work cooperatively on licensing in Hong Kong, so we could have a real formal presence in Hong Kong,” said Sam Bankman-Fried, the chief executive of FTX. But that only goes so far: “We’re going to be excited to be in the [countries] that are excited about crypto.”
Here is a look at the state of crypto regulation around the globe:
U.S.
Securities and Exchange Commission Chairman Gary Gensler has called crypto the “Wild West” and said more activity should be subject to government oversight.
In a recent meeting with an industry lobbying group, the Blockchain Association, Mr. Gensler promised tougher discipline if exchanges and other businesses continue to offer assets without complying with the appropriate rules.
“You may look at it as regulation by enforcement,” Mr. Gensler told the group, according to a summary of the meeting that was seen by The Wall Street Journal. “I just call it bringing people into compliance that are over the line.”
A spokesman for the association said the group supports “smart regulatory guardrails” and engages with regulators to “establish clear rules for industry moving forward.”
The SEC’s chairman has also said that new powers might be necessary to “prevent transactions, products and platforms from falling between regulatory cracks,” as he told Sen. Elizabeth Warren (D., Mass.) in a letter dated Aug. 5.
That step hinges on Congress passing legislation to either expand the SEC’s powers or create a special regulatory code for crypto. Either change is a long shot in Congress, which has been slow to understand how the industry works.
Regulators including the Federal Reserve are taking a deeper look at stablecoins, crypto assets designed to mimic the value of the U.S. dollar. They make it easier to trade in and out of crypto assets such as bitcoin.
Stablecoins are pegged at $1 and several issuers have previously said their tokens were completely backed by dollar reserves. Tether, the most widely used stablecoin, revealed in early 2019 that its reserves included assets other than cash, including payments tied to loans made to third parties. Tether now says assets that back its value include short-term commercial debt and certificates of deposit.
Coinbase COIN -0.13% Global Inc. claimed on its website that for another stablecoin, USD Coin, each was “backed by one US dollar, which is held in a bank account.” Circle Internet Financial, which formed a partnership with Coinbase to develop the coin, disclosed last month that USDC is also backed by commercial paper, corporate bonds and certificates of deposit. By September, the reserves backing USDC will exclusively be cash and short-term U.S. government debt, Coinbase said Sunday.
Regulators including Mr. Gensler say that stablecoins, because they are backed by securities, may qualify as investments that should be regulated.
“People have already been hurt and more people will be hurt without those fundamental investor protections,” Mr. Gensler said in an interview.
EUROPE
Rather than subject crypto assets to existing regulations, Europe is taking steps to draft a new rulebook for investors and developers.
Known as the Regulation on Markets in Crypto Assets, or MiCA, the European Commission’s plan would subject crypto exchanges to regulation, including standards for policing fraud, ensuring transparency and establishing governance standards. It also would ban the paying of interest on deposits of some kinds of stablecoins and require existing stablecoins to seek authorization to be traded within the European Union.
Some have argued that countries need to prevent stablecoins from becoming entrenched in the broader financial system.
“If we wait too long, they become too big to stop. It’s about protecting the sovereignty of our countries,” said Corrado Passera, CEO of Italian digital bank Illimity Bank SpA and former CEO of Intesa Sanpaolo SpA.
Issuers of most other crypto assets would have to file white papers disclosing the purpose of a digital coin and how it works. National regulators, which would review the papers, could suspend the issuance of a token or require additional information.
Companies providing services such as trading, investment advice and safeguarding assets would need national approval to operate. They would also face regulations regarding information security and governance.
The EU’s efforts to regulate crypto assets are consistent with its deeper focus on open banking, said Linda Jeng, a former Federal Reserve regulator and now head of policy at digital-payments software company Transparent Financial Systems.
The proposal still has to be passed by representatives of the member countries and the European Parliament and might not come into force for years.
In the U.K., most crypto regulation has focused on preventing money laundering and terrorist financing. Firms doing business in the U.K. have to register with its Financial Conduct Authority and provide details on their technology systems, how they mitigate and prevent money laundering and other risks.
Some firms have withdrawn applications after realizing how much information they have to provide to regulators and are looking to other countries with fewer restrictions.
The FCA has also nixed the sale of crypto derivatives to retail consumers and more recently said that Binance isn’t permitted to conduct any regulated activities in the U.K.
After the FCA’s notice, Binance—which says it operates without a headquarters—updated its terms of use to prohibit U.K. individual investors from trading its derivatives.
ASIA
China was the birthplace of some of the world’s largest cryptocurrency exchanges, including Binance and Huobi. Other major crypto exchanges, including FTX and BitMEX, are based in or have had employees in nearby Hong Kong.
But the tide has turned. In May, a powerful state regulator in China vowed to crack down on bitcoin mining and trading, and China’s central bank later ordered its largest banks and payment processors to take an active role in rooting out cryptocurrency-related activities.
“They want financial stability and social stability at all costs,” Mira Christanto, a research analyst at Messari, said.
While China turned cold on crypto, Hong Kong and Singapore became hot spots. American investors often are able to access these exchanges even though their products are illegal in the U.S. Analysts have linked American users to overseas exchanges including FTX, which says it has tightened procedures to block U.S. users.
“It’s messy. Each government is taking their own actions here, and it is different from place to place,” Mr. Bankman-Fried said.
FTX has grown quickly to become one of the biggest brands in crypto. It paid to have its name on the arena of the National Basketball Association’s Miami Heat and its investors include SoftBank Group Corp. 9984 -1.07% , Silicon Valley venture-capital firm Sequoia Capital and Third Point, the hedge fund led by billionaire Daniel Loeb.
But like Binance, FTX has in the past offered 100 times leverage on some futures contracts tied to cryptocurrencies—that is, allowing a user putting $1 down to make a $100 bet. It reduced that ratio in late July, while stressing that the industry views the process as a collaborative one.
Hostility between regulators and crypto entrepreneurs is “not going to end well for anyone,” Mr. Bankman-Fried said.
BitMEX still offers 100 times leverage on some assets. Most traders opt to use less leverage, BitMEX said.
Registered in the Seychelles, BitMEX has offices around the world. Some employees are based in Hong Kong, where local residents aren’t allowed to access it. Arthur Hayes, one of BitMEX’s founders, once bragged that he incorporated the company in the Seychelles because it cost “a coconut” to bribe regulators, according to an indictment returned by a U.S. grand jury last year.
Alexander Höptner, the CEO of the holding group behind BitMEX, said the firm is a “different company now” that it is following rules to prevent money laundering.
“A little less Lamborghini, perhaps, but with the same long-term ambition,” he said in a July statement.
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