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How Cryptocurrency Regulation Is Evolving

February 5, 2021
With the cryptocurrency markets beginning 2021 in earnest, we review the regulatory approaches taken by different jurisdictions. Last month, European Central Bank (ECB) President Christine Lagarde called for Bitcoin (BTC), a "highly speculative asset," to be regulated on an international level. But, is a uniform approach possible with such different degrees of comfort toward cryptocurrencies between global regulators?

Despite Bitcoin's almost 12 years in existence, today, the digital asset regulatory landscape is every bit as polymorphous as before. While some countries have been quick to embrace this rapidly growing sector, others are taking a more cautious approach. 

This article provides a snapshot of what we are seeing in terms of the development of  cryptocurrency regulation around the world and provide some context that may give an indication as to how the situation may evolve.

The Uphill Hurdle for Traditional Derivatives

There has often been fear that accompanies new technology and crypto is no different. In fact, comparisons can be drawn between crypto and the introduction of stock index futures in the 1980s. When the first S&P 500 futures contracts were introduced by the CME in 1982, many expressed deep concern, claiming futures would take money away from the stock market and that equities would tank.

Of course, that reality did not materialize, quite the opposite in fact. For the first time, there was a mechanism in place to hedge equities, leading to greater participation in the stock market as people could do so in a risk-controlled fashion. Once regulators around the world began to understand and observe the benefits of futures, we slowly began to see them rolled out across jurisdictions – as well as some conformity around regulation. But it spanned almost a decade.

The FTSE 100 index was launched in January 1984 with futures contracts on the index introduced that same year. In May 1986, the then Hong Kong Futures Exchange introduced the Hang Seng Index Futures contract, and Japanese financial regulators finally followed suit allowing for the Nikkei 225 Futures in September 1988. 

Since then, we've seen the popularity, growth, and sheer size of the global futures market balloon with global futures and options trading reaching record levels, according to the latest statistics from the FIA. Many times, the introduction of new technology and products doesn't turn out the way the initial pundits think. And this is very likely to be what will happen in the crypto derivatives market. 

Regulating Cryptocurrency Around the World

When you have a situation in which some regulators are more comfortable than others, that in itself leads to confusion. The net result is what we are currently observing. What is permissible in one jurisdiction is not allowed in another. 

A major concern is that if there are differing regulatory stances, it creates the potential for  "regulatory arbitrage". Worse still is that investors might look elsewhere to gain exposure to an asset class without the protection of their home regulator, and innovative companies may also go elsewhere depriving those economies of investment.

We saw this happening in the USA around the time of the Initial Coin Offering (ICO) boom in 2017. A distinct dragging of the heels and lack of clarity drove many companies to relocate to more crypto-friendly countries like Switzerland, creating "Crypto Valley," and providing a home for multiple industry participants. 

However, the winds of change appear to be blowing. After what seems like a very long time to warm to the idea of cryptocurrencies, the U.S. is now taking a more open approach. One landmark move opening the cryptocurrency markets to institutional investors occurred in July 2020 when the Office of the Comptroller of the Currency (OCC) granted permission for U.S. banks to provide cryptocurrency custody services for customers.

More recently, the OCC has moved to allow national banks in the U.S. to use stablecoins and blockchains to facilitate the settlement of payments. And with a changing of the guard in the U.S. Securities and Exchange Commission (SEC), President Joe Biden has nominated former head of the CFTC Gary Gensler as the new chairman. Well-known for his recent proactive stance on cryptocurrencies, the incoming administration could be very bullish for crypto, and (dare we say it?) 2021 might just be the year of the elusive Bitcoin ETF.

What Moves Is Europe Taking?

With a potentially friendlier set of regulators moving into Office in the U.S., what is the response from over the pond when it comes to crypto regulation? Here, once again, it's hard to find a consensus across different member (and non-member) states. The UK had always appeared to follow an open approach as one of the pioneering countries to understand the potential of blockchain and digital assets in Europe. HM Treasury even released a comprehensive report as far back as 2015 analyzing the benefits, risks, and barriers to adoption.

However, the UK now appears to be erring on the side of caution with the FCA banning retail investors from trading crypto derivatives in January and the regulator going further to issue a warning that all investors in digital assets like BTC should be prepared to "lose all their money." 

Of course, these types of regulations can be useful in providing adequate investor protection. The FCA estimates that the ban will save retail traders some £53 million a year in losses. Certainly, no responsible regulator wants an industry to grow off the back of a category of investors that cannot cushion their losses. However, it will be interesting to keep an eye on the next moves that come out of the UK – and whether they continue with this approach. 

Very different conversations have emerged from countries like France, Switzerland, and Malta. Malta has taken a regulation-first approach with new laws created meant to accommodate the different facets of cryptocurrencies that simply cannot be regulated under existing laws. In 2019, France came out all guns blazing with the PACTE act, creating the French Digital Asset Association to facilitate the regulation of digital assets and introduce attractive taxation incentives for blockchain-based startups.

But, as with all areas of this still-nascent industry, regulation in Europe remains very much in flux. Switzerland recently threw a curveball at participants by adding what is sometimes called their tradition ‘Swiss finish.’  With the implementation of the "travel rule" on Virtual Asset Service Providers on transaction amounts above $1,000 is required across all Financial Action Task Force member countries, Swiss regulator FINMA added a requirement to prove ownership of non-custodial wallets. While this is something being studied in the U.S. at the moment, it is again another example where regulation is still evolving.

If the rules around noncustodial wallets begin to tighten, we may see an encroachment on the growth of the sector and decentralized finance (DeFi) in particular. As the European Commission begins to concentrate efforts to standardize crypto regulation across Europe, how this framework emerges will be one of the key developments for the future of the digital asset industry.

No Uniformity Across Asia

There is certainly no universal agreement on how to broach cryptocurrency regulation across Asia either, with large markets for cryptocurrency such as China and South Korea providing mixed reactions – from outright conservative bans to a legislative framework making it hard for businesses such as digital asset exchange to compete. 

Indeed, we have seen well known crypto exchanges invest in Korea, only to backtrack later. 

Hong Kong, too, is toughening up its stance by banning retail traders from trading cryptocurrencies and requiring all digital asset exchange operators to hold licenses under a new rule aiming to clear up the "grey area" surrounding cryptocurrencies and strengthen anti-money laundering and counter-terrorist financing regulation. 

Singapore, on the other hand, has taken a more pragmatic regulatory and legal stance. The Monetary Authority of Singapore (MAS), Singapore's financial regulatory body, aims to ensure adequate regulation to monitor risks, tackle the threat of money laundering and terrorist financing, and protect investors – while ensuring that it does not stifle innovation.

It's interesting that even when countries do take a strong stance against cryptocurrency, that grey areas seem to continue. China may have banned cryptocurrency trading yet it remains the largest market of retail traders in the world. 

Regulatory harmonization on the horizon

Regulation of cryptocurrency markets is vital, and how open and progressive regulators are will play an extremely important role in determining how the rules for the industry will be set. In order to avoid regulatory overreach and crush innovation, there must be a willingness to hold a dialog with market participants and work with them to create a framework that allows the industry to grow and flourish while ensuring adequate protection for retail investors.

While it still looks somewhat scrappy right now, it’s hard not to draw parallels to the introduction of traditional futures. Cryptocurrencies have proven that they are here to stay. 

So we think it's only inevitable that a more uniform style of regulation across jurisdictions will emerge. Just like the stock index futures of the 1980s, it's going to take time but the growth trajectory of crypto derivatives will be equally astronomical. 

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