The recent approach to crypto asset regulation
In most jurisdictions, regulators have approached crypto asset regulation by first trying to identify whether a crypto asset would be classified as a type of instrument that is already regulated. While nearly all regulators have determined that crypto assets are not currencies, there is not much consensus beyond that. Here we explore how jurisdictions across the globe are approaching these issues.
 

United States
Currently, a crypto asset can be classified into one of three categories depending on its characteristics:

• Security: falls neatly within the Securities and Exchange Commission framework, including registration of issuance and registration of relevant intermediaries.
  
• Commodity: subject to the jurisdiction of the Commodity Futures Trading Commission (CFTC); however, the CFTC regulatory framework does not require registration for issuance of commodities and, except for anti-fraud supervision, generally does not regulate spot transactions in commodities.
  
• Virtual currency: this designation often triggers state-level registration requirements as a money services business.

Whether a particular crypto asset is a security or a commodity depends in part on whether the instrument satisfies the Howey test.1 However, the subjective nature of the test makes it open to interpretation.

As discussed in more detail below, there have been a number of recent developments evidencing the focus of US regulators to bring regulatory clarity to the treatment of crypto assets. These developments include the issuance of a report on stablecoins by President Biden’s Working Group, a joint statement by US prudential regulators on their areas of focus for crypto asset policy in 2022, and an executive order by President Biden mobilizing the government to focus on crypto asset regulatory matters.
 

Europe
While current laws in most European Union (EU) jurisdictions do not clearly categorize crypto assets, where they can either be financial instruments under the Markets in Financial Instruments Directive (MiFID) or “other assets” depending on their characteristics, that is set to change, as a result of the Markets in Crypto Assets Regulation, commonly referred to as MiCA.

MiCA is expected to establish a regulatory framework for virtual asset issuers and service providers in the EU similar to the framework that applies to financial instruments under MiFID. As an EU regulation, MiCA would be a binding legislative act that will be applied in its entirety in the law of each jurisdiction once finalized and approved.

While many European jurisdictions are awaiting the passage of MiCA, Germany has taken a proactive approach:

• Banking Act (Kreditwesengesetz (KWG)): includes crypto assets/units of account as non-MiFID financial instruments under the German law2 and add custody of crypto assets as a financial service requiring a license from the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)).
•  Electronic Security Act (Gesetz zur Einführung elektronischer Wertpapiere (eWpG)): to clarify the tokenization of traditional financial instruments, eWpG introduced the concept of a crypto securities registrar, an entity responsible for maintaining a decentralized register for instruments authorized to be issued on distributed ledger technology. The BaFin proposed regulations for the issuance of collective investment vehicle units (crypto fund units) on a distributed ledger in September 2021. To the extent similar models are adopted in other jurisdictions, this could transform how securities are issued and transferred.
   

Asia Pacific
In Singapore, a crypto asset could be a capital markets product, a digital payment token or e-money. Most cryptocurrencies qualify as digital payment tokens under the Payment Services Act 2019, which sets forth clear licensing and registration requirements for a range of crypto asset services. This clarity, as well as the fact that Singapore took a welcoming approach to crypto assets in part through its creation of a FinTech regulatory sandbox in 2016, has led to Singapore being viewed as a crypto asset favorable jurisdiction.

With some of the most well developed legislation regarding crypto assets, Japan’s Payment Services Act now includes “crypto assets” as a specific type of instrument, which is defined to include cryptocurrencies such as bitcoin and ether that are, “usable as a payment method to an unspecified person and not denominated in fiat currency.”3 Entities that provide specified services for crypto assets are required to register as crypto asset exchange services providers (CAESP), which includes business entities involved in the sale, purchase or exchange of crypto assets and custodians of such assets.

Amendments to the Payment Services Act also established a new self-regulatory organization, the Japan Virtual and Crypto Assets Exchange Association, which is required to review any new crypto asset proposed to be supported by a CAESP.4 For crypto security tokens (e.g., tokens that represent equities or bonds), such instruments are regulated under the Financial Instruments and Exchange Act as electronic recorded transferable rights indicated on securities. Entities
that offer, buy, sell or exchange such instruments must register as Type I Financial Instruments Business Operators.

Progress toward a global framework to address anti-money laundering and combatting the financing of  terrorism considerations 
While local regulators continue to debate the appropriate framework for issuing and licensing intermediaries for crypto assets, regulators have made progress on forming a global framework for addressing anti-money laundering and combating the financing of terrorism (AML/CFT) considerations.

In particular, the Financial Action Task Force (FATF), an intergovernmental organization that sets international standards to combat AML and terrorist financing, promulgated a standard, known as Recommendation 15, covering the registration of service providers with respect to “virtual assets.” Published in October 2018, it introduced the concept of a virtual asset service provider(VASP), and provides that to manage and mitigate the risks emerging from virtual assets, countries should ensure that virtual asset service providers are regulated for AML/CFT purposes, and licensed or registered and subject to effective systems for ensuring compliance with the relevant measures in the FATF Recommendations.”5

A VASP includes a natural or legal person that, as a business, conducts one or more of the following activities:

1. Exchange between virtual assets and fiat currencies

2. Exchange between one or more forms of virtual assets

3. Transfer of virtual assets

4. Safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets

5. Participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset

With this recommendation as a baseline, a number of jurisdictions, including the EU,7 Hong Kong,8 Singapore,9 and Australia10 have implemented rules and regulations as part of their AML framework that require entities to register with local AML/CFT authorities before providing VASP services.
 

Greater regulatory clarity on the horizon in 2022?
Starting in late 2021 and continuing through 2022, there have been a number of global regulatory developments that point to coming clarity in global crypto asset regulation.
 

US prudential regulator “crypto sprint”11 and US executive order on
insuring responsible development of digital assets12
In November 2021, US prudential regulators, as part of a “crypto sprint,” issued a joint statement on crypto asset policy, identifying areas of prudential regulator focus for 2022, which included providing clarity on safety and soundness expectations for the provision of crypto asset custody services by banks as well as facilitation of customer purchases and sales, loans collateralized by crypto assets and issuance and distribution of stablecoins.

On March 9, 2022, President Joe Biden issued the executive order on Insuring Responsible Development of Digital Assets. The executive order takes a “whole of government approach” with a statement of general US policy for digital assets. It also includes a request for more than 24 federal agencies to produce reports that address the risks posed by digital assets, study how existing regulations and policies apply, and further evaluate whether there’s an appropriate role for CBDC within the US economy. A core theme of the executive order is collaboration among federal agencies as well as among global regulators, with the US taking a leading role.

The executive order establishes the following principal policy objectives:

1. Protect US consumers, investors and businesses

2. Protect US and global financial stability, and mitigate financial risks
    a. Digital asset issuers, exchanges and platforms, and intermediary     oversight entities should be subject to compliance with regulatory     and supervisory standards like traditional firms using the “same     business, same risks, same rules” model.

3. Mitigate illicit finance and national security risks posed by misuse of digital assets

4. Reinforce US leadership in the global financial system and in technological and economic competitiveness

5. Promote access to safe and affordable financial services

6. Support technological advances that promote responsible development and use of digital assets

A positive step for the US, the executive order represents important momentum toward developing a coordinated regulatory framework for digital assets, further illustrating the strategic importance of the industry. The focus on identifying and mitigating risks while also supporting innovation is welcome.

It will be important for the industry to participate fully in the process as reports and analysis are published and discussed.
 

European Union Markets in Crypto Assets Regulation (MiCA)13
Since the European Commission introduced MiCA on September 24, 2020, the proposal has progressed through the EU legislative process, and, on March 31, 2022, entered into the final phase known as the trilogues, which are tripartite negotiations among the European Commission, European Parliament and European Council. Once approved by all three institutions, which is expected later this year, the regulation would automatically become legally binding for each EU member state, following a transition period.

While final text is subject to negotiations, the framework proposed under MiCA is as follows:

Objectives: to facilitate legal certainty for instruments not covered by existing financial services legislation, to support innovation, to instill appropriate levels of consumer and investor protection and market integrity, and to ensure financial stability, particularly as it relates to stablecoins.

Instruments covered: MiCA was designed to cover a gap in the
regulatory framework for crypto assets not covered under other financial services regulation, such as financial instruments regulated under MiFID. More specifically, MiCA covers: asset-referenced tokens, e-money tokens, and other crypto assets. Asset-referenced tokens and e-money tokens are variations of stablecoins, with asset-referenced tokens having multiple fiat currencies, commodities or other crypto assets as reference assets and e-money tokens having only a single fiat currency as reference assets (e.g., USD Coin).

Issuer obligations: MiCA imposes a series of obligations on
issuers of all crypto assets, with more stringent requirements applying to each stablecoin category. Core requirements are that crypto assets must be issued by a legal entity.

The issuer is also required to publish a white paper containing core information and disclosures about the crypto asset prior to its issuance. Similar to a prospectus for a financial instrument, an issuer cannot disclaim liability for misstatements or omissions in the white paper.

In addition, the issuer is required to provide initial purchasers with a 14-day right of withdrawal. Limited exceptions to the white paper requirement apply if the crypto asset is offered for free, is automatically created through mining as a reward for the maintenance of distributed ledger technology or validation
of transactions (e.g., Bitcoin), or is non-fungible.

Crypto Asset Service Providers (CASP): In addition to the crypto assets and their issuers, MiCA also establishes authorization requirements and standards for providers of crypto asset services. The CASP services covered under MiCA are broader than those of a VASP under FATF Recommendation 15, and include:

a. The custody and administration of crypto assets on behalf of third parties
b. The operation of a trading platform for crypto assets
c. The exchange of crypto assets for fiat currency that is legal tender
d. The exchange of crypto assets for other crypto assets
e. The execution of orders for crypto assets on behalf of third parties
f.  Placing of crypto assets
g. The reception and transmission of orders for crypto assets on behalf of third parties
h. Providing advice on crypto assets

With the exception of custody, the services are largely the same as services regulated under MiFID with respect to traditional assets. Entities authorized to provide services under MiFID are not required to obtain a separate authorization, although they are required to comply with the other relevant obligations under MiCA.
 

United Kingdom
Her Majesty’s Treasury released a report14 on April 4, 2022 detailing

The report identified that the Financial Conduct Authority, Prudential Regulation Authority and HM Treasury would establish the Financial Market Infrastructure (FMI) Sandbox. With this approach, participants could request exemptions from or modifications to existing legislation, to facilitate testing of distributed ledger technology in FMIs and enable UK authorities to better understand the legislative changes necessary to accommodate distributed ledger technology. The report anticipates that the sandbox would be up and running in 2023. Finally, the report noted that HM Treasury is continuing to assess the appropriate regulatory response to crypto assets used as a means of payment other than stablecoins and stated its intention to consult later in 2022 on its proposed approach.

Hong Kong January 2022 consultation, joint circular and guidance Unlike China, which has banned cryptocurrencies, Hong Kong is focusing on regulating their use. In January 2022, the Hong Kong Monetary Authority (HKMA) issued a discussion paper15 seeking comment on how to bring crypto assets and stablecoins within the regulatory perimeter. The majority of the paper focuses on stablecoins and raises the question of whether the existing Payment Systems and Stored Value Facilities Ordinance can be expanded to cover stablecoins or whether a new legislative framework is required. The paper further asks market participants to opine on the appropriate scope of legislation. With respect to other crypto assets, the paper noted that the HKMA will soon provide financial institutions with detailed regulatory guidance on their interaction with and provision of intermediary services to customers related to crypto assets.Comments to the paper were due on March 31, 2022.

On January 28, 2022, the Hong Kong Securities and Futures Commission (SFC) and the HKMA issued a joint circular on intermediaries’ virtual asset-related activities,16 and the HKMA published guidance to authorized institutions regarding their interface with virtual assets and VASP.17 The joint circular applies to existing SFC-licensed corporations and authorized institutions that want to distribute virtual asset-related products and provide virtual asset dealing and advisory services. The circular imposes specific requirements on how SFC-licensed entities should conduct this business alongside their existing securities-related businesses. This includes only providing products and services to professional investors; assessing suitability of virtual asset products and services for their clients; and, when engaging in dealing services, using only SFC-licensed platforms and otherwise complying with the regulatory requirements for dealing in securities even where the virtual asset in question is not a security.

Finally, the HKMA guidance, which was only directed at authorized institutions, emphasized that institutions would not be prohibited from engaging in virtual asset-related activities. However, it notes that authorized institutions are expected to have appropriate risk management measures in place, including appropriate capital reserves, and must notify the HKMA prior to conducting any such activities.
 

Australian crypto consultation paper
On March 21, 2022, the Australian Treasury proposed a new regulatory framework for crypto asset secondary service providers (CASSPrs)18 separate from the existing Australian Financial Services Licensing (AFSL) regime for financial products. The new regime would be administered by the Australian Securities and Investments Commission and would define the scope of crypto asset services covered similarly to the definition of VASP under FATF Recommendation 15. In addition, the consultation paper also seeks feedback on how to categorize crypto assets in advance of a token mapping exercise the Australian government is seeking to finalize by the end of this year. Comments to the consultation paper are due by May 27, 2022.
 

Regulating crypto assets’ explosive growth
The surge in the crypto asset marketplace and concomitant growth in institutional investor interest has accelerated the discussion and development of regulatory clarity for these instruments and services.

Through the first quarter of 2022, we have seen jurisdictions across the globe take concrete steps to bring regulatory clarity to facilitate the continued responsible growth of the market, including with respect to the provision of custody services by financial institutions. As noted above, in the US, we are expecting prudential regulators, as part of their crypto sprint, to provide clarity regarding their expectations for banks providing such services. In Europe, we have the anticipated passage of MiCA, which includes a custody licensing framework. In Asia Pacific, there is an ongoing consultation regarding CASSPrs that includes proposals on crypto asset custody, and in Hong Kong, recent consultations and guidance indicate that authorized institutions will not be prohibited from conducting virtual asset-related activities, such as custody, provided that they have appropriate risk management measures in place and discuss them in advance with the HKMA.

There will no doubt be challenges along the way. But input by market participants in the ongoing legislative and regulatory consultations can help guide regulatory frameworks for this burgeoning industry.