Crypto Assets and International Law: Is There Need For An International Regulatory Framework For Crypto Assets?
The principle of “ same risks, same activity, same regulations” underpins robust supervisory and regulatory frameworks in the financial world.
Indeed, virtual asset providers perform similar roles to traditional financial service providers.
But should they be subjected to regulations identical to conventional monetary establishments, bearing in mind their decentralized, intermediary-less, and anonymous nature?
SECONDLY, should governments, virtual asset providers (VASPs) and international bodies collaborate to create a global legal framework(s) to oversee crypto asset activities?
Granted, crypto assets, like stablecoins, perform functions worthy of oversight by payment system regulators and central banks.
The lack of comprehensive global supervisory and regulatory frameworks makes dealing with these assets incredibly risky.
This article explores the relationship between crypto assets and international laws. It endeavours to answer one of the most pertinent questions in the crypto industry. Stick around to find out!!!
Table of Contents
∘ Why Should International Bodies, Governments and Crypto Companies collaborate to Establish an International Legal Framework for Crypto Assets?
∘ Group1
∘ Group 2
∘ Jurisdictional Issues in Cryptocurrency Regulations
∘ Final Thoughts On Whether There Is a Need for an International Legal Framework for Crypto Assets.
Highlights
- The meteoric rise of cryptocurrencies globally has brought about concerns regarding their legality and effect on global financial stability.
- The inconsistent nature of crypto regulations causes complications related to financial stability, market integrity, consumer protection, national security, jurisdiction, among others.
- International organizations, crypto companies, and governments must work together to establish a uniform legal instrument(s) regulating virtual assets and virtual asset providers (VASPs)
- Regulations must uphold a delicate balance between risk mitigation and innovation. They must not stifle innovation by over regulating the sector.
- The principle of” same risks, same activity, same regulations” underpins robust supervisory and regulatory frameworks in the financial world.
Why Should International Bodies, Governments and Crypto Companies collaborate to Establish an International Legal Framework for Crypto Assets?
The absence of adequate national and international legal frameworks regulating cryptocurrencies jeopardizes national security and the global economy.
The decentralized nature of cryptocurrencies makes them prone to various forms of abuse, including money laundering, terrorist financing, and crypto scams.
Additionally, it undermines national efforts to regulate the crypto industry. Indeed, some jurisdictions looking to control the crypto sector may fail to do so effectively due to insufficient information, resources or power to enforce regulations.
To remedy these, international organizations, crypto companies, and governments must work together to frame uniform legal instruments to regulate the crypto industry, limit regulatory arbitrage, and secure the continuous effectiveness of regulatory and supervisory frameworks.
The framework must create regulatory bodies that hold virtual asset providers accountable while bringing to justice users who flout regulations.
While doing this, the regualtory framework must not stifle innovation, rather it should encourage responsible innovation.
The international instrument must also give those regulatory bodies international jurisdiction to enforce rules.
The distribution and issuance of crypto-assets by virtual assets providers(VASPs)in a manner mirroring the traditional financial sector demands that they be subjected to regulations consistent with international standards applicable to conventional financial service providers.
In December 2022, the Basel Committee on Banking Supervision (BCBS) published rules regarding the prudential treatment of crypto assets exposure.
Per the rules, crypto assets are classified into two groups by banks:
Group1
Crypto assets that fall under this category comply with the set classification conditions.
They include tokenized traditional assets, which are subject to the same market and credit risks prone to the asset’s non-tokenized (traditional) form. And crypto assets with effective stabilization mechanisms, whose value is linked to traditional assets like currencies.
The capital requirements of Group 1 crypto assets are subject to the existing Basel framework.
Additionally, stable coins must pass a redemption test and additional regulatory/ supervisory requirements to be classified as group 1 assets.
Redemption tests help to ensure that a crypto asset’s reserve assets are adequate to enable their redemption anytime, especially during periods of extreme stress.
Group 1 crypto-assets don’t include crypto assets that utilize protocols to maintain their value, or algorithmic stablecoins (undercollateralized stablecoins), such as magic internet money ( MIM) and terraUSD (UST).
ALSO READ: Legal Considerations to Make Before Investing in Digital Assets.
Group 2
These are crypto assets that don’t meet any of the classification conditions. As such, they are subjected to conservative capital requirements, as they pose a higher risk to the market.
Group 2 assets include:
- All un-backed crypto assets and stablecoins.
- Tokenized traditional assets that fail to meet group 1 classification conditions.
A hedging recognition criteria provides conditions for group 2 assets with limited hedging.
The rules also provide conditions for group 2 assets where hedging is not recognized. Additionally, banks’ exposure to this asset class should not exceed 2%
The BCBS rules are designed for regulatory/supervisory authorities. The standards include directions on updating regulatory practices in lieu of the crypto industry’s evolving nature.
In the future, the Basel Committee will provide authorities with further clarifications and refinements to enhance the consistent implementation and understanding of the instrument or to address emerging risks.
While the BCBS standards are not yet legally binding, banks looking to partake in the crypto market must consider them in their capital and business plans.
In October 2022, the Financial Stability Board ( FSB) published recommendations and a proposed framework for the international regulation of global stablecoin arrangements and crypto assets.
As mandated by the G20, the FSB interrogated supervisory and regulatory issues stemming from the crypto industry to address its financial stability risks.
The report highlights several challenges to the national application of crypto assets supervision and regulation.
The report covers, among other things:
- The extensive utilization of distributed ledger technology
- Applicable global supervisory and regulatory standards for crypto asset activities
- Challenges, including regulatory and supervisory gaps, related to crypto asset activities
- Risks related to lending and borrowing activities, trading and custody services, and wallets.
- The interconnectedness of the crypto markets and their essential activities
- A set of nine high-level recommendations.
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The FSB requires governments to subject virtual assets to the same financial regulations applicable to traditional financial instituions.
This requires them to cultivate resources, powers, and tools to regulate the rapidly growing crypto and stablecoin markets.
Additionally, regulatory agencies should cooperate locally and internationally to boost uniformity, knowledge-sharing, and consistency.
Global stablecoin arrangements, for instance, should be subjected to high trust and transparency standards, including stabilization mechanisms, and redemption rights.
They should also have clear quality and composition requirements for reserve assets.
The primary purpose of the nine high-level recommendations is to boost the comprehensiveness and consistency of regulatory and supervisory approaches to digital assets.
Additionally, they encourage international cooperation between regulatory agencies and promote information sharing.
Towards establishing an effective, consistent, coordinated, and mutually supportive framework, the FSB works with various international organizations.
Some of the organizations FSB works with include the IMF, BCBS, the International Organization of Securities Commissions (IOSCO), the Committee on Payments and Market Infrastructures (CPMI), and the Financial Action Task Force (FATF).
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Cryptocurrencies may have been originally created to operate free from control, but the lack of a robust global regulatory framework for digital assets is harmful for the sector, innovation and consumer protection.
Laura Talvitie Senior Manager, Digital Assets Regulation PwC UK.
Jurisdictional Issues in Cryptocurrency Regulations
The global nature of cryptocurrencies brings about complications related to national security, jurisdiction, financial stability, and conflicts between national policies and regulations.
Undoubtedly, questions regarding financial misconduct and jurisdiction demand crypto companies, investors, and governments ask critical questions.
For instance, will international laws benefit the nascent industry while balancing the need for national capital control, and the dark realities of virtual currencies.
They must also answer the question, are crypto transactions multi-jurisdictional or jurisdictional?
In addressing whether virtual currency transactions are multi-jurisdictional or jurisdictional, we must consider the nature of blockchain technology, which underpins digital currencies.
The decentralized nature of this technology makes it impossible to pinpoint a ledger’s exact location, offering users greater privacy than conventional trading systems. This makes it hard to determine where a transaction occured.
In crypto, nodes (computers that connect users to a crypto network) operate in various jurisdictions. As such, copies of the ledger are stored in multiple jurisdictions with different regulations, making it impossible to tie a transaction to a single jurisdiction.
Privacy is at the core of virtual currencies. Online anonymity is a double-edged sword, the anonymous nature of crypto transactions provides courts with a tremendous jurisdictional issue regarding enforcement and finding liability.
While blockchain technology is designed to limit human error through immutable records of transactions or agreements via smart contracts, ERRORS DO OCCUR.
Courts face the impossible task of establishing liability, as the nodes involved in transactions are located in various jurisdictions worldwide. Additionally, the decentralized nature of the cryptocurrency software makes it difficult to determine its country of residence.
The decentralized nature of distributed ledger technology complicates the process of choosing the proper jurisdiction and the determination of applicable laws.
Two questions spring from this complicated state of matters:
- Should aggrieved parties institute proceedings against the firm hosting the crypto platform? Or
- Should aggrieved parties attach their claims to the underlying technology which powers the crypto platform?
This challenge is well captured in Re Tezos.
In Re Tezos, the plaintiff, an investor residing in Illinois, instituted proceedings against the defendant, claiming it had conducted an unauthorized ICO contrary to US securities laws.
In its pleadings, the plaintiff sought to rescind the contract and claim damages. In its ruling, the District Court of Northern California first sought to address the issue of whether the plaintiff had established personal jurisdiction against the defendant.
Per US laws, there are two ways of establishing personal jurisdiction where a defendant is not a resident of the forum state: Specific and general jurisdiction.
The court dwelled on specific jurisdiction by establishing whether the defendant has minimum contact with the state, ensuring the exercising jurisdiction does not upset the tenets of substantial justice and fair play.
The court ruled that it would not establish specific jurisdiction against the defendant merely because an Arizona server hosted its company website, which was highly interactive and accessible to all.
In this matter, the court faced two jurisdictional issues; legislative jurisdiction, which determines the governing rules of the dispute, and judicial jurisdiction, which pertains to the court’s ability to entertain the proceedings.
It is quite easy to establish the location of conventional databases compared to decentralized ones. This makes it easy for authorities to determine the appropriate regulatory authorities and laws in a dispute.
However, block chain technology makes this approach obsolete. Consider this, in a permissionless network, the participant computers are scattered across the globe.
As such, every jurisdiction involved may wish to assert its authority over a claim, if some of the participant nodes reside there.
This does not only pose a legal problem; it forces crypto companies to comply with different regulatory regimes, which may undermine the anonymous nature of crypto transactions.
It may also expose creators of crypto offerings to multiple legal proceedings in various jurisdictions. Legal scholars constantly debate how many participant nodes must be in a jurisdiction to confer personal jurisdiction.
Crypto-asset conglomerates operate via networks of international affiliates, providing services across multiple jurisdictions. Most crypto firms’ headquarters are unknown or are situated in unregulated off-shore jurisdictions.
In case of an issue, enforcing rights against a specific individual in a decentralized system, lacking adequate governance mechanisms, would be extremely difficult.
Furthermore, it curtails effective regulation and supervision from domestic authorities. The situation is made worse by the absence of international supervisory and regulatory compliance frameworks.
The jurisdiction-shopping behavior demonstrated by some crypto firms poses serious regulatory issues, which demand a global solution. This issue presented itself prominently during the FTX bankruptcy hearing.
Since FTX was domiciled in the Bahamas, some liquidators submitted to the US Bankruptcy Court for the District of Delaware that part of the matter should be presided over by a Bahamian court.
The presiding judge, John Dorsey, shot down the application, citing that,
“Under no circumstances would I ever defer a core jurisdictional issue to a foreign court,” “And, the core jurisdictional issue here is whose assets are [these].”
Bahamian liquidators argued that, in practice, FTX was run in the Bahamas, giving Bahamian courts jurisdiction over the matter. On the other hand, the US Bankruptcy Trustee argued that the entity, set up in Bahamas, was merely a side show.
Additionally, US authorities claimed that the information shared with their Bahamian counterparts was likely to be abused, as FTX founders Gary Sam Wang and Bankman-Fried were in collusion with the Bahamian government.
Generally, crypto companies set up bases in lax jurisdictions. Jurisdictions that enforce crypto regulations poorly, or those that lack the resources and power to implement rules effectively.
They do so not just to avoid supervision and oversight but to maximize profits at the expense of retail investors.
Following the FTX collapse, people were concerned about the US government’s ability to protect investors from the misconduct of centralized crypto exchanges, like the FTX, headquartered in jurisdictions with lax crypto regulatory ecosystems like Malta, the Virgin Islands, and the Bahamas.
Binance is notorious for its jurisdiction shopping activities. Binance, the largest centralized crypto exchange, was founded in 2017 in China.
However, in 2018, following the Chinese government’s crackdown on crypto activities, it relocated to Malta after signing a memorandum of understanding with the Maltese government.
The same year, the company signed a memorandum of understanding with the Bermuda government.
To date, the location of the company’s headquarters remains a mystery. However, Binance’s chief growth officer has gone on record stating that the firm’s “spiritual headquarters” is in Malta, despite the company being kicked out by Maltese regulators in 2020.
The suggested global crypto regulations by the FSB strikes a balance between risk mitigation and innovation, fostering growth without stifling progress.
Bianca Veleva, head of legal and regulatory compliance at Nexo.
Additional Resources: The Intersection of Block chain Technology and Securities Laws: An Overview
Final Thoughts on Whether There is Need For An International Legal Framework For Crypto Assets.
Inconsistencies regarding crypto regulations have thrown the industry into disarray. Different jurisdictions view digital currencies differently, some view them as investments while others disregard them completely.
Needless to say, this ambiguity has caused tremendous confusion among supervisory and regulatory authorities regarding the appropriate regulatory and supervisory frameworks to implement.
The meteoric rise of cryptocurrencies globally has brought about various questions regarding their legality, partially due to their potential for being used as tools of fraud, terrorist financing, and money laundering.
The crypto space is largely unregulated. The absence of adequate regulation poses a great risk to the crypto industry, market integrity, national security, among many other risks.
A robust global regulatory framework is necessary to remedy these concerns, while enhancing consumer protection.
The FSB is currently working to establish a global regulatory framework for VASPs, and virtual asset activities.
As institutional market players enter crypto, governments, central banks, and investors must tread carefully to avert systemic risk.
The speed at which innovations occurs in the industry coupled with the lack of a sufficient risk management systems further exacerbate the problem.
Crypto companies are engaged in vicious fights with regulatory agencies due to their unsettled legal status. Indeed, regulatory agencies and international bodies approach the crypto issue differently.
Some view the crypto industry as the future, while others view it as a tool for financial misconduct, organized crime, and fraud, all with good reason.
For instance, recent collapses of major crypto companies have caused a drastic decline in consumer trust in the crypto industry.
Be as it may, concerns regarding the crypto industry are well founded; through their existence, crypto companies have been involved in numerous international fraudulent schemes that have resulted in colossal losses for investors.
Unfortunately, crypto-asset activities bring about various issues, as block chain technology thrives on online anonymity, which is a double-edged sword.
The legal issues emanating from the use of virtual currencies are bound to increase since no authority or intermediary possesses exclusive jurisdiction to handle those matters.
Until this is resolved, the risks posed by the crypto industry will continue to be a reality to investors across the globe.
