Self-regulation is once again a trending topic in the cryptocurrency landscape as major exchange platforms have announced the creation of self-regulated organizations (SROs) to achieve some standardization in digital currency governance. Government regulators across various jurisdictions continue to exert greater regulatory pressure on their local cryptocurrency industries.
Even inter-governmental agencies like the Financial Action Task Force have in recent times put crypto governance at the forefront of their regulatory ambit. For digital currency stakeholders, many of these regulatory measures can negatively impact innovation in the industry. Some even warn that harsher laws will see both capital flight and a brain drain from nations that adopt these stringent measures.
However, there is an argument to be made against the effectiveness of the approach adopted by some of the existing SROs. Some critics posit that their recommendations do not come with the appropriate authoritative weight to trigger lasting changes in the crypto regulatory landscape. Furthermore, without the participation of government regulators, it might appear that self-policing measures only amount to an elaborate exercise of “guessing legality.”
Crypto self-regulation in South Korea and Japan
Before the “crypto frenzy” of the late 2017, China was the only major market to have issued any definitive ruling in the form of a ban on digital currency trading and initial coin offerings (ICOs). In the aftermath of the meteoric rise in crypto prices and the subsequent increase in global consciousness, the start of 2018 begun to see more serious government consideration of the market.
In early 2018, reports began to emerge of plans in South Korea and Japan to create self-regulating bodies for their crypto markets as a way of preempting stringent laws from the government. Thus, Japan and South Korea became some of the first jurisdictions to have some sort of crypto SRO such as the Japanese Virtual Currency Exchange Association (JVCEA), which formed in April 2018.
The JVCEA emerged mostly as a reaction to the January 2018 Coincheck hack that saw the theft of more than $530 million in NEM (XEM) tokens. The association focuses on the Japanese crypto trading arena, working together with the country’s Financial Services Agency to enforce strict compliance among its members. Thus far, the JVCEA has worked to enforce regulations for hot wallet use and limits for crypto margin trading. The association became a recognized SRO in October 2018.
As early as February 2018, Cointelegraph reported that the Korean Blockchain Association (KBA) was already considering the creation of a self-regulatory framework for local exchange platforms. At the time, regulators in the country had already started taking stringent measures against crypto exchanges.
The KBA framework also mandated that its members manage client funds separately from their own while maintaining minimum equity of $1.8 million. Exchanges under the KBA also have to publish regular audits and financial statements.
SROs in the U.K. and U.S.
Crypto stakeholders in the United Kingdom also joined Asian countries in pioneering self-regulation for the industry in early 2018. Formed in February 2018, CryptoUK is the first-ever self-regulating trade body for cryptocurrencies.
Coinbase, CEX.IO, eToro and other major crypto businesses came together to form the association. With the U.K. having no cryptocurrency regulations, CryptoUK has sought to lobby members of Parliament to create favorable laws for the local crypto industry.
In the United States, crypto exchange and custody giants like Coinbase, Bittrex and Kraken established the Crypto Rating Council (CRC) in the end of September 2019. The CRC is an independent body that provides insight on whether crypto tokens can be classified as securities or not.
Again, the CRC is another example of a country-based SRO focusing on a major pain point of its local crypto scene. In the U.S., exchanges have to carefully navigate unclear regulations about which crypto tokens constitute securities.
Given that the U.S. Securities and Exchange Commission (SEC) has consistently maintained that most ICO tokens are securities, some U.S. platforms have been forced to geofence certain tokens or create separate local exchanges that list only tokens deemed not to be securities.
Before the CRC, U.S. crypto exchange platform Gemini proposed the formation of an SRO for digital commodities. According to a Gemini published post from March 2018, the Virtual Commodity Association (VCA) would only focus on nonsecurity crypto tokens. As previously reported by Cointelegraph, three other platforms — Bittrex, Bitstamp, and bitFlyer USA — joined Gemini in establishing the VCA.
In the past, several commentators have called on the crypto industry to pursue self-regulation. Even members of regulatory agencies like “crypto mom” Hester Peirce of the SEC and Brian Quintenz of the U.S. Commodity Futures Trading Commission (CFTC) have stated in the past that crypto businesses should develop modalities for self-regulation.
Back in mid-2018, Cointelegraph published a survey by Foley & Lardner LLP — an international law firm showing 86% of crypto executives being in favor of formalized self-regulation for the industry. Commenting on the need for robust self-regulation for the crypto industry, Iqbal V. Gandham, chair of CryptoUK and CEO of trading and brokerage firm eToro, wrote to Cointelegraph in an email, saying:
“Effective self-regulation combined with necessary industry-informed government regulation to promote confidence is the key to realizing the potential of the industry whilst providing the necessary protection for consumers and businesses. The cryptoasset industry is still relatively new, with advances in technology and industry collaboration already creating solutions for many of the initial concerns surrounding the asset-class, such as protection of consumer assets through cold storage.”
Over-regulation: A threat to digital innovation?
Self-regulation is not unique to the crypto space. In fact, there is an argument to be made that these SROs are trying to become the crypto analogs of organizations like the National Futures Association (NFA) — with the ability to promulgate important rules and guidelines ratified by government regulators.
In the U.S., for example, the CRC is trying to develop a nuanced approach to determining which tokens should be considered securities, as several stakeholders in the U.S. crypto space have bemoaned the current regulatory climate in the country.
In an email to Cointelegraph, Yusuf Hussain, head of risk at Gemini, explained that self-regulation could help to temper some of the more stringent crypto laws being enacted by several governments. According to Hussain, “thoughtful regulation in cryptocurrency is a win-win for the market and regulators alike. Done right, it can pave the way to healthy and sustainable markets and fuel long-term innovation that unlocks the promise of cryptocurrency and transforms society for the better.” Hussain went on to add:
“The crypto industry and regulators are trying to solve for regulatory uncertainty, and the U.S. Securities and Exchange Commission (SEC) is taking a conservative approach while trying to define what is and is not a security. The SEC is looking to the industry to help come up with a sensible approach in conjunction with them, and a self regulatory organization (SRO).”
Back in July 2019, Ripple signed an open letter to the U.S. Congress, asking for fair crypto regulations. In the statement, the blockchain startup urged agencies not to enact laws that put U.S. cryptocurrency businesses at a disadvantage to their overseas counterparts.
Goldman Sachs-backed Circle also echoed similar sentiments earlier in the year, claiming that U.S. regulations were constituting a hindrance to digital innovation. The company has since moved the bulk of its crypto exchange business — i.e., the Poloniex platform — abroad.
In late September 2019, reports emerged that the U.K.’s Financial Conduct Authority (FCA) was looking to ban crypto derivatives. When asked for its response on the matter, CryptoUK told Cointelegraph:
“A ban would potentially expose retail customers to poorly regulated investment products in other jurisdictions, which could lead to fewer avenues for recourse and less protection for consumers. We believe retail customers interested in derivatives are best served by a well-regulated UK market overseen by the FCA and ESMA, who can utilise less restrictive measures, such as leverage limits, to achieve their aims.”
As reported by Cointelegraph, crypto exchange OKEx is looking to create a self-regulating body for cryptocurrency trading platforms. Commenting on the potential role of SROs in the face of increasing government scrutiny, Andy Cheung, head of operations at OKEx, wrote to Cointelegraph, stating:
“Working parallel internally and externally would strike a balance to shape a better industry.”
Government agencies in some countries appear to be exerting ever-greater regulatory pressure on their local crypto industries. Small- and medium-sized exchange platforms are coming under increasing pressure in trying to comply with tough banking laws.
Such is the extent of the problem that about 97% of these platforms are close to going bankrupt. South Korean blockchain startups are electing to list their tokens on overseas exchanges, further causing the local token trading market to shrink.
Establishing a global crypto self-regulating body
Thus far, most of the efforts at crypto self-regulation appear contained in servicing local markets. However, OKEx is looking to form a global SRO that will work toward standardizing the industry at a macro level.
As a global SRO for crypto exchanges, such an organization may function like the World Federation of Exchanges in lobbying regulators across different countries to come up with more favorable laws.
Commenting on the need for a global governance standard for the crypto industry, Cheung wrote to Cointelegraph, stating that an SRO is the only way for “exchanges to grow and deliver impact is by joining together to develop practices and policies that will set a global standard and adapt to regional regulatory frameworks.” For Cheung, rather than focus on any one local jurisdiction, the exchange’s planned SRO will have a more worldwide focus. Explaining further on the subject, Cheung said:
“This SRO will be an independent, membership-based organization that is neutral and open to exchanges of all sizes and jurisdictions. Member exchanges will work together to define and adopt standards that will promote digital asset adoption globally, educate governments and regulators, and develop metrics and criteria for trading, listings, and reporting.”
CryptoUK also expressed willingness to join a crypto SRO with a global focus but maintained that the U.K. market remains its primary objective. In an email to Cointelegraph, a spokesperson for the association declared:
“We are always open to partnering with a global forum that promotes international collaboration to introduce policies that strengthen the conduct of the global crypto industry. However, our priority remains UK regulation, reflecting the ongoing review of existing regulatory frameworks by the FCA, along with consultations on the development of new crypto-focused policy by HM Treasury.”
Gemini’s Hussain also touched on the possible emergence of a unified SRO for the global crypto market, stating, “Currently, there is no precedent for a global SRO. However, many VCA members are part of SRO initiatives in other jurisdictions, which can provide a unified, consistent approach to self regulation across multiple jurisdictions.”
However, there are critics who argue against the measures being adopted by these SROs, describing their methods as not amounting to effective self-policing. Some of the arguments against the current operations of SROs hinge on the absence of consonance between these organizations and government regulators, which have the final say on what constitutes a legal framework for cryptocurrencies.
For Hussain, self-regulation cannot exist in a vacuum, adding that in the U.S., self-regulatory organizations will always be accountable to federal regulators:
“There are specific requirements of an SRO in the United States set forth by existing regulations that require oversight by a regulatory authority.”
The Gemini executive further stated that SROs in the U.S. financial market, such as the Financial Industry Regulatory Authority and the NFA, are accountable to the SEC and CFTC respectively. Until SROs and government agencies can agree on a suitable middle ground, crypto business will have to endure the patchwork of usually stringent regulations in different countries.