Authored by Francisco Moran and Casper Xiao

Introduction

Hoping to invest or explore cryptocurrency? This guide to global cryptocurrency regulation will provide valuable insights into the regulatory regimes of Australia, the United States and the United Kingdom. Learn about the lack of transparency in the crypto industry, issues surrounding stablecoins, and the federal approach to crypto regulation in the US. We also touch on the IRS perspective and the Financial Crimes Enforcement Network (FinCEN) in the US, as well as the proposed amendments to existing legislation in the UK. We’re dedicated to helping our clients navigate the complex regulatory environment in the crypto space, while positioning themselves for growth and success.

Please also see our article on the 6 key risk factors contributing to  crypto investor loss here.

I. Australian Crypto Regulatory Regime

In Australia, while there is no specific cryptocurrency specific legal framework, crypto assets are currently captured by a number of regimes including the following.

The Corporations Act & The ASIC Act: Under these two, certain types of Crypto Assets are treated as if they are securities (i.e. if they are likely to be managed investment schemes, derivatives or securities). The benefit to this is that it is federal legislation and uniform across Australia. By treating certain crypto assets as financial products, crypto providers are captured by the Consumer Law and restrictions on advertising and misleading conduct would apply. Furthermore, crypto exchanges and other entities creating crypto investment products are required to have an Australian Financial Services License (AFSL) in order to operate.

Australian Consumer Law: This provides consumer protection to holders of Crypto Assets in exchanges, especially those Crypto Assets that are found to not be considered securities or financial products. Protections include the prohibition against unconscionable conduct, unfair contract terms as well as misleading and deceptive conduct. It also requires heavy disclosure language in the Terms and Conditions of trading or wallet platforms, accounting for what would be “fintech” disclosure standards. However, the enforcement of these laws can be challenging when it comes to cryptocurrency-related scams and rug pulls. This is because many of the individuals or entities behind these schemes are based overseas, making it difficult to pursue legal action against them. Additionally, the decentralized and anonymous nature of many blockchain-based projects makes it difficult to identify the specific individuals or entities responsible for fraudulent activities.

National Credit Consumer Protection Act (NCCPA): This provides a framework for regulating credit activities in Australia. Under the NCCPA, businesses that engage in crypto lending activities may be required to obtain a credit license from ASIC. Crypto lenders are subject to the same specific requirements as other credit providers, such as the requirement to disclose the terms and conditions of loans and credit products to consumers and providing accurate and up-to-date information about the cost of credit, as well as to provide dispute resolution avenues for consumers.

Anti-Money Laundering and Counter Terrorism: This includes obligations to report significant transactions ($10,000 or more) to AUSTRAC. Digital currencies have been recognised as a method of transferring value and have come under KYC, AML and CT regulations.

Taxation: While no specific cryptocurrency tax legislation exists, The Australian Taxation Office (ATO) has issued guidance on how digital assets, including cryptocurrencies are to be taxed. Crypto assets are subject to the same GST thresholds as other goods and services. Crypto assets are treated as capital assets and thus subject to Capital Gains Tax (CGT) when they are disposed of, similarly to stocks. The ATO explicitly states that for tax purposes, crypto assets are not to be treated as money.

Proposed Australian Crypto Regulation

Australia has been actively analyzing whether existing frameworks are sufficient to handle the gradual acceptance of digital currencies and crypto assets. One notable development is the introduction of a private member’s bill, the Digital Assets (Market Regulation) Bill 2022, which Liberal Senator Andrew Bragg has recently put before Parliament. The Bill aims to improve Australia’s regulation of cryptocurrency, by creating a new regulatory framework specific for digital currencies and crypto assets. While it may not pass through the current government expediently, it nevertheless provides an important first step forward in the ongoing debate about how best to regulate crypto assets in Australia.

Lack of transparency

The collapse of one of the biggest crypto exchanges, FTX, and also the bankruptcy of Celsius, another former top 10 platform, have raised serious concerns about the lack of transparency and assurance that customer funds are “safe” in the crypto space. In the Celsius bankruptcy, Judge Martin Glenn, the chief U.S. bankruptcy judge in the Southern District of New York, concluded that the deposits in the lender’s yield-bearing Earn accounts belong to Celsius, not individual account holders. Celsius had 600,000 accounts in its Earn program when it filed for Chapter 11 in mid-2022. The accounts collectively held about $4.2 billion, including stablecoins then valued at around $20 million. This is a major understanding on how exchange accounts differ from other institutional businesses accounts, where commingling is not only allowed but it rather severs ownership.

Unfortunately, the cautionary term “not your keys, not your crypto” has reached its realization in Court. Another one of the key issues highlighted by these incidents is the lack of legal requirements for crypto exchanges to provide proof of asset pools and reserves that demonstrate the health of the exchange, in direct contrast to how bank or financial services insurance works.. This has led to a lack of trust and confidence among consumers and regulators, which has directly impacted the valuation and user integration of these exchanges. The proposed bill aims to address these concerns by introducing requirements for certain disclosures to be made by crypto exchanges to consumers and regulators, which includes information about their assets and liabilities and financial health.

The Bill specifically prohibits the mixing of customer funds (commingling), which was a major issue that contributed to the uncertainty and abandonment of users after the collapse of FTX and other crypto exchanges. In the aftermath of these incidents, it was found through post-mortem and regulatory examinations that customer accounts were being intermixed with the company’s own business investment accounts and used for risky trading strategies, putting the funds of customers at risk. This prohibition on the mixing of customer funds is a crucial measure that will help to increase the transparency and accountability of crypto exchanges, and will provide a greater level of protection for customers’ funds.

Not so stable stablecoins

Another important regulatory lesson that has emerged from the crypto market is the issue of “stablecoins”, which are marketed as cryptocurrencies that have their value pegged to a traditional asset class such as fiat currency like the US dollar or Australian dollar. The collapse of the Terra Luna token, which dropped rapidly from a value of 1USD to 0.02USD in May 2022, highlights the risks associated with stablecoins. This collapse was caused by a variety of factors, including large panic sales in a crypto bear market and large, unregulated withdrawals by large players, who lost belief in the integrity of the Terra peg. One key concept proposed by the Bill is the creation of an audited licensing regime for stablecoin issuers, and the additional regulatory requirements and standards for stablecoin transactions, especially those to combat “rug pulls” and “pump and dump” schemes and other large transactions that will cause the value of the stablecoin to plummet.

II. American Regulatory Framework: Federal Approach

Similar to Australia, depending on the product or service a crypto service can be caught by different regulatory agencies.

The Fallacy of No-Jurisdiction

A big misconception regarding Web3 projects, which includes DAOs, hot-wallets and crypto exchanges, is that there is no jurisdiction applicable to them unless they choose one, and that even in that case they can use an offshore jurisdiction where regulation is friendlier and looser.

Although as believers in what blockchain technology can do for the world we find it an enticing thought, it is far from reality. First of all, most countries are moving towards a “consumer rights” approach, which make it clear that a consumer can bring a claim against the organization at his own domicile if that’s where the transaction occurred, or at the domicile of the organization or the owner/director of the organization (in accordance with most consumer rights legislations) in case the organization has no established place of business. This will force some definitions as to “where” transactions actually occur in some jurisdictions, but the overall majority of them have an interest in protecting consumers locally, and forcing businesses to play by local rules, which can be hectic for a company without the appropriate safeguards and policies… But then there is the catch-all rule, which bases jurisdiction in the United States for its concentration of servers, which is another place where “transactions occur”.

In a recent case involving foreign bribery under the FCPA, the U.S. District Court for the Southern District of New York found that the mere use by persons with no ties to the US, on a non-US issuer company, of email servers located in the US was enough for the US to have jurisdiction (SEC v. Straub). There’s an increasing talk by regulators that the same rationale can and should be used for validating the US as a jurisdiction for exchanges with US servers, even if Straub was a bribery case and not a general business jurisdiction case.

The IRS Perspective

Under the Infrastructure Investment and Jobs Act, crypto provisions in this legislation have provided the legal requirement that every centralized cryptocurrency exchange must issue a Form 1099-B to each customer and the Internal Revenue Service (IRS),  allowing customers to keep track of their profits and losses in a transparent manner.

Since 2014 the IRS has characterized crypto assets as property. As in Australia, Crypto assets are subject to capital gains tax. Interestingly, a capital gain event in the US includes a transfer from one crypto currency to another. The IRS maintains other obligations such as record keeping.

The SEC and the Kraken skirmish

The SEC has long sustained that crypto assets are a security, falling under the definition of “investment contract”. This theoretical position took physical form in its charges against Kraken (the commercial name under which Payward In. and Payward Ltd. operated) for the “staking-as-a-service” option Kraken offered on its platform. This was a hinge moment for the crypto community, since the claim that staking constitutes a security could very well reshape the exchange market and force a deep rethinking of how the crypto exchange business is structured. The SEC successfully leveraged Kraken into a $30 MM settlement and a shutter of the staking-as-a-service offering in the Kraken platform. Although a settlement is not law, it certainly is a precedent. And if the SEC has its way, staking will be subject to the same securities regulations and disclosure requirements, which can be costly and undertake a lot of work from a legal team (boy, do we know about it!).

All assets considered securities would need to be registered with the SEC or Risk fines… Tokens acquired in ICO’s would be included in this structure, bursting the bubble of all those who dream of a blockchain based crypto market who answers only to users and holders who can make their own rules.

Financial Crimes Enforcement Network

FinCEN regulates Money Services Businesses (MSB). As such any transaction that moves funds must comply with FinCEN regulations. Since crypto has been a godsend for those small companies who cannot deal with institutional banking companies (either because of their fee structure, being new startups, or having remote and disperse operation, for example), there has been a wide adoption of using crypto assets and tokens as a means to “transport” and exchange money, simulating a sale of crypto assets in order to leverage existing payment/banking options without going through traditional and expensive channels. For example, there have crypto businesses who had subsidiaries in the Russian Federation, and used methods similar to this to evade sanctions and move money out of or into Russia.

Any venture looking to engage in these kind of services must be aware that methods like this are textbook money laundering techniques, and that they are at risk of severe liabilities and criminal charges in most jurisdictions. The successful ventures are the ones that seek proper legal advice as to how crypto assets can be used to comply with KYC, AML, CFT and other requirements similar toFinCEN’s. who impose a strict identity verification process for customers of cryptocurrency exchanges.

Future Crypto Regulation in the US

In the US, the federal government has begun taking steps for further regulation of crypto and digital assets. In March 2022, President Biden signed an Executive Order on Ensuring Responsible Development of Digital Assets, directing various branches of government to conduct research on and recommend policy. The executive order provides principles for research such as:

• Investor and consumer protection (including security and data privacy);
• ‘Financial stability and systemic risk’;
• ‘Combating crime and illicit finance’;
• International cooperation and American Competitiveness; and
• Promoting ‘responsible’ innovation.

SEC commissioner Hester Pierce was celebrated in 2021 for proposing certainty to the crypto market. However, not much regulation has happened at a federal level since her promises. In the wake of stablecoins taking a thrashing, Pierce highlighted the importance of not stifling innovation by rushing through regulation.

Like Australia, America awaits continued research and proposals at the federal level. It is important to note that while the federal government has begun taking steps towards regulation, individual states such as Wyoming have also implemented their own regulatory frameworks for digital assets and crypto.

State Regulatory: Wyoming

Even with Federal level regulation, different states in the US each have their own regulatory frameworks. Wyoming is widely recognized as being one of the most crypto-friendly states in the US, having a set of clear protections for consumers as well as incentives to promote innovation, and launching experimental frameworks, such as the “Wyoming DAO law” (which gives DAOs a legal structure and treatment similar to LLCs, though its critics say it does not grasp the peculiarities of a DAO).

Wyoming has a specialized Banking code, which is designed to allow crypto businesses to acquire capital funding. The Digital Asset Statute, recognizes the complex regulatory landscape at the federal level that might capture a crypto provider. The intention is to provide a service that “integrates” these requirements and provides a level of certainty. This institution is now called a “special purpose depositary institution”, which has a legal requirement to maintain 100% liquidity. This approach is designed to provide a level of protection and security for consumers while also promoting innovation in the crypto space.

Furthermore, Wyoming has adopted the Common law concept of bailment for banks dealing crypto. This means that banks that trade crypto will be considered as custodians and owe gold responsibilities to maintain the asset. The concept is attractive as it maintains the libertarian principles that spawned crypto and blockchain in the first place.

UK Regulatory Framework

Financial Conduct Authority

In the UK, there has been progress in the development of a regulatory framework for cryptocurrency and digital assets, spearheaded by the appointment of the Financial Conduct Authority (FCA), which oversees cryptocurrency for anti-money laundering (AML) and counter-terrorism financing (CTF) activities. All UK crypto exchanges need to be FCA registered, however some can obtain e-licenses instead of registering under the FCA. The FCA has shown its teeth in January 2021, when it banned retail cryptocurrency derivatives in order to protect consumers from market volatility.

Tax

Cryptocurrency trades in the UK will be subject to income tax and also capital gains tax. Airdropping into a wallet will also be considered as “miscellaneous income”, if a service or goods/money has been provided in exchange for it.

Future Crypto Regulation in the UK

In 2021, the UK government published a consultation paper on the regulation of crypto assets, outlinking several key proposals aimed at creating a robust and comprehensive regulatory framework for digital assets in the UK. One of the main proposals in the paper is the amendment of existing legislation in the Electronic Money Regulations 2011 and Payment Service Regulations 2017, to allow for a robust framework that is capable of regulating stablecoins and the provision of cryptocurrency wallets and custody services.

In April 2022, the Finance minister at the time and current Prime Minister, Rishi Sunak, proposed a grand scheme for making the UK a global hub for technology and hub for cryptocurrency. In October 2022, UK lawmakers agreed to implement new rules for stablecoins.The government’s recognition of stablecoins as a valid form of payment will provide greater legitimacy and acceptance of stablecoins as a form of payment, and will also encourage greater use and adoption of stablecoins in the UK economy.

Furthermore, in early 2023, 5 UK Associations, including the City of London Corporation, Digital Pound Foundation and TheCityUK and UK Finance have formed a crypto alliance with the aim of enhancing better policies for the crypto space in the UK.

The Treasury’s Financial Services and Markets Bill, which is currently in progress of navigating through UK Parliament and expected to pass into law around April 2023. If passed, the legislation would grant regulators increased authority and powers over regulating cryptocurrencies and other digital assets.

How Biztech Lawyers can help you

As the world of cryptocurrency and blockchain technology continues to evolve, the global regulatory landscape is also rapidly shifting. At Biztech lawyers, we are dedicated to staying at the forefront of these changes, and provide the necessary legal advice to businesses operating in this exciting and unpredictable field.  We understand that navigating the complex regulatory environment can be challenging for businesses, which is why we are dedicated to helping our clients stay compliant while also positioning themselves for growth and success. Read more on how to protect your crypto investments here, as we examine 6 key factors contributing to investor loss.

We are a global law firm with presence in the UK, US and Australia, who work closely with our clients to understand their unique business needs and provide tailored legal advice specific to their situation. Book in a free legal strategy session here.