Cryptocurrency Regulations

Digital Asset Regulations: Where We Stand – January 2022

Below is a snapshot state of play of the major sources of digital asset development and regulation as of January 2022.

“Digital asset” is a broad term and different definitions have been proposed, but taking the UK’s Financial Conduct Authority definition as a well-articulated starting point, we can think of a digital asset as a cryptographically secured digital representation of value or a contractual right that may use some form of distributed ledger technology and which can be transferred, stored or traded electronically.

ISDA & Crypto Derivatives

The recent work of the International Swaps and Derivatives Association (ISDA) (a trade organization of participants in the market for over-the-counter derivatives) seems to be a key indicator that traditional finance is rapidly getting ready to treat crypto and digital assets as a legitimate investment asset class.

A digital asset derivative is simply a derivative (essentially just a contract for something that derives its value from the value of another thing) for which the underlying asset is one or more digital assets. In contrast to digital assets, a digital asset derivative typically will be considered to be a stock/financial instrument so those trading it will have to comply with certain financial regulations – see this statement from the UK’s Financial Conduct Authority.

Currently, institutions trading digital asset derivatives typically either use entirely bespoke legal agreements that they’ve developed themselves or an amended version of existing ISDA definitions and template legal agreements. The benefit of standardized legal documentation such as ISDA’s is increased legal certainty and transparency and liquidity for the traded assets.

ISDA announced on 30 September 2021 the launch of its Digital Asset Documentation Working Group. to develop specific legal standards for the unique characteristics of crypto assets (e.g. forking, airdrops, cyberattacks, changes in law or regulation, valuation of assets traded 24/7) so that ultimately crypto derivatives can ultimately be treated in a comparable way to other derivatives. On 14 December 2021, ISDA published its paper ‘Contractual Standards for Digital Asset Derivatives.

From a market value of effectively zero a decade ago, the total value of all digital assets is today estimated to be approximately $3 trillion.

The paper notes: “As the broader financial industry seeks to take advantage of these opportunities, the development of a robust and liquid derivatives market will be crucial, as will the emergence of the contractual standards underpinning those transactions.”

ISDA has also produced a supplement that sets out a granular, technical analysis of different ISDA product definitions and their potential applicability to digital asset derivatives.

UNIDROIT International Private Law for Digital Assets

Not to be outdone, the International Institute for the Unification of Private Law (UNIDROIT) (an intergovernmental organization that seeks to harmonize international private law) launched its Digital Assets and Private Law Working Group in July 2020 and is expected to provide a guidance document on digital assets and private law this year, with a consultation following thereafter. See the outcome of the Working Group’s meetings and Revised Issues Paper here.

Industry Proposals

In our weekly crypto policy roundup for 19 November 2021, we reported on Ripple’s proposal for crypto and digital asset regulation, the proposals of the Global Blockchain Business Council, and those of FATF.

FTX has also published some recommendations on what they think crypto regulations should look like.

UK ‘digital assets’

Separately, the UK’s Law Commission was requested by the UK Government to make recommendations for legal reforms to support and facilitate the development of digital assets, including crypto-assets in the UK. See here.

On 24 November 2021, the Law Commission published an interim update paper on its digital assets project and anticipates publishing its digital assets consultation paper in mid-2022.

The intentional breadth of the Law Commission’s working definition of ‘digital assets’ is noteworthy, and it proposes that its consultation paper will apply underlying legal principles of private law and its proposals for law reform to different broad sub-categories of digital assets, using examples where appropriate.

EU ‘digital assets’

We’ve previously reported on EU developments in our weekly crypto policy roundup for November and January.

One of the most hands-on and least laissez-faire approaches has to be that of the European Union. The European Commission’s Digital Finance Package published on 24 September 2020 includes proposed legislation on crypto-assets i.e. the Markets in Crypto-assets (MiCA), a draft framework for the Digital Operational Resilience for the financial sector (DORA), and a proposed pilot regime on distributed ledger technology (DLT) market infrastructures.

The stated purpose of the package is to foster innovation and competition in digital finance whilst ensuring risk mitigation.

MiCA does not cover CBDCs, tokens issued by public authorities, non-fungible tokens (NFTs), tokens representing physical assets or services, or tokenised securities, the latter falling under the EU securities law as ‘financial instruments’ (i.e. MiFID II). MiCA applies to the issuance and trading of cryptoassets, including utility tokens, payment tokens, stablecoins and e-money tokens, including for firms that are not based in the EU but which service EU clients.

MiCA attempts to plug the cap in EU financial services legislation under which a lot of digital assets are not covered. MiCA will require providers of cryptoasset services to comply with conduct of business, prudential, custody, complaints handling, conflicts and outsourcing requirements.

DORA requires information and communication technology risk management to try to limit the effects of cyber-attacks, and sets requirements on a firm’s use of third-party service providers. 

One wonders whether the EU, with its circa 450 million population, is seeking to set the tone of digital asset regulation worldwide. However, as with other nascent sectors, a careful balance between clear regulation and space for innovation will be needed, with jurisdictions that can provide for (or at least not penalize) entrepreneurial incentives winning out over time.

USA ‘digital assets’

While the US appears to be a little behind what is a surely red hot pace elsewhere, the Chair of the House Committee on Financial Services, announced on 16 June 2021 the establishment of the Committee’s Digital Assets Working Group. This working group would be responsible for innovation in the cryptocurrency and digital asset space by meeting with experts and proposing draft legislation on cryptocurrency regulation, the use of blockchain and distributed ledger technology, and the development of a US Central Bank Digital Currency.

We’ve previously reported on US developments in our our weekly crypto policy roundup for January.

We covered the CEO’s testimony to Committee’s Digital Assets Working Group here.

Digital Assets in Singapore and Japan

Way out in front appears to be Singapore with its Guide to Digital Token Offerings’ (last updated on 26 May 2020) and which is general guidance on the application of securities laws administered by the Monetary Authority of Singapore on offers of digital tokens in Singapore.

Another clear trailblazer in the crypto space is Japan, having amended its Payment Services Act to cover cryptocurrency exchanges in April 2017, and having grasped the definitional nettle on ‘virtual currency’ as far back as May 2019 (effective 1 year later), which has now been replaced with a definition of ‘crypto-asset’ to better cover the broad range of digital assets on the market.

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