The Cryptocurrency Regulatory Framework: How Countries are Approaching the Virtual Currency

It goes by many names: cryptocurrency, crypto, digital assets, tokens, coins, virtual assets, virtual currency—the list goes on. Regardless of the name, cryptocurrencies are virtual currencies that utilize cryptography to validate transactions on a blockchain. Although there are no centralized bodies or authorities regulating the transfer of cryptocurrencies—which can be sent peer-to-peer without the involvement of an intermediary—cryptocurrency transactions are fully traceable and thus transparent within the blockchain ecosystem, contrary to popular belief. However, the pseudonymous nature of wallets today has led some to believe that all cryptocurrency is illicit or used for nefarious activities.

Since the first Bitcoin transaction in 2009, cryptocurrencies have evolved to mainstream use that includes investing, cross-border payments and interbank transfers. There are some significant advantages—such as the inability to create fictitious transactions, no need for third parties, generally low transaction fees, and global accessibility, to name a few—but with anything that provides some good, there are certainly some trades offs, such as market volatility, the belief that crypto is only used for nefarious purposes, scalability of networks and the lack of a comprehensive regulatory framework.

The Global Crypto Regulatory Regime

Regulators worldwide have been wrestling with how best to regulate the crypto industry. To answer that, they must consider: if there is over-regulation, it may hinder any chance of innovation. And if there is under-regulation, not addressing issues such as money laundering or terrorist financing can hurt businesses, investors and consumers.

So, how have countries approached the regulation of cryptocurrencies?

To date, there have been several different approaches to regulating crypto. We have seen, and will likely continue to see, a variety of methods by some countries, such as a total ban of cryptocurrencies (as done in China), a “wait-and-see” approach, a partnership between public and private and a comprehensive approach. Depending on who you ask, these approaches—which are further explained below—can either be viewed as favorable or negative.

Banning Crypto

There are presently nine countries that have banned cryptocurrencies altogether and about 40 more around the globe that have essentially restricted them within their financial systems by prohibiting banks from dealing in crypto. Again, this approach is predicated on the false, mainstream perception that bad actors use crypto to facilitate illicit activities, like money laundering or terrorist financing.

If we applied this concept of banning the use of assets because they might be used by bad actors, then how would the rest of the world’s financial instruments fair? According to a blog post by blockchain analysis firm Chainalysis, cryptocurrency-linked crime surged to a record high last year in terms of value, with illegal addresses receiving $14 billion in digital currencies, up 79% from $7.8 bn in 2020. While these figures seem high, $14 bn and $7.8 bn represent less than 1% of crypto transactions.

Meanwhile, the UN estimates that approximately $1.6 trillion in cash is laundered each year.

How would a ban work in a country like the United States, where an estimated 50 million people own cryptocurrencies?

Wait and See

While the U.S. has increased its interest in crypto and its crypto regulatory oversight to date, there remains a lack of ownership or accountability of the industry by a specific regulator. When a country takes a strict wait-and-see approach around the evolution and regulation of crypto in their jurisdictions, the potential for ultimately stifling future innovation and implementation of the technology within their respective countries is likely. It could be argued that this limited and conservative approach inhibits the development and acceptance of crypto and blockchain technology throughout the world.

Public and Private

This approach seeks to create a partnership among innovators and regulators to develop laws that strike a balance between the evolution of the blockchain technology underpinning crypto and ensuring that all aspects of anti-money laundering (AML) compliance are maintained. Additionally, this approach encourages regulators to be better educated on the technology and have greater insights into how best to apply or develop regulations that will combat nefarious activity.

By working together, regulators are more likely to develop and apply effective standards and policies—instead of applying outdated and inappropriate regulatory frameworks that might not even be successful.

Comprehensive Approach

A comprehensive approach is one in which regulators design and implement regulations governing the activities of a regulated entity. A good example of this is how the U.S. requires licensing requirements for cryptocurrency exchanges at the federal and state level as part of the Financial Crime Enforcement Network (“FinCEN”) and its payment processing regulatory framework.

What’s to Come

While some cryptocurrency enthusiasts oppose new regulations (or any regulations at all), the vast majority understand and welcome the need for such guidelines. Still, we must ask, “How and to what extent it will be regulated?” In recent weeks, the reports coming in from the U.S. government suggest it’s not a matter of if further regulation is coming, but when.

In addition to these reports, the war on Ukraine has urged President Biden to take steps to regulate crypto through executive order. This comes at a time of heightened security and raises critical concerns and fears that Russia will use cryptocurrency to evade sanctions. With many groups praising the order, many others wonder if this is what the crypto industry needs. Or, will there be a rushed effort to create policies and write rules that may serve a purpose today, only to prevent any future or long-term technological advancement? Will the need to update policies become outdated before even having a chance to be implemented?

If done correctly and proactively, crypto regulations should create more market stability. Creating more regulatory guidance would likely reduce speculation and create investor confidence that could be regarded as an important tool for consumers for years to come. But this regulatory guidance shouldn’t come from regulators and government officials alone—there needs to be a partnership between and among the regulators and industry experts to provide a scalable regulatory framework.

About the Authors

John Arvanitis is a managing director in the Compliance Risk and Diligence practice of Kroll based in the Boston Office. John advises clients worldwide on anti-money laundering matters and other aspects of compliance programs, bringing impactful and valuable insight to their challenges via his extensive international and domestic financial investigative experience. He has significant experience across a broad range of compliance-related programs, including anti-money laundering, know your customer, global AML processes, and program and policy formation.

James Brennan is a director in the Compliance Risk and Diligence Practice and is based in New York. He has over 15 years of experience in accounting, auditing and litigation consulting services, including global forensic accounting and fraud investigations, AntiMoney Laundering Compliance, Cryptocurrency Regulatory Compliance, OFAC/sanctions review and accounting malpractice and bankruptcy related litigation.