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Partner Kate Gee and Associate Joshua Ryan explore the effect of legislative divergence in different jurisdictions on the regulation of cryptoassets.

Kate and Joshua’s article was published in Compliance Monitor on 9 October 2023, and can be found here. 

As the global crypto market looks to regulators to provide guidance as to the treatment of cryptoassets, there is an increasing level of divergence in how those regulatory bodies are responding. In the United States, there is also domestic tension between two key regulators – the Securities Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) – as they compete for control of crypto regulation.

Crypto exchanges typically evaluate a jurisdiction according to the level of legal and regulatory clarity which it provides for their business. By virtue of regulators moving at different speeds and taking an individual approach, this impacts the future direction and geographical footprint of the industry.

Charting its own distinct course, the EU adopted Markets in Crypto-Assets Regulation (MiCA) in April 2023. MiCA acknowledges digital assets as a new class of assets through a bespoke framework, and provides legal certainty around cryptocurrencies, security tokens and stablecoins. Scheduled to come into force across EU member states between mid-2024 and early 2025, it is anticipated that MiCA will provide crypto exchanges with regulatory certainty going forward.

In contrast to the EU approach, US ‘traditional’ financial agencies are seeking to retain control of the crypto industry, by classing digital assets within existing asset classes, either as securities or commodities, and regulating and supervising them accordingly by the SEC and the CFTC.

As recent legal action by the SEC shows, these traditional regulators of the financial sector can be unforgiving of (perceived) non-compliant behaviour, even if that behaviour took place at a time when the regulatory position was unclear.

In June 2023, the SEC filed two separate lawsuits against Binance and Coinbase, two of the most prominent international crypto exchanges. The complaints allege inter alia breach of SEC rules. As longstanding operators within a strict regulatory framework, traditional financial institutions are – broadly speaking – required to separate their different services. The SEC’s allegations include the following:

• The SEC alleges that Binance, the world’s largest crypto exchange, operated “multiple unregistered offerings” and combined “the functions of exchanges, brokers, dealers, and clearing agencies” – which in turn led to disproportionate (and concealed) risks and potential for conflict of interest. The SEC further alleges that Binance has been commingling funds, as well as its functions.
• In its complaint against Coinbase, the SEC adopts the position that crypto tokens traded through Coinbase are effectively securities by nature, and therefore subject to the strict US regulations relating to securities trading. The SEC accuses Coinbase of operating since at least 2019 “as an unregistered broker … an unregistered exchange … and an unregistered clearing agency” thereby defying “the regulatory structures and [evading] the disclosure requirements that Congress and the SEC have constructed for the protection of the national securities markets and investors.”

Unlike its allegations against Binance, the SEC does not suggest that Coinbase has been commingling funds – its complaint alleges the non-separation of its functions, albeit ones which traditional financial institutions would be expected to separate.

Allegations of this nature are nothing new in the traditional finance space. But the complaints filed by the SEC indicate that it is seeking to take control of the sector through enforcement action in the crypto space for breaches of US securities law. This has been described by several US commentators as being part of a ‘power grab’ by the SEC, despite the fact that the regulatory position in relation to crypto is still at a very early stage – and remains largely untested. It is likely that these SEC complaints will be very disruptive to the crypto market – of which the SEC will be well aware. As an initial indicator, when news of the SEC charges against Binance emerged, the price of Bitcoin fell by 5.5% to $25,662 – its lowest point in almost three months prior. Regulatory action against another rival exchange FTX, which collapsed in November 2022, similarly led to a significant drop: the price of Bitcoin fell by almost 25% in the immediate aftermath.

The complaints against Coinbase and Binance indicate that the SEC is keeping this sector under scrutiny, and accordingly other crypto exchanges, which also allow US investors to trade such cryptocurrencies, might face similar action. Notably, in March this year the CFTC sued Binance, only three months before the SEC launched its own legal action against the exchange.  This is a further indication of the battle between US authorities regarding the future supervision of crypto tokens, and there is no doubt that SEC oversight would require significantly stricter compliance standards.

Another thing that is clear from these recent developments is that, in order to grow sustainably, the crypto industry needs a global regulatory regime that is robust, consistent (or sufficiently consistent) and reliable.  As regulatory certainty becomes increasingly important for the digital asset industry, the sector may see crypto companies choosing to move away from the US to other markets that offer a regulatory environment that is more stable and/or more transparent, such as the EU, or to jurisdictions which are more quickly developing bespoke crypto regulatory frameworks, including Gibraltar, the UAE, and Switzerland.

It remains to be seen whether the SEC’s commencement of formal legal action will lead to an exodus of this nature. Alternatively, US regulators may progress a draft bill, which, for example, includes proposals for the treatment of tokens as commodities instead of securities – a position that the CFTC say would likely provide more clarity – and therefore comfort – for market participants.

Indeed, a burst of activity in the US Congress during late July saw lawmakers engaged in shaping draft crypto bills. The House returned from recess on 12 September to vote on this legislation, which includes a process to determine when and whether digital assets will be treated as securities to be regulated by the SEC or commodities overseen by the CFTC.

In parallel, the SEC has taken other steps which indicate an intent to assert greater authority over the market.  In July, the SEC asked Coinbase to halt trading in all cryptocurrencies other than bitcoin. According to the Financial Times, the SEC “made the recommendation before launching legal action against the Nasdaq-listed company last month for failing to register as a broker.” Identifying the 13 most lightly traded cryptocurrencies on Coinbase’s platform as securities, the SEC asserts that by offering them to customers the exchange falls under the regulator’s remit.

In the UK, the future remains unclear. The prime minister, Rishi Sunak, has historically been a strong supporter of the crypto sector, stating that his goal is to make the UK “the jurisdiction of choice for crypto“. However, political ambitions are much easier to give than legislative and regulatory substance is to deliver.

So far, legislative progress in the UK has been a bit slower than in the US or the EU. In April 2022, the government confirmed that it was committed to introducing a new regulatory regime for cryptoassets. As part of its ‘phased approach’, the UK Treasury launched a closed consultation in February 2023, together with a call for evidence on a series of proposals, entitled: Future financial services regulatory regime for cryptoassets.

The consultation sets out proposals to regulate certain categories of cryptoassets and related investment activities. The proposals “seek to deliver on the ambition to place the UK’s financial services sector at the forefront of cryptoasset technology and innovation and create the conditions for cryptoasset service providers to operate and grow in the UK, whilst managing potential consumer and stability risks.”

Beyond these broad vision statements, the intention set forth in the proposals is that cryptoassets which carry a similar investment risk to ‘traditional’ asset classes are subject to the same regulatory oversight. In this respect, the Treasury is considering whether to treat cryptoassets as specified investments for the purposes of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO), which means that any specified activities performed in relation to cryptoassets will be captured by the regulatory regime.

In scope, the proposal is that persons who undertake certain activities in relation to cryptoassets will need to be authorised to do so under the RAO. It would therefore be prudent for companies which are engaged in such activities in the UK to consider whether they might fall within the scope of the proposed regulated and designated activities. If they have any questions on how they should review the governance of their businesses – as well as their client and asset protection – they should seek advice so that they are well placed once the result of the UK Treasury’s consultation is published later this year. The consultation ended on 30 April 2023, and it is anticipated that the UK government will implement the new regulatory proposals ahead of MiCA’s scheduled launch next year across the 27 EU member states.

In parallel, and pending regulatory reform, the courts of England and Wales continue to respond to the demands of dealing with legal action involving crypto companies and digital assets. To date, the laws and courts of England and Wales have proven to be sufficiently resilient and flexible to recognise certain digital assets as things to which personal property rights can relate. The recent UK Law Commission’s Report on digital assets considered that those core legal issues have already been dealt with sufficiently.  Accordingly, it is the “highly nuanced and complex” areas that mean to be dealt with by regulatory and statutory reform – and this will continue to be the case as both technology and the market for these types of assets continue to develop. The Report describes the UK as a jurisdiction “well-placed” for these new financial services, and one which shall – with its common law system – remain a “globally competitive and flexible tool for market participants in the digital asset space”. Accordingly, regardless of the timing of new regulation, we expect to see more claimants bringing new or reformulated causes of action in claims relating to digital assets.