Navigating Crypto Regulatory Challenges: Key Insights for Stakeholders

Key Crypto Regulatory Challenges

A promising financial technology can only be as good and secure as its guardrails of monetary policy and regulatory authority. Let’s explore crypto’s current regulatory landscape and its challenges.

Defining Cryptocurrencies

Cryptos can be as fluid or as rigid as their purpose demands — some, like Bitcoin, are used for payments, and others like Ethereum are used for smart contracts, or even governance (DAOs). Their use cases can also overlap, making them difficult to categorize: are they an asset, a virtual currency, or a security? This ambiguity makes it difficult to regulate as it isn’t a one-size-fits-all situation.

AML/KYC Compliance

As a decentralized financial network, the crypto markets can offer many benefits beyond what traditional finance can do for customers. However, this can also make it susceptible to illegal activity — take the Plus Token Ponzi Scheme in 2019 as a clear example. As a response to these risks, cryptocurrency exchanges must follow strict Anti-Money Laundering (AML) practices, including Know Your Customer (KYC) policies, to operate diligently.

Adhering to these regulations means crypto networks must invest in more safety procedures to vet users and their transactions, possibly increasing fees as infrastructure improvements demand more maintenance and constant supervision.

Taxation

The lack of global crypto regulations makes taxation a massive hurdle for everyone involved. In places like the US and Canada, cryptos are seen as property rather than currency, triggering capital gains or losses taxes — its volatility makes defining tax rates even more complex.

On the other hand, rewards from mining and staking carry a duality, where they can be defined as currency or property in other countries, further blurring the lines for taxation. Cross-border payments face the same fate as each jurisdiction defines these financial instruments, transactions and assets differently.

Data Privacy

In places like California or the European Union where existing laws like the CCPA and GDPR are heavily enforced, blockchain technology can pose a significant challenge to data privacy. For example, the nature of blockchain, an immutable distributed ledger technology, conflicts with citizens’ right to control their personal data as they can’t delete records upon request. And, because of its decentralized dynamic, it’s difficult for regulators to place responsibilities on a specific blockchain entity.

Security and Cybersecurity

Security has always been tricky in crypto markets — highly globalized yet with little global standards. Malicious actors can take advantage of the gaps in geographic frameworks, and the anonymity granted to users, to hack and steal assets and data. Entities like the Financial Action Task Force (FATF) and the Securities and Exchange Commission (SEC) do their best to enforce controls in these networks, yet many cases still fall through the cracks.

These disparities show the need to implement mandatory audits, more disclosure requirements, stronger authentication protocols, and secure custody solutions to further consumer protection and reduce illegal activities in the industry, but there’s a long way to go.

DeFi Regulation

Decentralization is something that traditional financial institutions and regulatory agencies have never dealt with before. This means it’s necessary to think outside the box to begin conceptualizing security regulations for DeFi. For example, who’s accountable when an incident arises, and how can it be fixed? As anonymous stakeholders, the absence of a central system, and the inability to revert transactions rule in DeFi, there has never been a more complex environment to regulate.

Stablecoin Regulation

Stablecoins are bridging the gap between digital assets and traditional currencies, making crypto markets friendlier for all. However, its digital nature still puts financial stability and consumer protection at risk. TerraUSD (UST), a coin previously pegged to the US dollar, is today’s cautionary tale on the issues posed by stablecoins. The digital currency experienced a “death spiral” when a few significant withdrawals took place in May 2022, leading the coin to destabilize and lose its equivalency with USD.

As with other cryptocurrencies, stablecoins still fall under a gray regulatory area worldwide, increasing complexities around consumer protection and sanctions when networks destabilize suddenly.

Navigating the Regulatory Landscape

So, how can the world begin to rein in crypto markets to make them a safer and more welcoming place for users? A few pointers include:

• Proactive Compliance: While crypto compliance has been mostly reactive until now, it’s necessary to implement proactive regulations based on the numerous past incidents in the industry. This way, issues like data breaches, rug pulling, and other financial crimes can be cut straight from the root.
• Legal Counsel: Although cryptocurrencies are a fairly new affair compared to traditional finance, the industry has undergone enough phases to foresee potential issues and build a team of experts to help protect companies in crypto markets. Seeking legal counsel is paramount to best adhere to ambiguous crypto regulation, find common ground in the laws of various jurisdictions, and stay compliant.
• Regulatory Monitoring: The regulatory authority is trying to keep the same pace of crypto evolution, meaning it’s ever-changing and very easy to fall out of line. To comply, anyone involved in the space should constantly monitor new changes, whether through government entities like the SEC, global institutions like the FATF and OECD, or popular publications like CoinDesk.
• Collaboration and Advocacy: Perhaps what’s missing in the industry is more unity and efforts to converge and discuss potential solutions to common risks. As such, it’s important for businesses to join associations and lead public and private initiatives to bridge security gaps and build a more stable industry.
• Risk Management Framework: Addressing challenges in such a risk-prone industry is crucial for crypto companies to stay afloat. Planning and implementing a risk management framework should become a must-have practice for these businesses. For example, supervising and updating AML and KYC practices, enforcing strict cybersecurity audits and daily approaches, and engaging legal counsel.
• Building Trust and Transparency: Complying with regulators and being outward about security practices ensure customers, investors, and regulating entities that a company takes matters seriously and cares for its users’ well-being. This is especially important in a novel environment filled with volatility.
• Jurisdictional Strategy: Lastly, knowing where to set up shop can be a strategic advantage depending on the crypto business founders want to run. The US, with its share of freedom in a vastly unregulated space, greatly differs from the European Union, where GDPR and Markets in Crypto-Assets Regulation (MiCA) make it less risky yet inhibiting to operate.

Future of Crypto Regulation

In hindsight, all of these crypto regulatory challenges demonstrate the crypto industry has a massive ceiling, only needing a little push to continue thriving and delivering democratized access to financial services, global standards, and more financial freedom.

One of the biggest challenges that needs enforcement actions is globalization harmony. Once companies can operate on a global scale and users can freely transact crypto and digital assets from one jurisdiction to another without major taxation and compliance hurdles, the industry will be ready to move on and scale even further. For now, the existing regulatory disparity threatens every actor in the space with uncertainties and legal loopholes.

Moreover, it seems the regulatory authorities are too focused on defining and controlling specific technologies rather than the industry as a whole. This is another obstacle that needs to be tackled soon, ensuring that regulatory frameworks focus on technology-neutral controls rather than hyper-policing aspects like Bitcoin, and forgetting other elements of crypto regulation like securing blockchain networks and emphasizing consumer protection.

But keeping up with crypto’s quick pace and financial innovation shouldn’t mean stifling its growth with overregulation — something often seen in markets in advanced economies like the EU. The best way to move forward is to ensure safety meets innovation, giving technology the space it needs to improve without putting users and economies at risk.

An underlying technology like AI can help bridge this gap by supporting automated monitoring, analytics, and vetting, allowing public and private institutions to protect their crypto assets and comply with securities laws and regulations with efficiency and accuracy.

The crypto landscape has been victim to skepticism, cyber threats and financial crimes from malicious actors, regulatory developments and many other ailments that could’ve put the industry to an end. Yet, its disruptive approaches and the major advantages it can bring to investors, businesses of all kinds, and the everyday consumer, have turned it into a resilient industry. Regulatory challenges might continue, but cooperation from regulators and entrepreneurs can make a massive difference in how crypto evolves.

Insurance Rebuilt, End-to-End

We've supported startups from stealth mode to huge funding rounds.

Get a Custom Quote