When the US supervisory authority SEC allowed an investment product referencing Bitcoin futures to be traded for the first time last October, this was widely perceived as a signal that cryptocurrencies had finally become established as an asset class.
By Dr. Alpay Soytürk, Chief Regulatory Officer, Spectrum Markets
When the US supervisory authority SEC allowed an investment product referencing Bitcoin futures to be traded for the first time last October, this was widely perceived as a signal that cryptocurrencies had finally become established as an asset class. This conclusion hasn’t been exactly precise because the instrument admitted to trading is an ETF, which means it is a sufficiently standardised product. The requirements for approval are linked to standards in terms of transparency, legal certainty and tradability.
Hence, the question is why an admission could have been refused at all, as long as the products represented in the ETF, whether securitised or as direct investments, are not prohibited by law and the investment vehicle otherwise meets all formal requirements. In other words, and this is probably what many market observers were expecting, the non-admission would have been an anticipation of a ban on Bitcoin by the supervisory authority – which the SEC nevertheless refrained from.
The reverse conclusion, according to which this would have been the starting signal for cryptocurrency ETFs in the U.S., isn’t correct either. This is not only shown by the subsequent decisions of the SEC: some ETFs were not approved, some decisions were postponed.
Currently, there is no overall regulatory framework for crypto assets in the U.S. – which is unusual for the world’s largest and otherwise quite strictly regulated capital market. What is unusual, too, is that U.S. legislation, for once, is lagging behind European rules.
However, in the context of Bitcoin & Co, some misunderstandings must also be dispelled, usually beginning with the terminology. For example, “crypto-asset” is a very broad very broad, collective term and not yet a universal definition. The European draft regulation MiCA defines crypto-assets as a digital representation of a value or right that can be transmitted and stored electronically and that uses distributed ledger technology (DLT). MiCA divides crypto-assets into “asset-referenced tokens”, “e-money tokens” and “utility tokens”.
Asset-referenced tokens are crypto-assets that are intended to serve as a medium of exchange and for which a stable value is assumed by referencing fiat currencies, commodities or other crypto values (also known as so-called stablecoins). E-money tokens are crypto assets that are intended to serve as a medium of exchange and which are denominated in a fiat currency. Utility tokens are crypto assets that offer digital access to applications, services or sources on the DLT and are only accepted by the issuer.
Cryptocurrency is not synonymous with crypto-asset
Despite or precisely because of the variety of terms, their meanings and the respective areas of application, cryptocurrencies are still largely equated with crypto-assets. Bitcoin, for example, neither falls into the category of asset-related tokens, nor is it e-money or even an e-money token, and it no utility token, too. And although the draft MiCA regulation attributes certain advantages to payment tokens like Bitcoin such as being cheaper or allowing faster and more efficient payment processing, especially across borders: they are not the subject of MiCA.
A paragraph dealing with the Proof-of-Work (PoW) consensus mechanism, which is particularly related to Bitcoin, was removed from MiCA. The PoW mechanism ensures that a transaction is immutably verified and stored securely on the blockchain – and it is extremely energy-intensive. While this sustainability aspect is no longer part of MiCA, it will enter into the EU taxonomy regulation. This is likely to have consequences, for example with regard to the composition of sustainable ETFs. Beyond that, Bitcoin is not regulated here.
In contrast to the crypto-assets as categorised by financial supervisory authorities, it is also noticeable that there is very little mention of “cryptocurrencies” officially and that the EBA rather speaks of “Virtual Currencies” (VCs). According to the EBA definition, VCs are the digital representation of an asset that is not created by a central bank or agency, and need not be linked to legal tender.
The German Banking Act (KWG) equates virtual currencies with crypto- assets and thus categorises them as financial instruments. Based on this definition and its own classification of VCs as units of account, BaFin also classifies them as financial instruments.
While meeting the general definition of money – Bitcoin functions as a unit of account, a means of exchange and payment and, for most people, also as a store of value – it does not represent money in the classic sense. For one thing, it misses the recognition as legal tender which, among other things, obliges the recipient of a payment to accept it in the relevant currency.
Above all, however, there is no coverage by a central debtor such as a central bank, which recognises the outstanding volume of a currency as its liability being prepared to exchange its equivalent value, and to aim for price stability in the relevant currency area.
Bitcoin as crime enabler
Currently, calls are growing more strident for a regulation or even bans on Bitcoin. This consistently happens in connection with money laundering, fraud and the financing of crime or terrorism. Recently, however, also due to the assumed possibility of circumventing sanctions.
Without issuing a clearing certificate for Bitcoin: it seems downright unsuitable for at least some of the above practices. A key argument against using Bitcoin to commit crimes is that transactions in Bitcoin are by no means anonymous. All transactions are not only public but permanently stored in the network. A Bitcoin payment transaction cannot be reversed, but only revised by a repayment by the recipient.
Bitcoin addresses can of course be changed, most crypto payment service providers or account providers now do this automatically for data protection purposes. However, all of these service providers are in turn subject to strict requirements for KYC processes which, among other things, have to take into account the applicable money laundering legislation and those for combating the financing of terrorism. Processing payments outside of these service provider networks is possible, but in practice means a severe limitation of options.
If one thinks of the different phases of money laundering, it becomes clear that in the third phase, the integration of the incriminated money into the legal economic cycle, the recipient of a payment must also accept Bitcoin. In combination with the limited volume of the cryptocurrency market itself, this seems to impose natural limits on the phenomenon of money laundering, at least on a larger scale.
For the exchange of the currency of a sanctioned state into Bitcoin a transaction platform such as Coinbase or Binance is needed. Aside from the questionable demand for a sanctioned currency, enforcing a ban on participants from affected countries is easily enforceable on these exchanges and already common practice.
Crypto regulation vs legacy regulation
It is important to understand that the proposed MiCA regulation will regulate the tokenisation of transferable assets or rights. It establishes uniform requirements for transparency and disclosure in relation to the issuance activity, operation, organisation and governance of crypto asset service providers. In addition, consumer protection rules and measures to prevent market abuse are anchored.
The “DLT pilot regime” also presented as part of the EU’s Digital Finance Package regulates the tokenisation of processes for market infrastructures, such as for trading and settlement platforms. So, if a MiCA-regulated security is no longer a certificate, but an entry in a decentralised cryptographic electronic register, the DLT pilot regime regulates the customs for the order books of trading platforms or the steps within the settlement process. Both sets of rules can already be described as groundbreaking for a capital market of the future and it is more than likely that regulation in other jurisdictions will be oriented towards these.
However, as stated above, Bitcoin is not a tokenised asset. Bitcoin is a virtual currency – let’s think again of it as a unit of account, means of exchange/ payment and a store of value – whose value has historically increased immensely, but which fluctuates very strongly, partly because it is not tied to a central bank function.
On the relevant exchanges, Bitcoin is traded against a fiat currency or against another virtual currency like with an FX currency pair. In general, anyone who trades virtual currencies in their own name for the account of a third party operates a financial commission business. This is, in contrast to the pure use of virtual currencies as a substitute for cash or book money, subject to approval. If the operator of a VC platform only brings together buying and selling interests without taking a position in the transaction, it is a multilateral trading system.
Although virtual currencies are not an explicit part of the new draft crypto regulations, this does not mean that there is no standardisation or protection through regulation in the VC realm. With the categorisation of virtual currencies as a financial instrument and the recognition of the custody, management and safeguarding of crypto assets as financial services, the scope of the KWG has been expanded accordingly.
In addition, trading in derivatives on payment tokens such as Bitcoin had already been within the scope of the Markets in Financial Instruments Directive (MiFID) before. An amendment to the definition of financial instruments according to MiFID to include those issued on the basis of distributed ledger technology, so-called “security tokens”, is in preparation, so nothing will change in this area of application in the future.
As calls for stricter and, more importantly, unified regulation of crypto assets grow louder, it is important to continue to look at the situation in a differentiated manner. This means not losing sight of the regulations that already apply with regard to derivatives on cryptocurrencies, for example. The same applies to the regulation of trading platforms. It should also not be forgotten that supervisory authorities are already insisting very strongly on compliance with uniform rules when marketing cryptocurrencies and that they are closely observing the new, powerful distribution platform of influencing via social media.
In general, it is to be welcomed that most governments are showing reluctance when it comes to general bans. Ultimately, a “race to the bottom” – the race for the most relaxed standards in the existing financial market regulation, which was feared by many in connection with Brexit – did not materialise.
With a view to a future capital market structure based on cryptographic processes and a high degree of digitisation, the opposite can even be observed. There are a variety of international efforts to create framework conditions that, on the one hand, take account of the speed and complexity of technological development by offering the developers of the relevant technologies the leeway they need. On the other hand, an attempt is made to ensure market integrity and stability and not to weaken investor protection.
Fortunately, Europe is making a name for itself as a pioneer here. However, in order for regulation to be able to actively contribute to the modernisation of the financial markets, especially in the area of crypto assets, a coordinated approach with a maximum degree of convergence between the world’s largest capital markets is essential.
Alpay Soytürk, Chief Regulatory Officer at Spectrum Markets
Alpay joined Spectrum Markets in 2019 and is heading the Compliance and Risk Department as Chief Regulatory Officer. He is appointed as the AMLO and is also responsible for MaRisk Compliance and Data Protection. Before joining Spectrum Markets he worked for Deutsche Börse Group from 2013 in different areas like in the Market Structure & Regulation team at Eurex, the Group Regulatory Strategy / Regulatory Analysis team and in the Market Data + Services division of Deutsche Börse AG, covering regulatory topics in the market data and index business area. Prior to his move to Deutsche Börse Group he was in charge of regulatory issues in the Regulatory Affairs division of Stuttgart Stock Exchange.
 Securities and Exchange Commission
 Exchange-Traded Fund
 Proposal for a Regulation on Markets in Crypto Assets
 European Banking Authority
 Bundesanstalt für Finanzdienstleistungsaufsicht
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