3 predictions on crypto regulation in 2022
2021 may not have been the year your grandparents started trading cryptocurrencies, but it was definitely a watershed year for technology. In fact, the volume of crypto transactions has grown 567% year-over-year to reach a value of 15.8 trillion dollars in 2021, demonstrating that digital asset trading is becoming more and more mainstream. While the market is seeing some correction in early 2022, 2021 has been such a leap year that no one can deny that cryptocurrencies are here to stay.
According to cryptocurrency compliance provider Elliptic, although the total volume of illicit activity in cryptocurrencies has grown in absolute terms, illicit activity today still accounts for less than 1% of all transactions. However, in the emerging decentralized finance (DeFi) sector, which has seen the greatest impact by far, losses from theft and fraud are accelerating to over USD 10.5 billion in 2021, compared to USD 1.5 billion. in 2020. These rising figures have been a driving factor in the numerous examples of regulatory activity that occurred around the world in the past year, with significant developments taking place in Dubai, the US, the EU and Korea of the South, just to name a few.
These developments are important, because they bring confidence to cryptocurrencies, which will be crucial to their success.
This year the progress will be even more significant. I believe 2022 will be a turning point for crypto regulation, with three key developments coming by the end of the year.
Prediction 1: Consumer protection authorities will take a stand
As the cryptocurrency industry matures and becomes increasingly integrated with the traditional financial system, regulators are looking beyond anti-money laundering (AML) and counter terrorist financing (CFT) measures to focus on consumer protection. This is due to the highly accessible nature of cryptocurrencies: although it democratizes access to financial markets, it also exposes non-accredited and sometimes unsophisticated retail clients to enormous risks.
As the capitalization of the crypto market has increased tenfold since the beginning of 2020 to 2.2 trillion dollars in January 2022, protecting consumers from market volatility and ensuring their integrity has become a priority.
This will lead regulators, such as the US Consumer Financial Protection Bureau (CFPB), to take an increasingly important role in overseeing the cryptocurrency industry as they seek to implement standards, primarily on transparency, to protect consumers from fraud and manipulation. The regulation issued in 2022 by consumer protection bodies is likely to address transparency regarding crypto asset services offered to consumers, including liquidity requirements, to ensure that consumers can access healthy and efficient financial markets and non-code-based disclosures. for DeFi operations.
This could include requirements for DeFi platform developers to provide clear public statements (as well as any open source code they develop), which clearly articulate how their platform operates, as well as any risks consumers might encounter as a result of its design. It could also include requirements for the code behind DeFi apps to be subject to a regular third party or even regulatory scrutiny.
Prediction 2: Financial regulators will zero the DeFi
The growth in the DeFi sector has been incredible, with Elliptic finding that the total capital locked in DeFi services grew by more than 1,700% in 2021, to reach $ 247 billion.
While this presents opportunities for individuals and organizations that lack access to financial services, there is a downside: DeFi is also being exploited by malicious actors to steal, defraud and launder funds.
Most financial regulators globally have not yet clarified whether their existing frameworks apply to DeFi protocols. Despite this, policymakers are attempting to apply the same regulatory principles used in traditional finance to this new ecosystem to protect investors, and it won’t be long before local regulators put DeFi under AML / CFT regulations. existing.
We are already seeing the basis for local approaches in some jurisdictions. In August 2021, the United States Securities and Exchange Commission (SEC) imposed a cessation and desist order on market operators or monetary DeFi, which offered over $ 30 million worth of securities in unregistered offerings using a DeFi protocol, due to concerns about money laundering and misleading their customers.
As regulators take a closer look at the DeFi industry, developers and market participants will need to prepare to comply with the new requirements.
Prediction 3: VASP due diligence will become standard practice
In October 2021, the Financial Action Task Force (FATF) published a guide introducing the concept of due diligence of the counterpart’s Virtual Asset Service Provider (VASP) in the cryptocurrency sector. These due diligence requirements mirror those of the correspondent bank.
In practice, this means that a cryptocurrency firm is expected to perform proper due diligence on any other VASPs it is exposed to through customer transactions, such as its inbound and outbound fiat currency. This includes seeking negative media coverage, identifying any regulatory action taken against the company, and ensuring evidence that it has sufficient controls for AML, KYC and data protection.
This represents a huge business opportunity for traditional financial institutions. With the common practice of VASP due diligence in the cryptocurrency industry, banks will gain confidence and trust in their compliance processes, attracting many to serve the industry for the first time.
To take advantage of this huge opportunity, banks need to start thinking hard and fast about the changes they will need to make to integrate crypto assets efficiently and effectively.
General framework on crypto regulation
Although cryptocurrencies have benefited from the lack of clarity and the fact that they are in a gray area, 2022 could be the year when regulation turns blacker or whiter. The reduction of information asymmetries will give confidence and credibility to the ecosystem.
This presents huge opportunities, not only for VASPs themselves, but also for traditional financial institutions, many of which have so far limited their exposure to cryptocurrencies due to market volatility and potential reputational risks.
However, financial institutions will need to prepare to move quickly when it comes to compliance. Slow moving people risk losing significant new revenue streams where their more nimble competitors have already established themselves.
Manuel Silva Martínez is the General Partner of Mouro Capital, a UK-based venture capital firm.