The crypto question

Tuesday, 30 August 2022
The rise of virtual assets is gradually changing the face of the financial world. Helen Swire looks at how governments are regulating these new technologies.

With the evolution of technology moving at an ever‑increasing pace and much of our lives governed by our online connectivity, it was only a matter of time before the world saw digital forms of asset permeate the financial space.

It is entirely legal to conduct virtual asset transactions in many countries around the world, subject to regulation; however, such assets are recognised as legal tender only in the Central African Republic and El Salvador.

Nonetheless, many countries are considering the possible merits of adopting digital currencies. ‘The European Central Bank, in coordination with the central banks of Canada, Japan, Switzerland, Sweden and the UK, is currently studying the merits of a central bank digital currency,’ notes Pamela Cross TEP,[1] Committee Member on the STEP Public Policy Committee.

Leigh Sagar TEP,[2] a member of the STEP Digital Assets Special Interest Group (SIG) Steering Committee, agrees that the conversation is just beginning: ‘I believe that more countries will recognise some form of crypto‑asset as legal tender. There is increased interest from some countries in the establishment of their own digital currencies, which do not use decentralised blockchain technology and which operate in parallel with their own fiat currencies. Other countries, such as the UK and the US, have expressed interest in adopting some of the existing stablecoin technologies as national digital currencies, but with increased oversight, in the form of added security and regulation.’

He warns, however, that ‘current initiatives to recognise bitcoin are unlikely to be sustainable’, due to both the instability of the cryptocurrency and the lack of infrastructure for it to be used as a financial token, enabling such activities as borrowing and lending. Moreover, any usage of crypto‑assets, whether as legal tender or not, requires a regulatory system that can cope with the challenges posed in terms of money laundering and tax evasion.

Country‑by‑country regulation

Although the speed of movement of digital assets allows immediacy of investment and exchange, many allow for owner anonymity. As a result, the regulation of such assets has proved a challenge for governments.

The OECD has noted that tax transparency laws, as they stand, must be modernised to take into account the fact that crypto‑assets ‘can be transferred and held without interacting with traditional financial intermediaries and without any central administrator having full visibility on either the transactions carried out, or the location of Crypto‑Asset holdings’.[3] Additionally, it comments that ‘the Crypto‑Asset market has given rise to a new set of intermediaries … which may currently be subject only to limited regulatory oversight’.

‘The inherent features of cryptocurrency, such as speed, anonymity and huge shifts in price, have led to massive financial speculation and to criminals misusing crypto‑assets to receive ransoms and launder their proceeds,’ a Financial Action Task Force (FATF) spokesperson says. ‘We have seen hundreds of cases, including ransomware attacks on critical infrastructure with payments demanded in bitcoin. Without proper regulation of virtual asset service providers (VASPs), including licensing, registering, supervision to ensure these businesses do customer due diligence and report suspicious transactions, we will continue to see such cases.’

Various governments are taking steps to bring VASPs and crypto‑assets under appropriate anti‑money laundering (AML) controls to mitigate the associated risks. ‘Currently, jurisdictions are taking very different approaches towards regulating crypto‑assets,’ observes Philip Kerfs, Head of the International Cooperation Unit at the OECD Centre for Tax Policy and Administration. ‘A number have issued blanket bans on crypto‑asset trading, while others have sought to encourage their use and provide certainty for intermediaries active in the crypto space. Equally, some jurisdictions rely on applying existing regulations to crypto‑assets, while others have proposed bespoke, targeted regulatory frameworks.’

In 2021, Brazil and the US consulted on appropriate amendments to AML laws to increase oversight of cryptocurrencies, with the US asking for greater transparency and imposing more reporting obligations on financial institutions.

Also in 2021, the Australian government announced plans to increase its focus on tax obligations associated with virtual currencies, expressing concerns that many investors do not understand the taxation implications of crypto‑asset ownership. This year, the German government has done similar, releasing legally binding guidance on the income tax treatment of virtual currencies and other tokens.

The Cayman Islands has taken a two‑pronged approach to the regulation of VASPs in the jurisdiction, issuing guidance in 2022 for the provision of services by virtual‑asset custodians and virtual‑asset trading platforms, following the January 2021 introduction of a compulsory licensing regime for VASPs under the Virtual Asset (Service Providers) Act 2020. Its initial consultation on this guidance drew comparisons with the various different rules issued in jurisdictions including the Bahamas, Bermuda, EU Member States, Gibraltar, Hong Kong, Liechtenstein and Malta.

Kerfs notes that although any regulation is positive, a case can be made for a cohesive approach across jurisdictions: ‘Given that crypto‑assets and virtual assets, more broadly, are inherently global in nature, there is certainly an argument for a globally coordinated approach in assessing the risks and appropriate policy responses.’

Global standards

Both the OECD and the FATF have approached the crypto question with a view to finding a global answer. The FATF released guidance for a risk‑based approach to AML regulation of virtual assets and VASPs at the end of 2021. In March 2022, the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes started to consult[4] on new rules requiring crypto‑asset exchanges to report customers’ aggregate investments and transactions to national governments, so that the information can be shared internationally.

It is not out of the question that countries would be prepared to work together on a joint solution to the regulation of crypto‑assets. Kerfs observes that the FATF’s Recommendation 15 on the regulation of VASPs and the OECD’s proposed Crypto‑Asset Reporting Framework reflect a step in this direction. Similarly, he says, the EU’s markets in crypto‑assets regulation will harmonise the regulatory treatment of crypto‑assets not covered by existing EU financial services rules. Meanwhile, over 200 countries globally have committed to the FATF’s global standards and Australia, Canada, the Netherlands, the UK and the US have formed the Joint Chiefs of Global Tax Enforcement (the J5). The J5 was established in 2018 to lead the fight against international tax crime and money laundering, including tackling cryptocurrency threats and cybercrime.

‘These organisations essentially want to ensure that the crypto‑asset world does not sit outside the existing frameworks, particularly when it comes to taxation,’ explains Ross Belhomme TEP,[5] Chair of the STEP Digital Assets SIG Steering Committee. ‘Recent cryptocurrency crashes have shown how retail customers can easily trust something that isn’t quite as it sounds, so unless the market self‑regulates better, more regulation may be needed around crypto‑assets.’

STEP’s response[6] to the OECD consultation called for further clarity on the position of intermediaries such as reporting crypto‑asset service providers and Belhomme suggests that a global standard is not guaranteed to emerge from the work of the OECD and the FATF. However, Sagar counters that a move in that direction has already begun ‘with the adoption of the FATF guidelines and increasing cooperation between international governments’. He notes that the OECD’s initiatives have engendered a greater international understanding of the operation of these new technologies.

As with all forms of technology, however, virtual assets will continue to evolve and develop at speed. ‘Regardless of how crypto‑assets came into existence, they have a momentum and a life of their own now,’ says Belhomme. ‘A tokenised economy as part of the Web3 evolution of the internet is on its way and huge numbers of people have moved over from the traditional world to work on crypto‑asset projects. Virtual assets are not going to be regulated out of existence.’

A different kind of digital asset

When we talk about digital assets, cryptocurrencies often spring to mind first – but what about all those photos in the cloud and social media accounts? Bereaved relatives are increasingly finding that on top of losing a loved one, they do not have appropriate legacy planning in place to access personal digital assets.

STEP is calling on the government and service providers such as Apple, Google and Meta to do more to help people to pass on their digital memories. It has launched a new public-facing website to give tips on planning for what will happen to our digital assets when we are no longer able to access them. Visit memories.step.org to find out more.

 

Digital Assets: A Call to Action

STEP and the Microsoft-funded Cloud Legal Project at Queen Mary University of London last year published the results of joint research on practitioner experiences with digital assets, sponsored by IQ-EQ. Key findings included that digital assets have become a common part of estate planning and administration; clients frequently experience difficulties accessing digital assets on the death or incapacity of a family member; law reform is needed to enable effective estate planning; and there is a need for greater education for practitioners on best practices for dealing with digital assets. The report, Digital Assets: A Call to Action,[7] recommends a threefold approach based on education, collaboration and legislation to address the challenges.

 

[1] Pamela Cross TEP is Tax Partner at BLG.

[2] Leigh Sagar TEP is a Barrister at New Square Chambers.

[3] OECD Crypto-Asset Reporting Framework and Amendments to the Common Reporting Standard Public Consultation Document, bit.ly/3mtWlv4

[4] Above, note 3.

[5] Ross Belhomme TEP is Managing Director at Asiaciti Trust Singapore.

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Helen Swire

Helen Swire is News Editor at STEP.

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