As the crypto adoption question continues to dominate the space, crypto-skeptics have pointed to compliance as the industry’s Achilles heel.
While that may be true on some level, things are changing with the transition to stable and mature markets.
Our team of experts have come all out to give us their thoughts on the ever-evolving relationship between compliance and adoption.
Here’s what they had to say.
Isaac Patka, Founder at Shield3
Traditional finance evolved complex regulations and oversight mechanisms to manage stability, trade, and limit harm to market participants. These regulations, while cumbersome, attempted to ensure a certain level of trust, safety, and order. When regulators approach the world of crypto finance, they attempt to impose or adapt these same rules. But the decentralized, borderless, and permissionless nature of blockchains often clashes with these traditional regulatory frameworks. For protocol developers, these impositions can feel impossible to reconcile, and risk stifling innovation. Recently US DOJ arrested developers of the privacy payments application Tornado Cash for violating sanctions. If the act of writing code that ends up being used by criminal organizations is a crime, then not only the crypto space but the entire software industry is at risk.
End-users, whether they’re individuals or businesses, have to deal with uncertainty about how they can safely engage with crypto systems without facing consequences from legacy systems. For example, companies that intend to leverage crypto assets can have a much harder time opening bank accounts. The increased scrutiny, just from mentioning any affiliation with the crypto space can lead to months to years long delays. This makes it difficult for companies to accept investment and operate their businesses. As a result of these challenges, innovators struggle to ensure compliance and push the boundaries of what’s possible. Instead of focusing solely on groundbreaking solutions, they often get stuck navigating regulatory hurdles.
One area that we are starting to see some clarity is in stablecoins. Stablecoins allow people around the world to access safe ways to save, borrow, and handle payments, especially if they live in an area with volatile and unpredictable Fiat options. Fiat backed stablecoins have to straddle both legacy and crypto financial systems. Some institution with a bank account has to hold the assets backing the tokens, and they are subject to regulations both where they are based, and all the markets in which they intend to operate. Recently the Federal Reserve in the US published a notice reminding banks that they have to manage their operational, cybersecurity, liquidity, sanction, and consumer protection risks when supporting stablecoins, the same way they have obligations for traditional banking products.
Sensible, consumer protection focused regulations on issuing stablecoins would actually aid in adoption and have a positive impact for people around the world. Earlier this year USDC was impacted by the collapse of banks holding the assets backing their stablecoin, leading to a temporary drop of USDC value. In order to avoid widespread crises in stablecoin based crypto finance, we need to ensure that the underlying assets are safe and secure, and have a competitive market of issuers to minimize the risk of any individual issuer failing.
John Mannino, Chief Compliance Officer at sFOX
Compliance practices play a significant role in shaping the adoption of cryptocurrencies and blockchain technology. The crypto industry has faced various challenges related to regulatory compliance due to its decentralized and often misconstrued belief in its pseudonymous nature.
In the US, crypto platforms that want to play by the rules have become increasingly frustrated with the SEC’s “regulation by enforcement” actions. Participants want to be compliant, but we all just need a clear and agreed-upon rule book.
Here are some positive and negative ways in which compliance practices impact crypto adoption:
Positive Impacts:
Legitimacy and Trust: Regulatory compliance helps establish legitimacy for the crypto industry in the eyes of governments, financial institutions, and the general public. This can foster trust and attract traditional investors, businesses, and users to enter the crypto space. This clarity can encourage innovation by reducing uncertainty and encouraging entrepreneurs to develop new and compliant solutions.
Institutional Participation: Institutional investors, such as hedge funds, investment firms, and asset managers, are often required by law to comply with specific regulations. Clear compliance practices can encourage these entities to invest in cryptocurrencies, thereby increasing adoption.
Reduced Risk: Compliance practices, such as anti-money laundering (AML) and know-your-customer (KYC) procedures, can help mitigate the risks associated with fraudulent activities, money laundering, and terrorism financing. This can make the crypto ecosystem safer for users and investors.
Negative Impacts:
Barriers to Entry: This is where smart regulation comes into play. Overly complex or burdensome compliance requirements can deter startups and smaller players from entering the crypto space. This can stifle innovation and limit the diversity of participants.
Decentralization Challenges: Some compliance practices may clash with the decentralized nature of cryptocurrencies. Striking a balance between compliance and preserving the core principles of decentralization can be challenging.
Geographical Fragmentation: Divergent compliance practices in different jurisdictions can lead to geographical fragmentation of the crypto ecosystem. This can lead to geographic regulatory arbitrage and can hinder global adoption and create confusion.
In conclusion, compliance practices play a critical role in shaping the adoption of cryptocurrencies. While they can provide legitimacy, attract institutional investors, and mitigate risks, they can also create barriers to entry, raise privacy concerns, and impact the decentralized nature of the technology. Achieving a balanced and well-calibrated approach to compliance is crucial to foster healthy growth and adoption within the crypto ecosystem.
Katherine Kirkpatrick, Chief Legal Officer, Cboe Digital at Cboe Global Markets
The concept of compliance can mean different things depending on the context, project, and jurisdiction. For example, a large compliance team is often necessary to ensure compliance in highly regulated industries or to respond to exams, inquiries, or rules applicable to an entity by virtue of operation in multiple jurisdictions.
Compliance in crypto can be difficult for a number of reasons. First, even at the early stages, many crypto projects touch multiple jurisdictions, so it’s difficult for the project to ensure compliance with all of those different rules without a large legal and compliance team on hand. Second, especially in this environment, many crypto projects are undercapitalized, so they can’t or won’t invest sufficiently in compliance or legal. Third, some of the draft legislation we’ve seen doesn’t fully appreciate the difficulty—due to the nature of the technology and/or the different aspects of the crypto ecosystem–in compliance. Finally, some projects resist certain aspects of compliance—such as the production of identifying information—because it is antithetical to the original and purest tenets of crypto.
Jen Hicks, Founder & Consultant, Annapurna Uprising; Previously Director of Client Development at Capital Fund Law Group
Understanding the compliance standards for digital assets across various sectors has been confusing for many. While other countries have adopted clear regulations, the United States has dragged its feet in implementing digital asset-specific rules and comprehensive guidance.
For example, investment managers managing funds with portfolios entirely or mixed with digital assets has been a perceived grey area. Although regulators have been using existing precedents on what is a commodity or security, managers must look to legal counsel with expertise in this area to avoid the potential of running afoul.
Some balk at the thought of additional government regulations, considering this an overreach. However, we should not dismiss the huge impact of the lack of regulations and compliance oversight on hundreds of thousands of investors. From the digital asset banking collapse to the downfall of FTX, we need to recognize the role that compliance oversight, or more accurately — the lack thereof, played in these disastrous outcomes.
Investors want to feel assured that investment managers, banks, custodians, and others have clear requirements to follow, and if not followed, strong consequences for such failures will be implemented. Our self-regulating bodies, such as the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), have a duty to mitigate investor risk from a regulatory level, especially with the increase of bad actors who have consistently preyed upon investors that do not have a deep understanding of the digital asset space.
Overreach is one thing, but implementing regulations to build investor confidence will help this industry gain credibility, expanding opportunities for growth to those dedicated to upholding their fiduciary duties. For now, digital-asset-focused companies would be wise to hire expert legal counsel and compliance specialists who take a conservative approach to digital asset regulations and compliance.
Mriganka Pattnaik, CEO at Merkle Science
The crypto industry’s ever-evolving terrain witnesses a dance of regulatory changes that yield both challenges and opportunities, requiring a nuanced balance between compliance, efficiency, and growth. Amidst this flux, compliance costs loom large for crypto businesses, demanding meticulous alignment with evolving regulations. These costs, though resource-intensive, embody a cornerstone of responsible growth. Regulatory compliance, safeguarding users, investors, and stakeholders, is non-negotiable, fortifying the industry’s long-term credibility and resilience. Within this context of compliance costs and resource allocation, the emergence of a compliance-first approach shines as a guiding principle. The compliance-first approach, beyond being a strategic commitment, empowers crypto enterprises to establish a culture where regulatory adherence is integrated seamlessly into daily operations. By proactively anticipating regulatory changes and embracing compliance as a guiding principle, businesses can chart a course of sustained growth, trust-building, and a resilient market presence.
Amid changing regulations, navigating licenses grows complex. Evolving crypto classifications add uncertainty. Crypto businesses must decipher evolving requirements, engage proactively with regulators, and showcasing compliance mechanisms. This underscores regulatory commitment in securing licenses within the dynamic landscape. Additionally, as businesses strategize, they must navigate the intricate world of regulatory arbitrage, carefully managing jurisdictional disparities across varied regulatory environments
In the evolving crypto regulatory landscape, businesses stand at a crucial juncture to proactively shape their path. Seeking direct guidance from local regulators on licensing, segregating and safeguarding user assets, AML/CFT rules and more is vital. This engagement showcases commitment to compliance and fosters nuanced jurisdictional understanding. Simultaneously, creating interim internal regulatory strategies based on this insight prepares businesses for smoother transitions when concrete regulations emerge. Additionally, adhering to internationally recognized standards set by organizations like the FATF further underscores the industry’s commitment to upholding rigorous standards. Collaborating with third-party technology service providers, including sanction screening and blockchain analytics companies, aids in aligning operations with compliance requirements. Herring, expert entities bring specialized insights that can ensure adherence to regulatory norms and best practices.
Interestingly, the crypto industry also stands uniquely poised to take proactive action by establishing self-regulatory standards and best practices. This self-regulation can align with government oversight, emulating established sectors like securities and futures. Encouraging and accelerating initiatives from notable organizations like the Global Digital Asset & Cryptocurrency Association, Blockchain Association, Global Blockchain Business Council, and CryptoUK holds the potential to set influential industry benchmarks, further advancing responsible growth within the sector.
Related: Brian Reisbeck of Coinme Explains Crypto Compliance and More
Caspar Sauter, Co-Founder at D8X
Sensible regulations from a regulator with a nuanced understanding of the industry are a long-term growth opportunity. Just look at Switzerland. Regulatory clarity allows institutions such as state-owned banks PostFinance and Luzerner Kantonal Bank to enter the industry. In a message to customers, PostFinance uses the regulatory oversight as a selling point, saying the bank’s “experience in regulatory compliance [… makes] crypto trading more secure and trustworthy.”
For DeFi projects, compliance with sensible regulatory approaches does not have to be overly difficult. The Swiss financial market regulator FINMA for example highlighted the importance of distinguishing “genuine DeFi applications” from those who are “decentralized in name only”, clearly suggesting that the latter fall within TradFi market regulations but not the former.
Complying with such a regulatory view essentially boils down to building a truly decentralized protocol. This is by all means not an easy task, but a goal that is fully aligned with the ethos of decentralized finance.
Mike Carter,Senior Managing Director, Blockchain and Digital Assets, FTI Consulting
Compliance in any industry is a necessity. In crypto, the lack of clear regulatory guidance can push compliance initiatives to the background for both emerging and established digital asset projects in favor of focusing on project development. Crucially, a crypto or defi project could touch on various compliance issues including fraud, consumer protection, global sanctions and data privacy, among others. Without common regulatory structures or standards, crypto projects looking to scale globally need to explore early investment in their compliance, legal and regulatory efforts.
The ”investment” in compliance requires upfront resource investment through both time and expense, however, the return is likely to result in positive long-term outcomes for digital assets projects. Efforts to abide by regulations, protect consumer assets and information, and exclude bad actors are more likely to build community trust and translate to wider adoption. A lack of proactive compliance can create substantial friction with regulators that may snowball into investigations, fines, reputational issues, consent orders, expensive remediations and loss of licensing… all of which can affect a project’s utility, scaling and profitability.
There are a few core principles that can support appropriate compliance, even during startup and growth phases when resources need to be prioritized:
- Hire experienced legal and compliance officers and listen to them. Many root causes of compliance failures start with a lack of expertise at the start.
- Establish reasonable financial and data frameworks. Regulators, examiners and auditors will frequently request various forms of financial, transactions and customer data. Good data establishes trust.
- Deploy quality third-party compliance tools. Otherwise, excess time and resources may be spent building, fixing and defending a proprietary tool. Regulators tend to ask fewer questions about the common RegTech tools they are familiar with.
- Focus on effectiveness. If an organization says it’s going to do something in a compliance policy, it should be carried out to the best of the available resources and capabilities. Possessing policies that a project doesn’t effectuate can sometimes be worse than no policies at all.
Related: What are the Best Compliance Practices for the Crypto Space? (Round Table Interview)
