Digital Assets – Where Are We Now?

cryptocurrencyJP Morgan recently announced the launch of “JPM Coin.”  We thought it would be good to recap our posts over the past year on the topic of cryptocurrencies and coin offerings and update you on the current state of this market.

As 2018 began, the market capitalization for cryptocurrencies and other digital assets had reportedly exceeded $500 billion. There was also a lot of hype on social media and in the press driving interest. If you just read the comments on LinkedIn, you would have thought Blockchain was going to solve every technology and transactional problem ever encountered and the returns on every coin offering would be huge. As a result, clients were asking us to help them develop their point of view on the market and to understand their regulatory and operational risk should they choose to participate in crypto. In response, we invested in a project to educate the broker-dealer and investment advisor community about cryptocurrencies, coin offerings, and the emergence of digital asset classes.

Since then, the total market capitalization has dropped significantly and much of the hype has subsided.

Many countries are instituting regulations in varying degrees of stringency, from China’s banning of all ICOs and currencies within its borders, to some countries taking the “wait-and-see” approach, to Bermuda’s Initial Coin Offering Legislation.  Bermuda has recognized that the level of regulation and supervision should reflect the risk of the transaction. Accordingly, Bermuda has designed its supervision to provide the greatest oversight for the digital asset businesses that pose the greatest risk to the public. When an Initial Coin Offering will produce Security Tokens which will only be used for a specific project, the ICO only requires the Consent of the Minister of Finance. Where the ICO will result in cryptocurrencies being marketed to the general public the ICO will be subject to licensing under the Digital Asset Business Act. For Exchanges which will facilitate the trading of cryptocurrencies, including STOs, the process will again require licensing under the Digital Business Act.

Some industry leaders are calling for standardized, international regulation, which usually doesn’t occur until a market is very mature. In October 2018 the Paris-based Financial Action Task Force (FATF) said it has begun working on developing a global framework to define laws around cryptocurrency. This would be a significant initial step to a global standardization of cryptocurrency regulation.

Debates continue over the classifications of securities and how regulatory bodies will design the rules or interpret existing rules to govern them. Earlier this year, the SEC indicated it would provide much-needed guidance on when it considers an initial coin offering a securities offering, and how it would treat secondary offerings. In a recent speech to the Georgetown Law FinTech Conference, CFTC Chairman Giancarlo indicated the need for the CFTC to keep up with the evolving industry technology: “The time has come for the CFTC to match its unparalleled market intelligence capability with unparalleled quantitative data analytical capability.  The CFTC is ready to lead the world in QuantReg.” States are also getting into the act and a regulated market is beginning to emerge.

US cryptocurrency regulatory enforcement announcements have been sporadic. In September 2018, the Financial Industry Regulatory Authority (FINRA) and the SEC levied charges and fines against companies involved with cryptocurrencies.  In November 2018, the SEC brought its first enforcement action against an individual for operating an unregistered crypto exchange.

The good news is that during this time, real companies have been doing the work required to solve some of the challenges facing those who want to invest in a digital asset. In the US, the industry has created options for SEC regulated entities to use a qualified custodian for digital assets. The futures industry has used the existing plumbing of the markets to help facilitate the trading of futures contracts, but there is still much work to be done.

The Takeaway:  

The financial services industry is struggling to keep pace globally with the evolving cryptocurrency technology. Increased regional, national and possibly international regulation appears to be a done deal, although for the time being it is inconsistent. That is a good thing! Trusted markets are vital to the success of creating capital, managing wealth, and transacting business. Regulators and the future industry participants are beginning to understand what that needs to look like so that the US can design solutions to the challenges of creating a new and transparent marketplace.

In the meantime, keep your focus on what your employees are doing to understand if they are involved in the crypto business, and if you are considering entering the digital asset space, how you will address the operational, risk, regulatory challenges that come with the opportunities presented by this evolving marketplace.

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About the Authors:

Ann Daniels is a Risk and Compliance professional with over 20 years’ experience in Regulatory Risk and Compliance in the Financial Services Industry. Utilizing her experience as a Financial Services Regulator, Ann honed her compliance and consulting roles with small and medium law firms, investment businesses, and money-service businesses, including the development, implementation and oversight of Compliance programs. Ann’s experience also includes the development and implementation of AML/CFT risk assessment policies, procedures, and training; automated monitoring systems; risk assessment methodologies; the implementation of standards and a program of oversight of compliance professionals.

Buddy Doyle is a passionate and innovative executive and has been in the financial services industry for over 30 years. Over the past 10 years, he and his team have built an award-winning organization serving hundreds of clients in the United States and Bermuda with consulting, outsourcing and software solutions.  Prior to starting Oyster Consulting, Buddy was a Senior Vice President at Wachovia Securities LLC (now Wells Fargo Advisors) where he held leadership roles in that growing organization in Operations, Finance, Commodities, Technology, Compliance and the Private Client Group. He gained experience working with both small and large firms by starting his career at Wheat, First Securities in 1987, when the firm had 50 offices and 500 brokers in the Mid-Atlantic region. Through 10 acquisitions and mergers, the firm evolved into one of the largest in the United States.

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