Managing these risks without curtailing innovation is the task ahead. The rule of law must play a relevant role in this effort: “decentralized but regulated” should be a guiding principle. Legislators in the EU, the US and elsewhere have started to understand this. They are now trying to strike the balance right. This process will take time – and is iterative by necessity. It will also require meaningful international alignment – as a high level of uniformity across jurisdictions is a necessary ingredient for a new overall system to emerge over time. Supporting this process is a very worthwhile endeavour for everybody involved.
Ukrainian refugees are seeking shelter in neighbouring countries and beyond. Some of them managed to bring cash – bundles of Ukrainian Hryvnia. Yet their hope to turn it into something to eat vanished as soon as they tried. Aside from the disastrous exchange rate, there is hardly an institution willing to exchange Ukrainian Hryvnia against Euro, US Dollar or any other tradable currency. In the end, their plight is the same as for those that could not bring any money in the first place – as their savings were locked in a crashed bank back in Ukraine. Most certainly, neither these banks, nor the Ukrainian central bank or the Ukrainian government can be blamed for the drainage of their people’s savings. But all the same, the money is gone. For all those affected, it is no relief that holding a private key for an e-wallet filled with crypto would have made all the difference. The Ukrainian government had learned that lesson fast – and acted accordingly. Through crypto donations, it raised and still raises funds that it can convert into food, commodities, or other useful things. Whilst these donations to Ukraine could have been made in traditional ways, through accounts of institutions abroad – any such handling would have been more costly and would have taken more time. It would have also required significant trust by all those concerned in the ability and loyalty in a foreign organization and its people – no easy thing in times of war and distress.
While the war is raging over Ukraine, governments and legislators in the EU and US have been unusually active to communicate and continue the dialogue on the most relevant questions of crypto assets and technology. On 14 March, the EU Parliament’s Committee on Economic and Monetary Affairs gave a green light for MiCA, the draft EU Regulation on Cryptoassets – with points of detail requiring further negotiations. As a result, the EU is on the way to have an all-embracing regulation for assets created by crypto technology. In the same context, the Committee also opined on the controversial question of energy consumption for certain validation mechanisms of crypto transactions. The week before, US President Joe Biden had issued an Executive Order of fundamental nature on the most relevant aspects of crypto technology. More recently, Senator Warren and other US senators introduced a draft bill to target enforcement on those who use crypto to evade the war-related sanctions. It is for another time to scrutinise any of these documents and communications. For now, we only want to highlight the prominent role that these new laws and regulations will play. They are a strong case in point that well-crafted laws and regulations issued with input from relevant stakeholders – industry players, regulators, law enforcement, and the public as a whole – are the single most relevant tool to protect the blessings of crypto technology from any risks that it may otherwise bring. In brief:
- Consumer Protection: While there are certain financial risks in the crypto market, applying similar standards as those used for other asset classes may be a useful starting point. The challenge will be to draw the lines in different countries in similar ways: so that there can be clarity on which cryptoassets can be issued and traded – and under which conditions. The approximation of regulations in this area on an international level will be a particularly challenging task ahead.
- Financial Stability: The arrival of stablecoins have been a major concern in particular for the European legislator: will they have the power to undermine financial stability of the monetary system? Creating a digital version of the official currency – so called Central Bank Digital Currencies – as a response has therefore been high on the agenda in Europe for some time. Since President Biden’s Executive Order, the topic may also gain pace in the US.
- Illicit Activity: Another point where law enforcement on an international level will be the key driver. Having a similar sense of direction in both the EU and the US is already an important first step in this direction. Good international cooperation – and diplomatic or economic encouragement if needed – is important. Strict regulation, observation and enforcement in specific cases will be required (including in the fields of international arbitrage and offshore investments), but caution needs to be applied to foster the benefits of the system.
- Financial Inclusion: Providing all members of society with uncomplicated access to safe and affordable financial services is a major challenge. The current system of service provision has some obvious shortcomings in this regard. There is much opportunity and promise of crypto-based, decentralized finance. It is not yet clear whether it will simply replace existing access barriers with new ones – such as those of digital literacy. Supporting blockchain’s potential to drive down costs and make access direct and easy will be one of the more difficult tasks ahead for governments and members of industry alike.
- Climate implications: No doubt, the way in which blocks of Bitcoin transactions are validated (“proof of work”) are highly energy-intense. It is another question though whether that should lead to any prohibitions as initially proposed by the EU legislator. Most new blockchains don't use energy intense proof-of-work anymore. Companies increasingly use energy neutral methods for transaction validation. It seems to be a typical example of situations where technological progress will overcome a problem before any regulation becomes useful.
We will follow and address all these points in more detail in subsequent Hogan Lovells - FinTech Perspective publications.
Authored by Leopold von Gerlach