Critical Global Crypto Regulations and Their Impact on the Future of DeFi

Initially, when cryptocurrency was introduced in 2009, it just used to be a buzzword for many, and some form of digital collectible for geeks. But over the years, blockchains, crypto, and other digital assets have drastically evolved, become more sophisticated, and have started dominating the financial world.

Several crypto spams and hacks also cost people a fortune. The governments and authorities of some of the most powerful nations like the USA, EU, and more are bringing new crypto regulations to control and manage the crypto world and use them for their own benefit as well. Thus, today, we are going to talk about some of the major crypto regulations introduced by the powerful and dominating authorities and how these regulations will shape the future of the DeFi industry.

SEC and Crypto Regulation

The US SEC or Securities and Exchange Commission (SEC) is a government body in the United States that oversees and regulates the securities industry, along with stocks and option changes, and related organizations and activities. The organization is responsible for keeping a check on investor protection, capital formation, market fairness, and efficiency. It is also responsible for navigating the debates regarding the classification of cryptocurrencies as commodities or securities.

With constantly evolving blockchain technology, the SEC is also evolving its approach toward crypto regulations, scrutinizing token sales and Initial Coin Offerings (ICOs) in more detail and analyzing how these digital assets meet the securities criteria for Howey Test. It is a U.S. Supreme Court that outlined a legal framework that determines if a transaction qualifies as a security and could be regulated or not.

Recently, in 2024, the SEC introduced and integrated cryptocurrencies into mainstream investment channels by approving Bitcoin ETFs (Exchange Traded Funds). This move will expand crypto’s market participation and might also stabilize the volatile crypto market in the future. But the latest SEC crypto regulations have also changed the definition of “dealer”, which raises concerns for the DeFi community. This may impose stricter compliance requirements, which could lead to restricting innovation and complicating adherence to securities laws.

In addition to making new laws, the SEC is focusing on applying some existing securities laws to crypto assets. These laws include the Securities Act of 1933, the Investment Company Act of 1940, the Exchange Act of 1934, the Investment Advisers Act of 1940, and the Dodd-Frank Wall Street Reform and Consumer Protection Act.

However, the SEC’s major concern is deciding whether to treat crypto as securities or not. Till now, the organization hasn’t decided anything specifically regarding this. However, investors and crypto geeks are more skeptical about the SEC’s new regulatory crypto laws. The organization has to carve new laws while protecting the decentralized and innovative nature of cryptocurrencies, and simultaneously reducing the risk associated with these digital assets.

Basel III Requirements for Crypto

The Basel Committee on Banking Supervision (BCBS) introduced Basel III, predecessors of Basel I and II, in 2010 after observing flaws in banking rules and the financial crisis of 2007-2008. The Basel III framework aims to improve banks’ resilience to economic and financial stress, emphasizing on enhancing transparency and risk management. G20 and a number of Organization for Economic Co-operation and Development (OECD) countries accept the global standard for banking regulation established by Basel III. However, the applications can vary from country to country, mostly affected by the specific banking systems and regulations.

After recognizing crypto assets’ growing impact on the financial landscape, Basel III reformed its framework in 2022. Now, the framework includes prudential standards for banks’ exposure to crypto assets. As per their new standards, the crypto assets are now categorized into the following two groups:

• Tokenized assets, including the ones with stabilization mechanisms.
• Crypto assets that possess higher risks and fail the classification conditions.

So as per Basel III’s new regulations, banks now have to increase flexibility for infrastructure risks in crypto assets, along with the ability to adjust risk add-ons as per requirements.

Stablecoins must pass a redemption risk test and be backed by entities with strong regulations to get into Group 1. On the other hand, the Group 2 crypto assets will be capped at 1% of the bank’s Tier 1 capital, and a new 2% threshold having stricter crypto regulations. The new framework also contains detailed requirements regarding managing liquidity, operational risks, and leveraging crypto asset exposures.

But there is more. BCBS is going more rigorous on ongoing oversight and adoption of more beneficial and strategical crypto asset standards, in order to pace up with the market evolution. They are exploring statistical methods to identify low-risk stablecoins, assessing the risk involved in permissionless blockchain, and aiming to adjust the exposure limits as necessary.

MiCA Regulations

The European Union has introduced the Markets in Crypto-Assets (MiCA) regulations in May 2023. It is a pioneering framework, and estimated to be enforced by the end of 2024. After its implementation, the EU will be the first large jurisdiction to introduce and enforce comprehensive rules for the crypto market.

The new regulations will target a number of participants within the crypto ecosystem, along with the legal and natural individuals involved in crypto asset services. However, the regulations will specifically exclude fully decentralized services lacking intermediaries.

MiCA distinguishes crypto assets into three primary categories:

Asset-referenced tokens (ARTs): These coins aim to maintain a stable value by being tied to a variety of assets.

• E-money tokens (EMTs): Primarily designed for transactions.
• Utility tokens: These tokens give access to the services within the DLT system.

The MiCA regulations also include stablecoins, mainly categorized as ARTs and EMTs. However, it leaves out crypto assets that don’t have a clear issuer, specific intragroup transactions, NFTs, and central banks’ or specified financial instruments’ issues digital assets.

As per the regulations, in order to operate in the EU, the crypto asset service providers have to get authorization from one of the member states, along with one EU-resident director minimum. MiCA has also endorsed a comprehensive whitepaper for crypto assets, talking in detail about their nature, issuer information, technological underpinnings, risks, and project objectives, and emphasis on excluding the unlikely risks. The required documents should be provided in an official language, relevant to the EU state, or the language prevalent for international finance, such as English.

The regulations also emphasize on environmental implications of crypto activities, recommending the adoption of greener consensus mechanisms. Thus, the issuer and the providers need to transparently disclose the major environmental impacts, as conducted by the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) regarding sustainable reporting standards.

The non-compliance with MiCA standards also entails different penalties, such as:

• Administrative fines of up to Euro 700,00 for individuals and Euro 500,000 for legal entities.
• Periodic penalty payments to prevent infringements.
• Supervision fees for notable crypto asset issuers.

These measures strengthen MiCA’s comprehensive approach towards fostering a more sustainable, secure, and competitive crypto market in the European Union.

Endnote

Unlike 2009, around the time of its inception, cryptocurrencies are taken much more seriously now, as they have a global market cap of $2.63 Trillion. Some of the most prominent global investors invest heavily in crypto now.

But along with constantly evolving crypto and blockchain technologies, the risk towards their hacks and frauds are also evolving and getting more sophisticated. Thus, governments and authorities across the globe are now more concerned and keen to regulate cryptocurrencies and other digital assets.

Now as you already know about the three most significant global crypto regulatory authorities, you will be able to create better DeFi products while keeping in mind the regulations you need to stick to, depending upon the country you are targeting.