Long reads

Why small jurisdictions are forging ahead with crypto regulations

Paige McNamee

Paige McNamee

Reporter, Finextra

The world has crypto on the brain. From this year’s early Bitcoin skyrocket, stablecoins approved for banking payments by the OCC, Christine Lagarde and Janet Yellen’s public wariness of the assets, to the FCA’s outright warnings, it seems the market can’t stop trying to make sense of digital currency’s place in today’s and tomorrow’s world.

Where we see larger markets and regulators unwilling or unable to quickly set out clear frameworks regulating the space in a comprehensive manner, smaller players have and are enthusiastically leaping in. Two such locales are Gibraltar and the Isle of Man.

Having recently announced the formation of a working group to deliver the jurisdiction’s 10th Core Principle for DLT regulation, Gibraltar is seeking to bolster its regime for digital asset exchanges. The Hon Albert Isola, Minister for Digital and Financial Services, explains to Finextra that the working group will focus on defining the appropriate market standards for crypto exchanges to strengthen market integrity.

Excitement is also on the radar on the Isle of Man (IOM), where its Financial Services Authority (FSA) recently opened registration applications for internationally based cryptocurrency firms ‘subject-to’ their residence being established on the Isle.

While the regulation still requires at least two IOM resident directors in order to gain full registration, given the clear restrictions Covid-19 has placed on travel, the IOMFSA is welcoming applications from firms looking to expedite registration ahead of a potential relocation (or perhaps hedge their bets with existing FCA registration applications).

The IOMFSA jumped at the opportunity to offer the process following the FCA’s clamp down and slow churn (if any churning at all) through UK based applications in January 2021. Firms have been extended temporary registration until July 2021, but there is still no guarantee that registration applications will be processed by then.

Steve Billinghurst, regulatory lead at the Isle of Man’s blockchain office, Digital Isle of Man, states that where crypto businesses aren’t carrying out regulated financial activities, their activities fall within the IOM’s 2015 Designated Business Registration Act and relevant Anti Money Laundering/Combatting the Financing of Terrorism (AML/CFT) requirements, meaning that the Isle has been positioned and equipped to supervise the relevant businesses for years.

“What they haven’t got from the FCA in London they can find here in the way they continue their crypto business […] You could argue that because of this Act, IOM is six years ahead of the UK in the way that it deals with crypto businesses in the AML CFT space.” The two jurisdictions also appear to take different approaches to regulating the sector, more on that later.

What makes these smaller markets bastions for progress in the DLT and crypto space?

Agility, first and foremost, argues Isola. “Gibraltar has always been very good at niche. Why? because we’re a small and agile jurisdiction. When we were developing the DLT framework it was the private sector, the regulator, the public sector, the government sitting around the table to work out what it was we were doing, what risk we were prepared to take, how to mitigate that risk (to the greatest extent possible).”

When everyone can be at the same table, he furthers, you can see the problems, opportunities and challenges very quickly. “I’d say that the agility and entrepreneurial spirit that small territories have through necessity is perhaps what drives us to be leaders in different areas.”

Niche is certainly the word, Isola raises the example of motor insurance and how the outpost now writes around 25% of the UK’s motor market insurance business (he adds that one in four cars in the UK holds a Gibraltar insurance policy).

But niche isn’t necessarily the objective that Gibraltar holds for DLT into the future. Isola notes that while blockchain is still in its “embryonic infant” stage, he hopes that it will provide long-term and sustainable business for the community.

Billinghurst also believes IOM sees the long-term appeal of digital currency, and while the Isle is yet to confirm any ‘subject-to’ applications since they were made available, the update will likely be warmly received by firms who are cornered both by process and circumstance.

The new provision, Billinghurst continues, is certainly a function of the times. “Covid-19 is creating a reasonable amount of uncertainty not to mention regulatory uncertainty about whether or not they can carry on their businesses in the jurisdictions that they call home. We think it’s a good solution for them and it’s a good solution for us in terms of having a pipeline of opportunity of businesses that are interested in coming to the Isle of Man.”

What are these regulatory regimes doing differently?

Perhaps the key to a robust regulatory framework for DLT or cryptocurrency doesn’t necessarily lie in new legislation. Billinghurst is quick to speak to the strength of existing regulations which don’t pile layer upon layer of new rules to try (and fail) to keep pace with the rate of technological advancement. He explains that the IOM legislative framework doesn’t look at the technology itself, it looks behind the technology to determine the activity.

“Being technology agnostic in your legislation really helps because it means you don’t have to re-write it. It might need tweaking at the edges but at the core it’s fit for purpose.”

This ‘if it aint broke’ mantra rings true with the IOMFSA guidance around the taxonomy of tokens released in October of 2020, which outlined that the body would take a neutral approach when it comes to digital currency and tokens, as they look to the substance of the activity being undertaken rather than the form.

“Our legislation quite plainly says a security is an equity, a debenture or a warrant for all intents and purposes. So, if I issue that in a digital form, which I can do, a digital token is still a security. If a token has attributes that make it look an equity, it is an equity. If it has attributes that make it look like a utility token it is a utility token. If it has attributes that make it look like an e-money token or a stablecoin it is an e-money token.

“So we haven’t rewritten any of our underlying legislation to actually address the issues of digital token because it’s down to the attributes that they hold, not the form that they’re in.”

Divergence of approach is becoming ever more obvious across the globe, as regulators are increasingly being pressed into answering calls for regulatory certainty. The question is far from answered in the US, where a crypto wallet KYC rule was proposed by the Treasury Department in December and is set to be finalised in the coming months. The outcome may set the tone for the future of crypto in the States.

Though not disclosing the name of a crypto firm looking into a stablecoin issuance on the IOM, Billinghurst is personally optimistic on the potential of stablecoins, arguing that the framework in place should not encumber efforts to bring the technology into the market.

“It shouldn’t matter in the IOM whether or not I’m doing it with fiat currency, or with a cryptocurrency because the legislation in place talks about the activities I carry out, not the currencies I use or the assets and liabilities I create from running that bank.”

On the question of the overarching regulatory approach, Isola echoes Billinghurst, stating that more and more jurisdictions around the world are looking at the actual assets themselves, “which I think is quite challenging. We went for regulating the technology.”

“So if you use a technology to hold or transfer a value for somebody else by way of business, you’re captured by our legislation. We wanted to throw a pretty wide blanket over anybody that got involved in advising, in selling, in storing. That’s the natural consequence of the framework that we introduced.”

Isola adds that Gibraltar is involved with the work being carried out in the UK, “That is our closest nexus, and we work very closely with them. We have shared our experiences and we are in touch with regulators around the world specifically in the blockchain space.”

Reinforcing his note on the appeal of regulatory agility, Isola comments that “different people will do it in different ways and I’ve always said that if we see one that we like better than ours we’ll quickly copy and move ours closer to that.”

Does a new regime encourage new criminal interest?

Cryptocurrency being used for nefarious purposes is well understood, well reported, and certainly remains a point of unease for risk-averse policy makers. But perhaps bolstering cryptocurrency’s role through rigorous regulatory regimes is the solution rather than the catalyst for criminal activity.

Isola explains that what Gibraltar has introduced is in fact a regime to filter out bad actors.

“It’s a very difficult process to become licenced in Gibraltar. Unless you have a track record, experience, meet the fitness and propriety requirements, a business case, a business plan, you’re just not going to get through the Financial Services Commission (FSC)[…] We wanted to encourage good quality firms to come to Gibraltar to be regulated here, where a DLT firm onboards a client in the same way a bank does, the rules are the same. KYC, due diligence, AML, it’s the same rules and legal obligations on the individual that does the onboarding work.”

Acknowledging the territory’s history as a tax haven, Isola notes that “yes, we were offering different types of services to what we do today. We took a decision a long time ago that we wanted to be onshore.” This decision he states, led to implementing and complying with literally every single international standard there is.

“Whether it's in terms of exchange of information, whether it's in terms of money laundering regulations, every single EU directive that there is still today on transparency, to the exchange of information, money laundering, terrorist financing - we are up to date.”

From the IOM’s perspective Billinghurst agrees, arguing that on the whole, technology provides more detail and more data around transfers of value digitally than a paper-based system. “That doesn’t mean it is completely watertight, but I think it has the potential to be more watertight than money with technology solutions in place for the problems around money laundering.”

He adds that “For quite a while I have been frustrated that people think it has to be ‘holier-than-thou’ as a new basis when money isn’t.”

Billinghurst adds that in his role as regulatory lead he is constantly horizon-scanning other jurisdictions, to observe and perhaps employ certain elements of the direction of travel they are taking.

“We will never be first to make a move, but we’re also trying to be a smart follower in terms of where we go internationally with our legislation and regulation.”

It may never be ‘holier-than-thou’, but if it’s ‘holier-than-most’ and continues to dominate the conversation each time Elon Musk scribbles nary half a tweet, it will be hard for larger regulators to avert their gaze from the momentum and examples around DLT and crypto regulation being set by their small, nimble counterparts.

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