Implementing an Effective Cryptoasset Regulatory Framework in the United States

There is no workable regulatory framework at the federal level for the registration or operation of cryptoasset trading platforms in the US, whether for securities, commodities, or payment instruments, with the exception of the Commodities Futures Trading Commission’s (“CFTC”) regulation of trading platforms for cryptoasset derivatives discussed in subpart (d) below. As a result, trading platforms operate under significant legal uncertainty and cryptoasset users and investors are subject to heightened risks of loss and fraud.

As discussed in the Phase I Report, the most important cryptoassets by market capitalization and trading volume – bitcoin and ether – as well as many other cryptoassets, are commodities and not securities under US law. Whereas securities exchanges are subject to the comprehensive enforcement and rulemaking authority of the SEC, spot commodities exchanges are not subject to the comprehensive regulatory jurisdiction of any US federal financial regulators. And even if a cryptoasset trading platform were to attempt to register as a securities exchange, it would be practically impossible for the platform to meet the registration requirements or the ongoing compliance requirements necessary to do so. As only one of several examples of this problem, securities exchanges can only allow registered broker-dealers direct access to their platforms. But most cryptoasset trading platforms provide direct access to customers, and registered broker-dealers are effectively barred from executing transactions in cryptoassets due to the unworkable compliance requirements discussed in subpart (b) below.

The policies of US regulators have exacerbated this situation. Initially, SEC Chair Gensler acknowledged that cryptoasset trading platforms are not subject to the regulatory framework for securities exchanges and that there is currently no regulatory framework for cryptoasset trading platforms. But the SEC has not taken steps toward the establishment of such a framework. On the contrary, since the publication of the Phase I Report, the SEC has pursued enforcement actions against several cryptoasset trading platforms alleging that they are operating as unregistered securities exchanges, despite the practical impossibility of a cryptoasset trading platform registering as such, and continued lack of clarity over which assets may be securities. Indeed, SEC Commissioner Peirce recently criticized the SEC for its unwillingness to provide interpretive guidance with respect to cryptoasset and its continued threats of enforcement actions.

Furthermore, SEC rules and guidance from banking regulators impose major limitations on the provision of cryptoasset custody services by third party custodians. In particular, SEC staff accounting guidance (Staff Accounting Bulletin 121 (“SAB 121”)) in effect requires major banks and broker-dealers to account for any cryptoassets that they hold as custodian as assets on their own balance sheets, which results in higher capital requirements. This is a significant and unexplained departure from the accounting treatment of all other types of custodied assets, which are not recorded on the custodian’s balance sheet. As Commissioner Peirce noted in a recent speech, the practical impact of this deviation from historical practice has been to limit institutions with expertise in safely custodying financial assets, particularly banks and registered broker-dealers, from offering cryptoasset custodial services at scale. It will also make it more likely that the customer’s cryptoassets could be subject to the claims of the custodian in bankruptcy. The Office of the Comptroller of the Currency (“OCC”) has also stated that it will apply “heightened scrutiny” to the provision of cryptoasset custody services by OCC-supervised banks. Major banks have cited this stance as another significant impediment to the provision of cryptoasset custody services and, indeed, any services in the cryptoasset sector. While various cryptoasset trading platforms have undertaken voluntarily to design and implement rigorous custody practices, others have not, and customers cannot rely on the market-wide standards that prevail in securities markets and therefore must assess platforms’ practices individually. Barring traditional custodians from providing cryptoasset custody services unnecessarily increases the risks to customers, particularly retail customers, that stem from improper custody practices. Further, the SEC and OCC’s current stance creates a competitive advantage for less regulated cryptoasset firms in the US, as well as foreign banks and broker-dealers.

The customer protection standards that govern securities broker-dealers do not apply to broker-dealers that route or execute transactions in the most valuable and commonly traded cryptoassets. As a result, these broker-dealers are not subject to the duty of best execution, qualified custodian requirements, or prohibitions on front running, that apply to an SEC-registered broker that routes or executes a transaction in a security for its customer. They are also not subject to the minimum margin requirements that apply to brokers who allow their customers to incur leverage. As discussed in Part III, while it may not be necessary to apply the same version of these standards in cryptoasset markets, currently customers have no overarching federal standards to rely on, though certain states, such as New York, have enacted custody requirements for brokers and other service providers.

Furthermore, SEC rules have effectively prevented registered securities broker-dealers from handling any cryptoasset transactions. In particular, SEC guidance—the special purpose broker dealer (“SPBD”) guidance—provides that a broker-dealer trading in cryptoasset securities must obtain permission to do so and limit its business activities solely to cryptoasset securities. A registered broker-dealer therefore could not handle cryptoasset security transactions for its customers unless it refrained from engaging in any other business activities including transacting in stocks, bonds, and non-security cryptoassets. The broker-dealer could also be subject to unworkable capital requirements resulting from SEC guidance that requires public reporting companies to record a liability for custodied cryptoassets on their balance sheets. And, as there are very few cryptoasset securities presently registered with the SEC, a registered broker-dealer approved to handle cryptoasset securities would have virtually no assets to trade. Indeed, only one broker-dealer has undergone the registration process, and it has yet to become operational. The lack of cryptoasset securities available to trade is due to the lack of a workable registration and reporting framework for cryptoasset securities. And, as described in subpart (c) below, the SEC has not made clear which cryptoassets are securities, and as a result market participants wanting to rely on the SPBD guidance are left to decipher old guidance and conflicting court cases to determine if a particular cryptoasset is a security. Indeed, the one qualified SPBD recently announced it would provide custody services for ether, resulting in controversy and confusion. In the past, the SEC has recognized ether as a non-security, which would mean registered SPBDs may not custody that asset. However, the SEC has more recently been sending signals that it has changed its stance and has not clarified its position despite recent calls from Congress to do so.

Issuers of securities to the public are subject to comprehensive disclosure and conduct requirements designed to protect investors and securities markets. However, cryptoassets have unique technical aspects that challenge the traditional categorization criteria for securities, and neither the SEC nor lawmakers have promulgated clear and legally binding criteria to determine which cryptoassets are securities. And even if a cryptoasset can be clearly classified as a security, the requirements that apply to the issuance and trading of securities often cannot be coherently applied to cryptoasset securities, and would omit information that is useful to cryptoasset investors. Furthermore, the offering and use of certain cryptoassets and the networks on which they operate have a tendency to evolve as they become decentralized, and there are no clear criteria under US law or regulations for determining how or when their regulatory treatment should change as this transition occurs.

Since the publication of the Phase I Report, a US court issued a summary judgment in a dispute between the SEC and a cryptoasset issuer regarding the status of a cryptoasset—XRP—as a security, finding direct sales of XRP were securities transactions while secondary sales were not. However, a judge in a separate suit rejected this distinction, finding certain additional cryptoassets to be securities. While the decisions provide some guidance to market participants on applying the definition of security to cryptoassets, the decisions are complex, do not reach consistent conclusions, and remain subject to appeal. More generally, relying on court decisions to apply existing securities law to cryptoassets is unlikely to generate comprehensive and easily applied criteria in the short term.

In contrast to cryptoasset spot markets, the trading of cryptoasset derivatives has generally been incorporated effectively into the existing framework for the trading of commodities derivatives, which includes custody protections and rules prohibiting abusive trading platforms, as well as the comprehensive enforcement and rulemaking authority of the CFTC. As such, when the trading platform FTX went bankrupt in 2022, in contrast to US customers of the FTX spot platform, US customers of the derivatives platform did not lose access to their funds. Six years after the launch of cryptoasset futures products on CFTC-regulated commodity futures exchanges,20 cryptoasset commodity futures markets are deeper and more liquid, transparent and well-regulated. The CFTC actively polices fraud and manipulation through enforcement. The relative success of cryptoasset commodities markets in the US suggests that a similarly effective framework for spot markets is possible.

In 2017, Japan implemented a mandatory registration system and regulatory regime under Japan’s Payment Services Act (the “PSA”) for cryptoasset trading platforms that facilitate trading in non-security cryptoassets, including bitcoin, ether, and most other major cryptoassets.

The supervisor of cryptoasset trading platforms is the Financial Services Agency (the “FSA”), which is the agency also responsible for the supervision of securities exchanges, banks, and insurance providers. Cryptoasset trading platforms must register with the FSA as “Crypto Asset Exchange Service Providers” (“CAESPs”) and comply with the PSA rules applicable to CAESPs. The FSA is authorized to issue business improvement orders to trading platforms that fail to adhere to these requirements and to require those that do not comply to suspend their operations. Trading platforms are also supervised by an FSA-certified self-regulatory organization (the Japan Virtual and Crypto Assets Exchange Association (the “JVCEA”)). The JVCEA issues additional rules governing the operation of cryptoasset trading platforms and the listing of cryptoassets.

The registration requirement applies to both domestic providers as well as foreign entities that seek to provide services in Japan. To qualify for registration, a cryptoasset trading platform must be a domestic Japanese company or have an office and representative in Japan. It must then obtain FSA preapproval of its organizational structure, operational systems, and compliance mechanisms.

Following registration, trading platforms must provide specified disclosures to their customers, including a balance sheet and income statement, detailed information about the features and risks of the cryptoassets that can be traded on the platform, and information about transaction fees. Platforms must implement and maintain operational security measures, adhere to anti-money laundering rules, and adhere to advertising restrictions.

Japan permits direct retail access to trade on cryptoasset trading platforms without the intermediation of a broker, which is in contrast to exchange trading of traditional financial assets, where broker intermediation is required.

Registered cryptoasset trading platforms are permitted to custody customer cryptoassets in accordance with cryptoasset-specific custody requirements. Specifically, the platform must (1) segregate customers’ cryptoassets from the operator’s assets by holding them in separate wallets, (2) hold at least 95% of custodied customer cryptoassets in cold wallets (i.e., wallets not connected to the internet), (3) hold enough of the platform operator’s cryptoassets in cold wallets to cover any customer cryptoassets held in hot wallets (i.e., wallets connected to the internet) and provide customers with the right to be repaid from those operator assets in the case of loss, theft, or insolvency. Trading platforms must also engage a public accountant for annual audits of their custody practices. However, in no event may cryptoasset trading platforms custody customer fiat currency, which must instead be held with a third-party qualified custodian.

Before a trading platform admits a cryptoasset for trading, the platform must conduct an assessment of the cryptoasset showing that the cryptoasset can be securely traded on the platform and submit the assessment to the JVCEA for approval. Each trading platform that seeks to admit a particular cryptoasset must conduct its own new assessment until the cryptoasset has been admitted to trading on at least three other registered platforms, at which point the assessment requirement is lifted for all other trading platforms. The precise criteria for this assessment are opaque and the approval process can be lengthy. This has reportedly led to a significant backlog in the JVCEA’s approval process, resulting in delays in the admission of cryptoassets to trade across multiple platforms. The FSA and JVCEA are therefore considering a new rule that would lift the assessment requirement once a cryptoasset has undergone an assessment and is admitted to a single trading platform.

If a trading platform facilitates the trading of a cryptoasset security (i.e., cryptoassets that provide the holder with ownership rights or a share of the profits in a business or investment enterprise), it must obtain the same registration status as a traditional securities exchange or securities broker.

Japan has not enacted any regulatory framework for decentralized trading platforms.

A broker-dealer that executes transactions on behalf of its clients in cryptoassets must register with the FSA as a CAESP. Cryptoasset broker-dealers must therefore fullfil the same registration criteria as a trading platform and comply with the same ongoing disclosure, operational security, anti-money laundering, and custody requirements that apply to cryptoasset trading platforms, as outlined above. Cryptoasset broker-dealers are also subject to the same duty of best execution that applies to broker-dealers in traditional securities markets.

Japan’s cryptoasset specific self-regulatory organization has created a specialized framework for the issuance of new cryptoassets to investors and users. These rules require (1) JVCEA approval of the issuer’s business structure, (2) the disclosure of specified information to offerees, including information on the offered cryptoasset, the issuer’s business, and the issuer’s proposed use of the offering proceeds, (3) segregation of the offering proceeds from the issuer’s other assets, (4) adherence to typical accounting standards, and (5) JVCEA approval of the issuer’s valuation of the offered cryptoasset. The issuer must also demonstrate that it will be able to ensure the secure operation of the underlying blockchain and wallet tool used to hold the cryptoasset. These requirements apply only if the creator receives money in exchange for the issuance of the cryptoasset – that is, they do not apply to gratuitous issuances (frequently referred to as “air drops”). 

Once issued, cryptoassets may only be sold by or through a registered trading platform or broker-dealer.

Japan has incorporated a specialized framework for the issuance of cryptoasset securities into the broader framework that governs the issuance of traditional securities. In general, if the cryptoasset security’s code requires that the issuer approve the transfer of the cryptoasset and limits ownership to institutional investors, the cryptoasset security is subject to the less stringent disclosure requirements that apply to private issuances of traditional securities to institutional investors. If the cryptoasset security is not subject to these transfer and ownership restrictions, it is subject to the more comprehensive disclosure requirements that apply to public securities issuance, including the requirement to file a registration statement with the FSA and issue a prospectus to potential investors.

Japan’s regulators have also promulgated clear and comprehensive criteria for distinguishing cryptoasset securities and non-securities. The criteria are based primarily on whether the cryptoasset token gives the holder ownership rights or a right to share in the profits of a business or investment enterprise.

Japan has amended its financial regulatory statutes to incorporate the trading of cryptoasset derivatives into the framework for the trading of derivatives on traditional financial assets. Trading platforms and broker-dealers that facilitate trading in cryptoasset derivatives must therefore register with the FSA, and information regarding over-the-counter trading of cryptoasset derivatives must be reported to the FSA.

Cryptoasset trading platforms must be licensed by the national regulator in the EU jurisdiction where the platform is based. To qualify for a license, the platform must demonstrate to the regulator that the platform has in place basic operating policies, governance arrangements, asset segregation and custody practices, and complaints-handling procedures. Once licensed in one EU member state, the platform may subsequently operate throughout the EU upon notice to their licensing authority.

Licensed trading platforms are permitted to custody customers’ cryptoassets according to cryptoasset-specific custody rules. In particular, (i) customer cryptoassets must be operationally and legally segregated from the platforms assets, including in bankruptcy, (ii) the platform may not use customer cryptoassets for its own account, and (iii) the platform must have written policies designed to minimize the risk of theft or loss of custodied cryptoassets, including from fraud or cyberattack.

Before admitting a cryptoasset to trading, the trading platform must (i) ensure that a compliant disclosure document containing information about the cryptoasset’s characteristics (referred to as a “white paper”) has been published either by the cryptoasset’s issuer or the trading platform itself, and (ii) conduct its own assessment of the technical design of the cryptoasset, the issuer and its development team, and its potential connections to illicit or fraudulent activities.

Trading platforms must adhere to ongoing customer protection rules, including a prohibition on an operator trading on its own platform, as well as pre- and post-trade transparency requirements, which require the publication of bid-ask spreads, depth of trading interests, and the price, volume, and time of each transaction conducted on the platform.

Within these requirements, trading platforms have considerable flexibility to facilitate trading in a variety of cryptoassets and offer multiple services to their customers. The framework also facilitates the provision of cryptoasset-related services by providers that are registered under existing financial regulatory regime without undergoing a separate licensing process, though they are required to adhere to the same ongoing compliance rules as newly licensed providers. Furthermore, the same trading platform is permitted to facilitate transactions in both non-security cryptoassets and security cryptoassets provided it is licensed under both MiCA and MiFID II.

Cryptoasset trading platforms are also permitted to allow customers direct access to trade non-security cryptoassets without the intermediation of a broker. This contrasts with the trading of traditional financial assets, which bar retail investors from trading without the intermediation of a broker. Currently, platforms cannot allow retail customers to trade cryptoasset securities without the intermediation of a broker. However, the EU is conducting a pilot regime that allows certain trading platforms to permit retail investors to directly trade a limited number of cryptoasset securities.

MiCA streamlines the licensing process for operators of traditional securities exchanges, which can automatically qualify for cryptoasset trading platform license by notifying the regulator in their home jurisdiction, though they are subject to the same ongoing compliance requirements as newly licensed platforms.

Cryptoasset broker-dealers are, like trading platforms, required to be licensed by the national regulator in the broker-dealer’s home jurisdiction by undergoing the same licensing process. Once licensed, the broker-dealer is permitted to hold custody of its customers’ cryptoassets in accordance with the same cryptoasset-specific custody rules that apply to licensed trading platforms. Cryptoasset broker dealers are also subject to the same duty of best execution as securities broker-dealers. As in the case of trading platforms, a registered securities broker-dealer can be automatically licensed to handle transactions in non-security cryptoassets.

Before a cryptoasset may be issued to the public or admitted to trading on a trading platform, the issuer must publish and submit to the relevant national regulator a “white paper” containing detailed information about the issuer, the cryptoasset, the underlying blockchain technology, and risks to the investor. The issuer must also adhere to restrictions on the content and timing of marketing communications.

These issuance requirements do not apply to (1) offerings where no money is received (e.g., “air drops”), (2) cryptoassets created automatically as reward tokens for the maintenance of a blockchain network or transaction validation, (3) utility tokens giving access to an existing product or service or that can only be exchanged for goods and services in a limited network of merchants or (4) “fully decentralized” offerings (i.e., offerings that are not controlled by the issuer, offeror, or other small group of people but rather a decentralized community of users.

The public issuance and admission to trading of security-type cryptoassets are subject to the same regulations that apply to traditional securities. These rules require publication of a prospectus before the security-type cryptoasset is offered to the public or is traded on a trading platform. However, unlike in the case of non-security cryptoassets, regulatory approval is necessary before a cryptoasset security can be offered or listed.

ESMA has issued detailed guidance articulating the criteria for whether a cryptoasset is classified as a security (i.e., a “financial instrument”) or non-security. These criteria consider whether, for example, the cryptoasset entitles the holder to security-like rights, such as the right to dividends or the right to vote on the issuer’s decisions.

ESMA has issued guidance clarifying that cryptoasset derivatives are subject to the existing MiFID II securities regime, regardless of whether the underlying cryptoasset is a security or not. Cryptoasset derivatives will therefore be treated like securities under the existing regime—the same as most non-cryptoasset derivatives, which can be traded, in most cases, by both institutional and retail investors.

Cryptoasset trading platforms that operate in Hong Kong or that market their services to Hong Kong residents must register as “virtual asset trading platforms” (“VATPs”).69 A VATP license permits a platform to facilitate transactions in non-security cryptoassets, such as bitcoin and ether, but does not extend to cryptoasset securities.

Once registered, a VATP must comply with comprehensive customer protection and other compliance requirements covering governance, disclosure, due diligence of listed cryptoassets, and anti-money laundering. Trading platforms may permit retail investors to trade directly on the platform without the intermediation of a broker.

Trading platforms must provide customers with specified information on the cryptoassets that trade on the platform including information on the management and development team that designed a cryptoasset, and the terms, features, and risks of the cryptoasset.

Trading platforms are permitted to custody customer cryptoassets provided that the custodied assets are held in a wholly owned subsidiary that limits its activities to custody and that adheres to specified custody rules. Specifically, the custodian must hold at least 98% of customers’ cryptoassets in cold wallets. It must have an arrangement that is approved by the SFC, and that compensates customers for the loss of up to 50% of their cryptoassets that the custodian holds in cold wallets and 100% of their cryptoassets that the custodian holds in hot wallets. Customer fiat currency must be held in a segregated account maintained with a bank and not pledged or otherwise encumbered. The bank must be located in Hong Kong unless client money is received outside Hong Kong and the SFC approves alternate arrangements.

To facilitate transactions in cryptoasset securities, the operator must obtain a license to operate a securities exchange under Hong Kong existing regulatory framework for securities exchanges. However, Hong Kong has harmonized its new framework for VATP with this existing framework by allowing a trading platform that has both a VATP license and a license to operate a securities exchange to combine trading of both categories of assets on the same platform. In addition, although the application processes for these licenses are currently separate, Hong Kong plans to introduce a single application process to streamline the framework.

Hong Kong’s framework does not cover decentralized trading platforms.

Broker-dealers that execute transactions in cryptoassets for customers in Hong Kong are required to register and obtain a license as “virtual asset service providers” (“VASPs”). They are subject to equivalent custody and disclosure requirements as VATPs. Additionally, those acting as fund managers are subject to a duty of best execution. Broker-dealers that execute transactions in cryptoasset securities are subject to the same registration requirements and customer protection standards as broker-dealers for traditional securities.

Hong Kong has enacted a framework for the issuance of new cryptoassets to the public that builds on its existing framework for traditional securities. In the case of cryptoassets that are not securities, issuers are not subject to any direct disclosure requirements. Instead, Hong Kong requires trading platforms, broker-dealers, and custody providers “to take all reasonable steps to ensure the product specific information they disclose is not false, biased, misleading or deceptive.”

Issuers of cryptoasset securities are subject to the same requirements as issuers of traditional securities, including the requirement to issue a prospectus and the requirement to obtain approval from the securities regulator before the offering. These requirements apply to any public offering of cryptoasset securities to Hong Kong investors, whether or not the issuer is based in Hong Kong or another jurisdiction. Hong Kong’s regulators have stated in guidance that a cryptoasset security is generally defined by granting the holder an ownership interest in a business enterprise or investment product of the issuer.

Hong Kong does not permit the trading of cryptoasset derivatives by either retail or institutional investors. However, the SFC is considering regulations that would allow for the trading of cryptoasset derivatives by institutional investors.

HM Treasury has described the broad outlines of the framework that will govern cryptoasset trading platforms. In general, cryptoasset trading platforms will be subject to the UK’s existing rules for traditional financial services, such as banking and investment advisory services (the “Regulated Activities” regime). They will also be required to obtain an FCA license to operate. Within this framework, cryptoasset trading platforms will be permitted to facilitate the exchange of cryptoassets for fiat currency, other cryptoassets, and other assets, such as commodities. The FCA will be empowered to create more detailed regulations that apply specifically to cryptoasset trading platforms.

The UK has also stated that it intends to regulate “safeguarding and/or administration (custody) activities,” for cryptoassets by cryptoasset trading platforms and “lending, borrowing and leverage activities,” such as “operating a cryptoasset lending platform.” The UK currently permits direct retail investor access to cryptoasset trading platforms and has not indicated that it intends to prohibit such direct access in the future.

The UK has already fully implemented legislation regulating the marketing of cryptoasset-related services, including cryptoasset trading platforms, to UK customers by incorporating these services into its existing financial services marketing regime (the “Financial Promotion” regime). For example, marketing and financial promotions by trading platforms are prohibited from offering customers incentives (e.g., “refer a friend” or “new joiner” bonuses) to trade on their platforms.

Like trading platforms, it is expected that cryptoasset broker-dealers will fall under the Regulated Activities regime and thus subject to FCA licensure, but the exact contours of the framework will be set by future rulemaking. Additionally, cryptoasset broker-dealers are already subject to the same marketing restrictions under the Financial Promotion rules that apply to cryptoasset trading platforms, discussed above.

The UK intends to regulate the public offering of a cryptoasset and the admittance of a cryptoasset to a trading venue under either the Regulated Activities regime or a newly created regime that is subject to either FCA or HM Treasury regulation but not FCA licensure (the “Designated Activities” regime). The details of the framework will be set by future rulemaking. 

Issuers that market cryptoassets to UK investors and users will be required to adhere to the same marketing restrictions as those discussed with trading platforms above. Notably, cryptoasset issuers will not be able to rely on exemptions for high-net worth and sophisticated investors that are available for traditional securities offerings. The new framework also adjusts the Financial Promotion regime by bringing “qualifying cryptoassets” into its regulatory parameters. These rules will apply to all cryptoassets that are both fungible and transferable, such as bitcoin and ether, but will exclude CBDCs and utility tokens with limited functions.

The legislation also provides the UK and HM Treasury with the authority to designate a cryptoasset as “systemic” if it is widely used for payment in the UK. Upon designation by HM Treasury, a cryptoasset would become subject to the supervision of the Bank of England, the UK’s central bank, and the Payment Systems Regulator.

The UK only permits retail trading in derivatives of cryptoassets if the underlying cryptoasset is a security and thus already subject to the UK’s existing financial regulations. The UK has banned retail trading in derivatives on cryptoassets that are not securities.

Singapore’s integrated financial services regulator (the Monetary Authority of Singapore (“MAS”)) has issued a proposed regulatory framework under the Payment Services Act (“PSA”) for cryptoasset trading platforms and other cryptoasset intermediaries that facilitate trading in cryptoassets that are not considered securities, which implements various operational requirements and customer protection measures. Under this proposal, which will take effect from mid-2024, cryptoasset trading platforms are required to obtain a license to offer their services in Singapore. Platforms are prohibited from offering retail customers margin trading or any incentives to trade. As a condition of listing a cryptoasset, platforms must disclose potential conflicts of interest, publish the criteria that govern the listing, and establish customer dispute procedures.

MAS has also issued rules addressing the issuance, custody, and trading of cryptoasset securities. Singapore has also amended aspects of its banking and payments legislation to address stablecoins.

More specifically, the MAS has issued rules indicating that cryptoasset securities are generally subject to Singapore’s existing financial markets regulatory statute for securities and derivatives (the Securities and Futures Act of 2021 (the “SFA”)).

The MAS guidance (1) trading platforms and broker-dealers facilitating or executing transactions in cryptoasset securities are required to register as “Approved Exchanges” or “Recognized Market Operators” respectively, (2) providers of custodial services for cryptoasset securities must obtain a capital markets service license and are subject to requirements for the safekeeping of client assets and (3) issuers of cryptoasset securities are, like issuers of traditional securities, required to file a prospectus with the MAS.

Australia has yet to implement a comprehensive regulatory framework for cryptoassets, but its regulators have issued proposals outlining such a framework and are in the process of soliciting public comments on those proposals.

More specifically, in October 2023, the Australian Treasury issued a draft proposal for a licensing regime for cryptoasset trading platforms and other cryptoasset service providers. The proposal would subject such services to customer protections and other compliance requirements, including custody requirements.

With respect to custody, many of these standards are in line with custody requirements for traditional financial products and services. However, cryptoasset custody providers would be subject to additional safeguarding requirements to avoid commingling customer and company funds. In addition, platform operators offering additional functions such as staking in digital assets that are not financial products will be subject to separate requirements.

Draft legislation implementing the proposal is expected to be issued in 2024.

Canada’s financial regulators have sought to integrate cryptoassets into Canada’s existing financial regulatory statutes by broadly interpreting existing statutory definitions under Canada’s securities legislation to cover many cryptoassets, including cryptoassets such as bitcoin and ether, that are not governed under securities legislation in the US or other jurisdictions.

Specifically, Canada’s national securities regulators (the Canadian Securities Administrators (“CSA”), which functions as an umbrella organization of Canada’s securities regulators, and the Canadian Investment Regulatory Organization (“CIRO”), which acts as a self-regulatory organization for the investment industry) have issued guidance stating that while such cryptoassets may not themselves be securities, the contractual relation between a customer trading such a cryptoasset and the trading platform is a security and thus causes the securities regulatory framework to apply.

Canada’s regulators have released joint guidance interpreting and applying the requirements of Canadian securities law to cryptoasset trading platforms, The guidance differentiates between platforms that permit direct access by customers to the trading book (“Marketplace Platforms”) and those that limit direct participation to registered broker-dealers (“Dealer Platforms”).

The guidance permits direct retail investor access to cryptoasset platforms so long as the platform does not provide any recommendations or advice to participants. Further, it recognizes that flexibility may be required to assess yet-to-be developed custody models and specifies some principles to manage risk, including segregation of clients’ assets and keys from those of the trading platform. However, cryptoasset trading platforms may not combine trading in cryptoassets such as bitcoin and ether that are not themselves securities with cryptoasset securities, (e.g., tokenized versions of stocks or bonds) on the same platform.

The guidance contemplates the provision of custody services by platforms provided the platform adheres to specified customer protection requirements. These requirements include keeping client property segregated, a prohibition against the pledge, rehypothecation, or other use of client property, and a requirement to hold cryptoassets in a “designated trust account” or in a designated account with an acceptable third-party custodian.

The United Arab Emirates (“UAE”) is a federation consisting of seven emirates, including Dubai and Abu Dhabi. The UAE’s federal financial regulator, the Securities and Commodities Authority (“SCA”) is responsible for regulating cryptoassets other than stablecoins. There are also two “Financial Free Zones” in the UAE—the Abu Dhabi Global Market (“ADGM”) and the Dubai International Financial Centre (“DIFC”)—which are not subject to federal civil and commercial law.

In 2020, the SCA enacted an initial framework regulating the offering, issuing, listing and trading of cryptoassets. The UAE then enacted legislation in 2022 establishing an activities-based licensing regime to be administered by the SCA (the “Virtual Asset Regime”). The regime covers cryptoassets which “can be used for investment purposes.” The law provides a list of activities subject to licensing, including operating a trading platform, exchange, transfer, brokerage, and custody services.

Responsibility to license and regulate under the Virtual Asset Regime has been delegated to the Virtual Assets Regulatory Authority (“VARA”) in the emirate of Dubai. In February 2023, VARA passed the Virtual Assets and Related Activities Regulations 2023, alongside four compulsory and eight activities-based rulebooks, including exchange, custody, and broker-dealer services, as well as cryptoasset issuance. The activities are designed to be “modular,” such that a service provider, “may apply for multiple activities and aggregate them under a single overarching license provided there is no specific need to segregate any of those activities.” Notably, retail investors may also be permitted to access virtual asset services.

The Financial Free Zones have also been very active. In the ADGM, the Financial Services Regulatory Authority (“FSRA”) issued wide-ranging regulations in 2018 to become “the first jurisdiction in the region to introduce a comprehensive and bespoke regulatory framework for the regulation of spot virtual asset activities, including those undertaken by multilateral trading facilities, brokers, custodians, asset managers and other intermediaries.” Such intermediaries are required to be licensed or approved by the FSRA. Cryptoasset services, including access to trading platforms, may be accessed by retail investors. The FSRA’s framework carves out cryptoasset securities, which are deemed to be subject to existing securities regulation in the ADGM, though the FSRA has also published separate guidance in relation to cryptoasset securities activities and offerings. Further, the FSRA allows intermediaries to provide services in both cryptoasset securities and non-securities, provided they obtain the proper approval.

In the DIFC, the Dubai Financial Services Authority (“DFSA”) has also introduced regulatory frameworks for cryptoasset securities and derivatives (“Investment Tokens) and for other types of cryptoassets (“Crypto Tokens”), excluding CBDCs, NFTs and utility tokens. Under the Crypto Tokens regime, anyone providing financial services in Crypto Tokens must be licensed by the DIFC. Existing licensees may apply to vary their licenses to provide Crypto Token services. Arrangers, dealers and platform operators may provide services to retail investors provided they have conducted an appropriateness test. Further, the DFSA has established specific cryptoasset custody requirements, applicable to both Investment Tokens and Crypto Tokens.

The share of global cryptoasset trading volume that occurs in the US lags far behind other markets, as well as the US share of trading volumes in traditional financial markets.

Figure 1 below compares the estimated percentages of global trading volume that occurs in US venues for both cryptoasset centralized trading platforms and exchange-traded equity markets, in each case over the 2018-2023 period. US-based platforms hosted approximately 10% of global on-platform cryptoasset transactions. By comparison, US exchanges hosted on average 50% of transaction volume in exchange-traded equities over the same period. The US’s share of exchange trading in equities markets was the largest in the world and was around five times greater than its share of cryptoasset trading platform volume.

A recent analysis of stablecoin transaction activities underscores the predominance of offshore trading venues: Specifically, it finds that as of 2023, 54.6% of stablecoin deposits by investors in North America were to offshore cryptoasset trading platforms.

The predominance of offshore trading venues in cryptoasset markets limits the ability of US customers to access cryptoasset markets, since many such venues exclude US customers. To the extent US customers are able to access these venues (either because they are permitted to do so, or because they are able to circumvent measures intended to exclude them), they are at risk from less reliable customer protection standards that often prevail in the jurisdictions where those venues are based. Further, when cryptoasset platforms are based offshore, the ability of the US government to oversee cryptoasset markets becomes limited. Indeed, a recent report from the Congressional Research Service studying terrorist financing in light of the October 7, 2023, Hamas attacks on Israel have noted the significantly greater failure of foreign-based cryptoasset platforms to comply with US anti-money laundering laws compared to domestic platforms, even when those foreign platforms conduct business with US persons. And Deputy Secretary of the Treasury Adeyemo recently noted that Russia has sought to use Tether, an offshore stablecoin, to subvert US sanctions.

The US dollar is the dominant currency in traditional financial markets and the dominant global reserve currency. This lowers the cost of capital for the US government and private businesses and enables the US government to impose sanctions and enforce anti-money laundering restrictions globally.

The situation in cryptoasset markets is significantly different. As explained in the Phase I Report, cryptoasset markets are distinguished from traditional financial markets in that they allow trades to be denominated in both fiat currencies (crypto-to-fiat trading) as well as cryptoassets (crypto-to-crypto trading). Thus cryptoasset transactions that are nominally denominated in US dollars can consist of crypto-to-fiat trades where actual US dollars are traded for a cryptoasset, or crypto-to-crypto trades where a US-dollar stablecoin (a cryptoasset intended to track the value of the US dollar) is traded for another cryptoasset.

In current cryptoasset markets crypto-to-crypto trades involving US dollar stablecoins predominate. However, this US dollar-denominated volume primarily consists of stablecoins issued by offshore entities. In particular, the US-dollar Tether stablecoin (“USDT”) has been involved in over 60% of cryptoasset trading volume at all times since 2019. The issuer of USDT is registered in Hong Kong, and its parent company is based in the British Virgin Islands. By comparison, the largest domestically issued USD-denominated stablecoin – Circle’s USDC – is involved in just 5% of cryptoasset trading volume.

Figures 2A and 2B below illustrate the extent to which foreign issued stablecoins have displaced actual US dollar transactions in cryptoasset markets. Figure 2A compares current volumes in foreign exchange markets with cryptoasset markets. Whereas in October 2023 the US dollar was involved in close to 90% of trading volume in foreign exchange spot markets, crypto-to-fiat trades involving US dollars constituted only 13.4% of cryptoasset trading volume and crypto-to-crypto trades involving foreign-issued stablecoins constituted 78.5% of trading volume. Figure 2B illustrates how this disparity has increased over the past five years. In 2018 crypto-to-fiat trades involving actual US dollars still constituted over 30% of cryptoasset trading volume and crypto-to-crypto trades involving foreign issued stablecoins constituted only 15%. Since then, US dollar usage has declined whereas foreign issued stablecoins have continued to become more prominent. 

The preeminence of the US dollar is not itself undermined by these trends. However, the ability of the US to regulate financial markets is curbed where crypto-to-dollar trades rely on foreign-issued stablecoins, since, for example, the US does not regulate foreign issuance and registration schemes for these stablecoins.

As discussed in the Phase I Report, the SEC previously prohibited the offering of exchange-traded funds (“ETFs”) holding spot positions in bitcoin or other cryptoassets to US investors. The SEC claimed that the businesses applying to offer spot bitcoin ETFs had failed to show that the bitcoin market was sufficiently resistant to manipulation. However, the SEC did not articulate any criteria that applicants could use to demonstrate sufficient resistance to manipulation.

In August 2023, the DC Circuit Court of Appeals ruled that the SEC’s rationale for refusing to approve bitcoin ETFs was “arbitrary and capricious,” thus paving the way for the offering of such funds to US investors. Since then, eleven US-based bitcoin ETFs have launched and have immediately attracted substantial investment. By February 2024 and within 6 months of the launch of the first US bitcoin ETF, US bitcoin ETFs already constituted 83% of the total assets of all bitcoin ETFs globally, surpassing the prior leader, Canada, which previously accounted for 46% of total assets. The rapid growth of US bitcoin ETFs following the DC Circuit’s ruling indicates that US investors value the option to invest in a US-regulated investment vehicle – when a regulatory impediment is resolved, cryptoasset market activity can quickly flow into to the US. The swiftness with which bitcoin ETF activity has flourished in the US also underscores the potential immediate benefits of addressing outstanding regulatory issues in the near term. 

Cryptoasset-related jobs are departing the US in substantial numbers. According to one estimate, 74% of cryptoasset developers are located outside the US, and the US has lost approximately 3% of the global population of developers each year since 2018. In contrast, Africa, India and other parts of Asia have increased their shares substantially. Furthermore, the US could lose up to one million jobs over the next seven years due to the overseas relocation of cryptoasset and blockchain technology businesses. Another recent analysis indicates that there has already been an observable decline in cryptoasset-related job postings in major US cities. It also shows that the number of monthly cryptoasset-related startup births in the US has declined from a peak of 125 in 2018 to less than 10 in 2022, despite the fact that a majority of cryptoasset investment funds do business in the US, as discussed in subpart (b).

There have already been numerous reports of cryptoasset businesses expanding overseas in lieu of the US.

• In June 2023, the blockchain developer “a16z” announced it will open its first ex-US office in London, stating that blockchain “can only succeed with a clear regulatory regime”;

• Cryptoasset trading platform Bullish indicated it plans to register in Hong Kong as a result of its developed cryptoasset framework while refraining from any commercial activity in the US due to the relative regulatory uncertainty.

• New York-based cryptoasset trading platform Gemini has announced multiple overseas expansion plans including a technology development center in India, expanding its employee headcount in Singapore to over 100 and plans to obtain a license to operate in the United Arab Emirates.

• Coinbase, the largest US cryptoasset trading platform, has announced plans to expand in Singapore, Australia, Brazil, Canada, and Europe, citing the increased certainty provided by the efforts to implement effective cryptoasset regulatory frameworks in those jurisdictions.

Total annual investment fundraising in cryptoasset-related businesses has grown substantially over the past four years, but the share of that fundraising that flows to the US is declining. This is despite the fact that recent reports find a slight majority of cryptoasset investment funds have a primary office in the US, and that US venture capital firms represent approximately 70% of assets under management of the top 50 cryptoasset-focused venture capital firms.

More specifically, total cryptoasset-related fundraising grew six-fold from approximately $3 billion in 2020 to $22.63 billion in 2023. However, each year, the share of fundraising deals reported to occur in the United States has fallen. In 2020 approximately 36% of total cryptoasset investment deals were reported as occurring in the US. This percentage has since continually declined, to 35% in 2021, 31% in 2022 and 25% in 2023. While fundraising can be cyclical and reflect market conditions, numerous reports attribute this decline to the ongoing regulatory uncertainty in the US relative to other jurisdictions.

Several studies have shown that blockchain technology has the potential to unlock billions in cost savings and provide increased transparency to financial markets. According to one estimate, blockchain-related technologies drove cost savings for banks of $301 million on cross-border settlements in 2021 and such technologies have the potential to generate $10 billion in additional savings by 2030.

Other reports estimate that blockchain technology could result in $15-20 billion in annual cost savings for the banking industry by lowering cross-border payment costs and securities trading and regulatory compliance costs. Blockchain technology also potentially offers benefits with regard to financial inclusion, supply chain management, and market surveillance, among other benefits.

However, according to recent reports, the US share of blockchain developers has been falling every year since 2018, from 40% to 26% in 2023. By contrast, the share of developers in Asia increased from 9% to 19% between 2017 and 2022. The loss of this technical expertise and businesses threaten the potential for US financial markets to benefit from the efficiencies provided by blockchain technology.

Capital gains income from cryptoasset holdings and transactions has the potential to generate billions of dollars in tax revenue for the US government. Indeed, US lawmakers estimate that cryptoasset trading could generate billions of dollars in income tax revenue over the next decade. However, if US persons decrease the extent to which they hold and trade cryptoassets, the amount of these income tax revenues will decrease. Furthermore, to the extent cryptoasset transaction activity continues to migrate to offshore venues, the ability of US authorities to monitor and collect income tax with respect to the cryptoasset transactions of US persons will be diminished. Income taxes are distinct from a financial transaction tax on cryptoasset transactions occurring on US trading venues, which should not be implemented. The tax revenue raised by a financial transaction tax would be minimal, because it would cause cryptoasset transaction activity to continue to move from US venues to offshore venues.

The Bahamas-based cryptoasset trading platform FTX operated two spot cryptoasset trading platforms until its bankruptcy in November 2022. The larger global platform was officially closed to US customers, but some US persons were reportedly able to circumvent those restrictions and trade on the platform. A smaller US-based platform was open to US customers. Neither platform was registered as a securities exchange or broker-dealer. FTX also operated a separate US cryptoasset derivatives trading platform under CFTC oversight, the rules of which prevented customer losses.

FTX engaged in practices that are prohibited under the US securities framework and that resulted in the loss of customer assets. In particular, on its spot platforms, FTX commingled customers’ assets with the assets of other customers and the assets of FTX and its affiliates. It loaned customer assets to affiliated firms without customers’ permission. It permitted an affiliated proprietary trading firm, Alameda Research, to trade on FTX platforms and engage in front running and wash sales that artificially increased trading volume. When the extent and significance of these activities became public, FTX froze customer withdrawals and declared bankruptcy. Globally an estimated 1 million customers lost access to billions of dollars of their assets. It remains unclear how much of these assets will be returned to customers. US customers may permanently lose access to $166 million in assets. Furthermore, the bankruptcy settlement may only entitle customers to receive the US dollar equivalent of the market value of their deposited cryptoassets as of the date of the day FTX become insolvent, such that customers would also lose the benefit of any appreciation in the market value of those assets. 

Celsius was a cryptoasset trading platform available to US customers that also offered customers interest-bearing cryptoasset deposit accounts and personal loans secured by cryptoassets. However, it used customer deposits to fund its own operations and make high-risk investments. The company’s actions resulted in bankruptcy and a settlement with the Federal Trade Commission. It remains unclear how many of their over $4 billion in assets Celsius customers will recover in the bankruptcy proceedings.

Bitfinex, a British Virgin Islands-based cryptoasset trading platform and custody service open to US customers, used a Panama-based payments processor to handle customer deposits and withdrawals. When the payments processor had its assets frozen by various governments Bitfinex lost access to $850 billion in customer deposits and yet continued to use the payments processor to accept new customer deposits. Bitfinex was only able to cover customer withdrawals via a payment of $625 million from its affiliate, the stablecoin issuer Tether. This payment included assets that Tether had represented as providing 100% US dollar backing for the stablecoin. Bitfinex and Tether settled claims of fraud brought by the New York Attorney General and the CFTC.