A Snapshot of the 2023 Crypto Regulatory Landscape

Crypto regulation is a wild beast, but few deny that the market desperately needs wrangling. After the collapse of crypto exchange FTX, John Ray III, the former Enron undertaker whom the court appointed to lead the defunct crypto exchange through one of the worst bankruptcy proceedings of all time, declared that he’d never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.”

Indeed, few of those heralded as the golden children of crypto are held in such radiant light today. Do Kwon, co-founder and CEO of Terraform Labs, is on the run from prosecutors since the collapse of Terra earlier this year. Three Arrows Capital, the crypto hedge fund that failed to repay loans after Terra’s collapse, also went bankrupt, sparking the collapse of lenders Celsius Network and Voyager Digital, leaving customer funds in the lurch and pummeling all the other companies from which Three Arrows had borrowed money.

Regulators and lawmakers are now picking up the pieces and investigating why the companies collapsed. The U.S. House Financial Services Committee is holding a hearing on FTX this week, and investigations will likely carry into the new year. After FTX went bust, FINRA started collecting information about crypto marketing practices – which could result in new policy. CoinDesk’s Nik De said that “lawmakers are paying attention,” and that this is the kind of case that investigators are interested in prosecuting. This could continue the drive of “regulation through litigation” that has dominated crypto for years.

So, what are regulators doing next year to patch up the industry, and are new laws needed to prevent another FTX-style collapse?

Regulators have long litigated the bad apples in crypto. In 2022, the U.S. Securities and Exchange Commission (SEC) sued Kim Kardashian for shilling ethereumMax during the 2021 bull market, as well as a number of other high-profile celebrities. The Treasury Department settled with BitPay over letting people in sanctioned countries, including North Korea and Iran, use its platform, and in March 2022, the DOH launched a taskforce to enforce sanctions against Russia.

A note from law firm Paul, Weiss, Rifkind, Wharton & Garrison LLP said that the U.S. government will likely continue its litigation in 2023, and that “we will see additional crypto-related sanctions guidance, enforcement actions and designations in the near term,” partly influenced by President Joe Biden’s executive order on crypto from March 2022, which required federal agencies to report on the industry.

The coming year will surely bring no shortage of litigation. In August 2022, the Treasury Department added sanctions against Tornado Cash, a decentralized crypto-mixing service for Ethereum. The SEC will also continue its case against XRP creator Ripple Labs, whom it alleged sells XRP in unregistered securities sales. Bankruptcy courts will continue to settle the matters of Three Arrows Capital, FTX, Voyager and Celsius (plus the companies their collapses claim as victims), no doubt setting legal precedents for the industry.

Preventing another FTX-style collapse is at the forefront of every government body’s mind. In the U.K., the deputy governor of the Bank of England called on Britain to “continue to bring these activities and entities within regulation.” New regulation, he said, would ensure that new stablecoins “meet standards equivalent to those expected of commercial bank money.” In the U.S., Treasury Secretary Janet Yellen has called for customer funds to be segregated from company assets.

On the regulatory front, the Senate Agriculture Committee’s Digital Commodities Consumer Protection Act (DCCPA) wants to protect people from another Celsius or Voyager by setting strict rules on customers’ assets. If it goes ahead, the Commodity Futures Trading Commission (CFTC) would oversee its implementation and litigate those who break the rules, but there’s pushback: critics think this could make decentralized finance (DeFi) protocols harder to operate. In an op-ed for CoinDesk, Cato Institute’s Jennifer Schulp and Jack Solowey argued that it threatens “DeFi’s unique features of composability and permissionlessness.”

But perhaps introducing a ton of new laws is not the way forward.

“We have very strong investor and consumer protection laws for most of our financial products and markets that are designed to address these risks,” said Yellen in a statement following FTX’s collapse, while calling for “more effective oversight of cryptocurrency markets.”

Lisa Braganca, a former SEC branch chief, thinks new regulations, if any, will not come from Congress but from the SEC and the CFTC.

“I have serious doubts still about whether Congress wants to step in and do something rather than letting the SEC and the CFTC figure it out,” she told CoinDesk.

SEC Commissioner Hester Peirce called on the two regulators to collaborate on fresh regulation, telling CoinDesk: “Having one regulator devoted to crypto could be problematic.”

Critics of the regulators argue the SEC didn’t do enough to prevent FTX from running away with customer funds, and the collapse could prompt the regulator to revise its policies. Harvard Law School emeritus professor Hal Scott and Committee on Capital Markets Regulation research director John Gulliver argued in an op-ed in Financial News that an SEC accounting rule dissuaded reputable large banks from holding crypto assets. They wrote: “If the SEC rescinded this bulletin, banks and affiliated broker-dealers could offer their services to U.S. investors in cryptoassets and to crypto exchanges, placing cryptoassets in the hands of the safest custodians in the world.”

The Biden administration’s report on stablecoins earlier this year proposed stablecoin regulation as well as the possibility of a digital dollar. 2023 could finally see some movement in a key stablecoin bill. Rep. Patrick McHenry (R-N.C.), one of the sponsors of the bill, which would allow the Federal Reserve to license stablecoin issuers, described it as a “pretty ugly baby” because of the competing disputes, chiefly about who should regulate stablecoin issuers.

If it’s the Federal Reserve, stablecoin issuers could borrow money from the central bank or insurance coverage from the FDIC. Its wording could affect major U.S. stablecoin issuers, like Circle and Paxos.

The European Union has charged ahead of the pack, and next year will continue to push through the Markets in Crypto-Assets (MiCA) Regulation. Law firm Akin Gump called the legislation “one of the first attempts globally at comprehensive regulation of cryptocurrency markets.”

The bill is wide-ranging, covering money laundering, the environment, corporate reporting and consumer protection. It would require stablecoin issuers to hold enough reserves to prevent their collapse, and would require crypto miners to disclose their energy consumption. What’s more, any exchanges that operate in the region will have to be monitored by a financial regulator from an EU member state.

Although it was supposed to be voted into law in early 2023, with the final text published in October 2022, BNP Paribas thinks that it’ll be delayed to the second half of 2024 – or 18 months after the law is published in the EU’s Official Journal.

The Crypto Policy Forum, taking place at the annual Consensus gathering in Austin, Texas, convenes leaders from government and the crypto and blockchain community to discuss, debate and determine where the affairs of the state should start and end within the Web3 economy.

The Forum explores the advance of central bank digital currencies, the tensions around stablecoin regulation, the widening enforcement of anti-money laundering and counter-terrorism rules against cryptocurrency services and the challenges in applying 20th century securities laws to 21st century decentralized protocols.

Speakers and participants seek an international consensus on how to optimize a regulatory approach that protects users and boosts confidence in the digital asset industry without overly constraining innovation or killing the objective of equitable financial access for all.