The Tightrope of Regulation

In a significant move at the recent G20 meeting in India, the International Monetary Fund (IMF) and the Financial Stability Board (FSB) released a joint paper outlining a framework for the global regulation of cryptocurrencies. While the proposals mostly tread familiar territory, what’s new is their conviction in crypto’s unstoppable growth and success.

A flurry of optimism greeted the G20’s endorsement of the report because it advocates that countries don’t ban crypto. Hidden in its text, however, are some worrying signs. For example, on the first page, they state, “Widespread adoption of crypto-assets could undermine the effectiveness of monetary policy, circumvent capital flow management measures, exacerbate fiscal risks, divert resources available for financing the real economy, and threaten global financial stability.”

It’s for these reasons that they place an emphasis on decentralized finance (DeFi) and stablecoins. At present, foreign entities can issue stablecoins pegged to any nation’s fiat currencies, which significantly limits the avenues for curbing capital flight. A case in point is China, where crypto created a shadow economy, enabling capital transfers abroad and forcing Beijing’s subsequent clampdown.

The report goes further, asserting, “Regulation and supervision of licensed or registered crypto-asset issuers and service providers can support the functioning of capital flow measures, fiscal and tax policies, and financial integrity requirements.” It adds, “appropriate reporting requirements can reduce data gaps, which are particularly important for capital flow measures that rely on monitoring of cross-border transactions and capital flows.”

Opposition to self-custody wallets has long been championed by policy lobbyists such as the Financial Action Task Force (FATF), ostensibly in the name of averting illicit activities and terrorist financing. However, increasingly, it becomes evident that this stance is intertwined with the broader goal of monitoring and controlling capital outflows.

The demand for additional reporting requirements seems strange in a landscape where public blockchains offer unparalleled transparency. This is especially so when considering regulators’ aversion to privacy-preserving blockchains like Tornado Cash.

As it stands, the most accurate means of geographically locating crypto transactions are at their point of intersection with traditional banks or centralized exchanges. Employing a virtual private network (VPN), a self-custody wallet, and a decentralized exchange (DEX), funds can easily traverse the globe without anyone knowing which country they are in.

If governments are intent on monitoring capital outflows from their territories at least, this would mean a crackdown on self-custody wallets and DEXs. Therefore, we’ll likely see stronger language and an increase in enforcement actions against these services in the coming months.

This appears to be confirmed later in the report when it states, “In February 2023, the FATF adopted a Roadmap to accelerate global implementation of AML/CFT controls and supervision in the crypto-asset sector, which will publicly identify the steps taken to implement the standard in jurisdictions with materially important crypto-asset activity in the first half of 2024.”

The FATF’s accelerated roadmap is thought to be the reason for the sudden surge in exchanges mandating “know your customer” (KYC) protocols this year. By the first half of next year, many governments, particularly the US, will probably attempt to roll out mandatory KYC and reporting requirements to most wallet developers and DeFi protocols.

The language used throughout the report illustrates how seriously the global financial system now takes crypto. Ironically, one of the major issues they have with it is its speed of transactions. They believe this can lead to rapid destabilization of the global economy and would prefer the ability to stop or slow transactions in volatile situations.

However, the report’s silver lining is the FATF’s target to implement their policies in the first half of 2024, which coincides with the Bitcoin halving cycle. This appears to indicate that they, and other members of the global financial system, believe the next bull market will be underway by the second half of 2024.

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