Why is America letting the EU take the lead with digital compliance?
The European Union is taking the world lead in overhauling its rules and regulations in regards to money laundering, especially as they pertain to large cryptocurrency transactions and the myriad of crimes that plague the metaverse, decentralized finance (DeFi) and non fungible tokens, better known as NFTs. In 2021 alone, there was a 30% increase in digital money laundering activity compared with 2020, of which a total of $8.6 billion (USD) was laundered, just through crypto. This move by the EU will be criticized widely by DeFi proponents and analyzed worldwide as governments around the world try to grapple with how to regulate the metaverse, crypto, DeFi and NFTs.
The United States will be paying close attention. Last April the White House issued an executive order that, in essence, said the federal government would spend the rest of 2022 studying how to address the decentralized and therefore unregulated cryptocurrency market. That EO was essentially like foreshadowing in a novel for those paying attention. Apparently, lawmakers in the EU were paying attention, and beat the Americans to the punch in terms of actually putting forth legislation. The big question is how governments regulate these digital entities and for those looking for clear cut answers, we only have to look as far as the Securities and Exchange Committee, which classifies cryptocurrency currently as a security.
According to current SEC Chairman Gary Gensler, the SEC now considers cryptocurrency coins to be securities under the Howey Test, and has stated that, “If somebody is raising money selling a token and the buyer is anticipating profits based on the efforts of that group to sponsor the seller, that fits into something that’s a security” (“SEC chair Gary Gensler on his vision for cryptocurrency regulation” Aug. 4, 2021).
What exactly is the Howey Test? The Howey Test is technically a law resulting from the Supreme Court case SEC v. W.J. Howey Co., 328 U.S. 293 (1946). In order for an investment to qualify as a security, the Howey Test requires the following traits:
— An investment of money,
— In a common enterprise,
— With a reasonable expectation of profits to be derived from the efforts of others
That is simple, cut and dried language, right? According to the SEC, cryptocurrency coins and tokens, which previously failed the Howey Test (pre-White House EO), have now been given a passing grade on the test and as a result will be listed as securities that require full regulation and disclosure. However, the water is murky here and a big reason why most of us still don’t have a clear cut understanding of whether these digital platforms are considered commodities or securities. Why is the water murky? Because while the SEC contends they are securities, other bills in play, such as the Responsible Financial Innovation Act (July 2022) are still seeking clarity about how digital assets are classified under securities laws in the United States. There is no standard answer in the US at this point, which is frustrating.
Basically, in the US the left hand and the right hand are not working together and so the news we are presented as a result of these EOs and bills is often conflicting. I think we have a long way to go (not months) in the US before centralization of the metaverse, crypto, DeFi and NFTs becomes a reality. As of right now, we are still having ‘brainstorm’ level discussions instead of taking action, as it appears the EU is prepared to do. Maybe following the EUs lead isn’t such a bad idea? Some of the world’s most popular, decentralized hot spots are based in Europe, such as CryptoValley in Switzerland, so their proof of concept might be much further along than our’s in the US. In this instance, finishing second to Europe in the race to centralize the decentralized, might be the smartest play. It will give the US a chance to gauge societal reactions and adjust accordingly.
For those who think regulation stinks, consider that your investments in these digital platforms would be much more secure and safe than they are today. In order to get there, the companies and the exchanges that control the metaverse, DeFi and cryptocurrencies need to achieve a standard level of compliance, which is becoming more and more important in all aspects of the business and financial world. According to a report conducted by Lexis Nexis in 2021 the total projected cost of financial crime compliance in the U.S. and Canada for 2021 was $49.9 billion (USD), a 19 percent increase from 2020, and a 58 percent increase from 2019.
These numbers should not be taken lightly. The report’s summary stated that the “digital transformation is a game changer for financial crime compliance operations. It requires a more sophisticated, multi-layered solution approach to mitigating risk and ensuring compliance.”
In layman’s terms that means we have a long road to hoe. Let’s let the EU take the lead and see how it all shakes out in 2023. It is going to be a wild ride next year and I am here for all of it — and hopefully you are too, and will join me on that journey right here, each week, as I catalog it.