2022 set to be landmark year in cryptocurrency regulation

Around the world, demand for digital assets is booming, not just in cryptocurrencies like bitcoin, ethereum, and stablecoins, but in newer instruments such as non-fungible tokens (NFTs), and in decentralised finance (DeFi). Because of the distributed and often decentralized nature of the underlying technologies — blockchain-based ledgers — policymakers can face a challenge in integrating digitalassets into their regulatory frameworks.

But that does not mean that innovative governments have not taken steps in the right direction. In early 2022, Dubai approved the Dubai Virtual Asset Regulation Law, aimed at establishing 'an independent authority to oversee the development of the best business environment in the world of virtual assets in terms of regulation, licensing, and governance’. The UAE has long seen the broad potential of digital assets and the Dubai government has its own blockchain strategy, which it believes will save it some $1.5 billion annually in document processing across government departments.

So, regulation is catching up to the digital asset world and this year we can expect to see more movement, both in the UAE and around the world, in regulatory matters.

1. Anti-Money Laundering: The pseudonymity of the blockchain has proved alluring to nefarious parties around the world, who last year laundered an estimated $8.6 billion of cryptocurrency, which was a 30 per cent increase on the previous year. If cryptocurrency is to gain widespread acceptance, robust anti-money laundering (AML) rules are a prerequisite and the immutable nature of blockchains and their inherent transparency mean with the right technologies, this can be accomplished.

The UAE’s introduction of laws for the digital asset sector was seen as the first step in a broader framework, with the initial focus on protecting against criminal activity, and in particular money laundering. Indeed, the UAE has already implemented several AML measures recommended by the global standard-setting body, the Financial Action Task Force (FATF), and has affirmed its commitment to meeting the standard in full, including as part of the establishment of it’s very own “Crypto valley” under the control of the DWTC.

At the international level, cross-border cooperation is vital if we are to raise the risk and costs for laundering operations and make investigators more effective. Today, virtual asset service providers (VASPs), such as crypto exchanges and custodians, employ compliance officers who are required to inform regulators and other government agencies of suspicious activity as well as to maintain high standards in terms of customer due diligence and transaction monitoring. When combined with effective information sharing between regulators in other nations, levels of compliance as well as effective detection of non-compliant activity, rises globally, and over the long-term, the industry becomes more robust and sustainable, allowing it to grow.

2. DeFi regulation: Distributed ledger technologies like blockchain can facilitated decentralised systems through the use of smart contracts with pre-programmed rules, where there is no single central authority which has control over the system as a whole. For digital assets, this means that certain services can be created, such as decentralised crypto exchanges, which can run autonomously, and these services make up the world of decentralised finance (DeFi).

Chainalysis’ DeFi Adoption Index records the digital asset sector to have grown by more than 2,300 per cent in the two years from Q3 2019 to Q2 2021, with total revenue in DeFi apps jumping from $1.3 billion to $578.2 billion. The UAE is ranked in the top 1/3rd of countries in the Chainalysis Index.

Unlike in centralised services however, in DeFi services there will not necessarily be a single person or entity with control over the entire system, and that could be responsible for ensuring legal requirements are met. Regulators though have begun to make progress in setting standards for promoting compliance in DeFi. The FATF has already issued guidance for AML compliance in DeFi systems, while the European Union’s draft Regulation of Markets in Crypto Assets (MiCA), also includes provisions relating to DeFi.

Caroline Malcolm is head of International Public Policy and Research at Chainalysis. Views expressed are her own and do not reflect the newspaper’s policy.