The eu is exploring a "blind spot" in the regulation of the encryption industry in an attempt to fill a gap in legislation

Eu discusses regulatory 'blind spot' in crypto asset industry to fill legislative gap
Block technology research and regulation

In April 2020, the European parliament published a study, cryptoassets: key development, regulatory issues and countermeasures, which identified some legislative blind spots related to the regulation of cryptoassets. While countries around the world are addressing the regulatory challenges posed by encrypted assets, the activities of individual countries are not really linked to each other, making it difficult to coordinate and communicate with each other.

The research report points out that global stability currency, cryptographic asset investment, cryptocurrency money laundering, network security and other aspects are among the regulatory blind spots in the field of cryptographic assets, and discusses the solutions to relevant problems, pointing out that it is necessary for the regulatory authorities to use new methods to implement relevant regulations in these areas.

1. The global stability currency project poses a threat to financial stability and monetary policy

'in terms of financial stability, when a global stability currency is backed by safe assets, the purchase of such assets may result in a shortage of high-quality liquid assets in certain markets,' the report said. If global stability currencies are considered more valuable than local fiat currencies, they may be more inclined to use them in times of financial turmoil, leading to domestic financial instability. The emergence of a global currency would also reduce Banks' retail deposits and increase their reliance on more expensive and volatile sources of funding. Moreover, once a global stability currency is used on a large scale by the public, real control of monetary policy may shift from central Banks to private companies.

As for solutions to this problem, the report says that risks associated with global stability currencies need to be further assessed and addressed in an appropriate manner before any global stability currency programme can become operational, as suggested by G20 finance ministers and central bank governors in recent days. The eu should align its actions on the global stability currency project with the ongoing work of international standard-setting bodies. Global stability requires not only a co-ordinated approach at the eu level, but also co-ordinated regulatory standards on a global scale.

2. Holding encrypted assets on financial institutions' balance sheets poses risks

Cryptographic assets are highly volatile (such as traditional "non-asset-backed" cryptocurrencies) or have yet to prove resilient to financial stress (such as most of the stable COINS circulating in the market today). There is a risk that financial institutions could face significant losses if they buy them, take them on to their balance sheets, or engage in activities related to them.

The solutions outlined in the report are in line with those expressed by the ECB's working group on cryptoassets and the European banking authority. As part of a conservative and prudent approach, the best way to deal with the uncertainty of encrypted assets may be to deduct them from financial institutions' own capital. For now, most cryptocurrency assets are risky and do not constitute a reliable contribution to financial institutions' own money.

3. Encrypted assets are often used for money laundering and other criminal activities

In December 2019, the eu published the fifth version of its anti-money laundering directive (AMLD5), which requires cryptocurrency companies based in the eu to comply with the relevant anti-money laundering/combating the financing of terrorism (AML/CFT) rules from January 2020. However, currently, AMLD5's protection coverage lags behind that of the AML/CFT standard for international cryptography assets.

The report recommends extended AMLD5 scope, including such as expanding the definition of virtual money to cover investment tokens and practical tokens, game currency and central bank digital currency (CBDC), etc., and expand the scope of the obligation entity solve encrypted currency exchange, financial service providers and trading platform of "blind spots". In addition, the mining of cryptocurrencies can also be used by criminal gangs as a possible way to launder money, the report said. Through direct or indirect mining, criminals can get clean cash. "Encryption dug from the plot of the new currency, by definition, is a" clean ", therefore, if someone (such as Banks) willing to transform it into legal tender or other encryption assets, so the money is clean. The first step in the regulatory can try to measure the use of this technology, then, if effective prove that it is an important blind spot, will consider to take appropriate measures ".

In addition, to address money laundering risks, the report suggests that an AML regulatory body in the eu region, staffed with highly trained IT personnel, could be set up to analyze the money laundering/financing of terrorism risks posed by new technologies.

4. Investments in encrypted assets

In practice, there is no clear answer to the question of whether cryptographic assets can fall within existing regulatory frameworks. In order to fully solve this problem existing in the current financial regulatory framework, a distinction should be made between cryptographic assets belonging to financial instruments and cryptographic assets not belonging to financial instruments or electronic currencies.

If encrypted assets are financial instruments under the eu's markets in financial instruments directive II (MiFID II), there needs to be a consensus on the legal eligibility of encrypted assets as financial instruments in order to create a level playing field and ensure adequate protection for investors within the eu. Eu member states have defined the term "financial instrument" differently in the process of converting MiFID II into their national legislation, requiring the European securities and markets authority to provide further guidance on the interpretation of the list of financial instruments in MiFID II under the question of cryptocurrency. In addition, eu lawmakers could consider speeding up the updating of the eu financial services law based on the characteristics of the crypto asset industry.

If cryptographic assets are determined to be neither financial instruments in MiFID II nor electronic currencies in the eu's electronic money directive 2 (EMD2), the eu needs new rules to address the specific risks and problems posed by these cryptographic assets.

5. Network security issues

The report pointed out that one of the existing network security problems is the theft of users' private keys by hackers, which has been on the rise in recent years. Another concern for regulators is ransomware attacks. Criminals involved in such ransomware attacks lock the victim's access to computers and networks and demand a ransom, often paid in cryptocurrency.

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