We sit down with our new Head of Crypto Sales, Jason Tucker-Feltham to discuss the hidden costs of regulations, upcoming crypto trends, and why 2023 is set to be crypto’s coming out year.
With the launch of region-wide regulations, 2023 is predicted to be crypto’s coming out year in Europe. Do you think the upcoming regulations (e.g. MiCA, TFR) go far enough to protect consumers and crypto exchanges from nefarious activities?
Absolutely. As of now most crypto assets are unregulated. The key segment captured by MiFID (Markets in Financial Instruments Directive) are security tokens, but that is a relatively small subset of the overarching crypto asset class. So, the likes of Bitcoin, Ethereum etc. are generally unregulated, and the EU was very sensible in identifying the need for there to be a strong regulatory framework that can capture those instruments that are currently unregulated. MiCA starts where MiFID ends in the crypto industry, and it has been described as the MiFID of crypto regulation.
Some say it goes too far, and you’ll mostly hear that from crypto businesses and crypto entrepreneurs. One of the reasons they say it’s going too far is the substantial cost of implementing MiCA. This may play to the benefit of TradFi firms that are looking to go into the crypto space, but for those crypto firms that are building emerging technologies, it may dissuade them from building, and it may lead to a certain number of crypto firms opting for other jurisdictions.
However, to do so might be short sighted because MiCA, as the biggest crypto regulatory framework that has ever been built, is not going to be the last piece of regulation for crypto. As other major jurisdictions are considering their own regulatory frameworks, by complying with MiCA now you are future-proofing your business and opening yourself to one of the biggest financial markets worldwide. In my opinion, MiCA does go far enough for now. Indeed, the big banks have already invested a lot of resources into lobbying for proportionate crypto regulation. For smaller players, however, they may say it goes too far.
So, would you say that the costs associated with implementing the MICA framework is prohibitively expensive?
Yes, absolutely. Even as of now, in the UK for example, a lot of crypto firms have estimated that the cost of implementing and getting on the FCA’s Money Laundering Registration is between £100 – 200,000, so that’s just one sunk cost on anti-money laundering compliance.
Therefore, the cost of MiCA, as an incredibly comprehensive suite of regulatory requirements, is going to be significantly higher than that, which is going to put off a lot of crypto businesses from implementing the MiCA framework. However, MiCA is undoubtedly going to protect consumers, reduce risk in the markets, and be conducive to institutional adoption of this asset class. So, there is a real purpose and need for this regulatory framework.
The European Central Bank recently warned European countries against the premature finalization of national crypto rules before EU regs were implemented, for fear of a patchwork system of regulations. Are there major differences in national crypto rules? If so, how will the euro zone be able to reconcile this?
Some jurisdictions have seen the inevitable implementation of MiCA as an opportunity to get ahead of the curve, and by sharing how applicable its national crypto regulations are, to attract crypto business.
Some jurisdictions have even gone as far as to offer certain tax advantages. A notable jurisdiction would be France, where two major crypto exchanges – Crypto.com and Binance – have shifted their European headquarters to, because there’s a certain amount of regulatory certainty, and research and development tax credits available.
These jurisdictions are trying to futureproof themselves and cement their presence in the EU, which, of course, is a significant market for their business operations.
For businesses themselves, it could be operationally inefficient to implement MiCA-esque requirements before the full implementation of MiCA, but trying to make progress in the direction of MiCA could be very beneficial for certain players in the long term.
What do you see as the major challenges currently, or in 2023, prohibiting further mass adoption of crypto assets?
I think the key thing at the forefront of people’s minds is going to be the actual security of those centralized exchanges and custody providers. As of now, it is very much an unregulated space, and so we’ve seen huge, catastrophic casualties in the industry, and that is partially as a result of it being pretty much a “free for all” for those companies that decide to build technologies and offer services in the space.
So, I think custody and protections for consumers is at the forefront of people’s minds and that is something that needs to be resolved in the near term. Big losses in the crypto industry are nothing new, fraud in the crypto industry is nothing new, but what we need to see is more corporate governance and structures to act in favor of consumers, even in the absence of regulation.
From the get-go, you would expect there to be strong onboarding processes to ensure you’ve got a client set that you are willing to take on per your risk tolerance, and you are operating in jurisdictions that you wish to operate in, given there are varying considerations depending on the jurisdictions of your clientele. In addition, I think it’s a case of rebuilding trust, and that will not happen overnight. People are going to be thinking about what happened with FTX and a whole host of other industry titans, where trust was strong until relatively recently. Trust needs to be built up within the industry over time.
Part of that is ensuring there are controls and solutions and technologies that help rebuild that trust, yet do not detract from the user experience too much.
What role will KYC, and in particular, eKYC play in the future of cryptocurrency, with regards to a) ensuring operators adhere to multijurisdictional regulations, and b) ensuring operators know who their customers are?
It is a common misconception that everything is harmonized across the EU in terms of regulatory frameworks and data protection etc. Each jurisdiction has its own interpretation of EU regulatory requirements, meaning there is regulatory divergence, even within the EU. In general, these are relatively minor deviations, but there are some notable differences, like in Germany, with the requirement for video verification, and video conference-style onboarding. However, with the right solution, there are more streamlined processes available, even for Germany.
So, solutions need to offer a certain amount of flexibility, yet this cannot fall below the regulatory standards. So it’s an evolving landscape and providers need to closely track regulatory change and where required they need to adapt their solutions to that change so that their customers can remain in full compliance with local regulatory requirements, and then when it comes to the point where the likes of exchanges or crypto businesses are applying for licenses, be it from BaFin or other major competent authorities, they are going to be well positioned to attain those licenses, because ultimately regulators around the world want to be assured that crypto businesses are doing the right thing; in particular observing local regulations, and selecting the right solutions in order to achieve regulatory compliance. The likes of IDnow are well poised to work with crypto businesses, to move their business in the right direction.
Increased levels of transparency and accountability is sure to appease the mass market and newcomers to the sector, but how about ‘old school’ crypto consumers, and so-called ‘cypherpunks’, how have/ are they likely to react to the new regulations and requirements?
I think a lot of the “old school” users of crypto are more likely to have libertarian values and, in some cases, enjoy the privacy afforded by crypto protocols. The likes of Bitcoin and Ethereum are pseudo-anonymous, and that gives a certain amount of privacy. There are numerous tools for users to enhance that privacy if a user so wishes, but ultimately all centralized crypto platforms must onboard users using KYC solutions, which obviously requires the verification of identity as part of that process.
For those who are really against revealing their true identity, a certain populace is moving to decentralized exchanges that do not require KYC, because as of now there is no generally accepted KYC platform for decentralized platforms, even though there are some undergoing development as we speak. The days of anonymous on-chain crypto usage may be numbered, especially as institutions want to gain exposure to decentralized finance yet are not going to operate with anonymous actors on-chain.
Obviously, it’s a necessary step for crypto businesses to understand who their customers are, and without understanding who your customers are, you don’t know what risks you are taking on; you could be transacting with criminals, or with sanctioned entities.
In some cases, exchanges want to reduce their US exposure because there are stronger punitive measures for that territory than in most other jurisdictions, so it’s a case of businesses establishing what their risk tolerance is, and if their risk tolerance means they need to understand who their customers are, they need to go through KYC, there’s no other option.
Why do you think fraud and other illicit activities are so rife in the crypto world?
I would disagree – this is a misconception in the industry. The percentage of fraud in the crypto industry is significantly lower than traditional finance. Chain Analysis and Elliptic – market leaders in understanding on-chain activity – have conducted a lot of research and established that a relatively low percentage of crypto trading and crypto transactions are attributed to fraudulent activity or illegal activity.
Yes, there are bad actors in crypto, but there are bad actors in any industry, and it should not be the technology that is blamed. It is always going to be the responsibility of the people that use the technology. The optics of crypto have improved over the years, and I think this is part of the reason why larger corporates and institutions are more receptive to the technology and this emerging landscape. But there are still opportunities to reduce incidents of fraud and reduce the ability of bad actors to engage in the space. It just takes the right technology and solutions to be built to create a more secure perimeter in which people can transact. To say there is a negligible amount of fraud or criminal activity in traditional finance, done using traditional financial instruments, is therefore incorrect.
What are the major risks and rewards of integrating crypto payments, or launching as a crypto exchange?
One of the major risks and challenges is safeguarding the privacy and custody of crypto assets.
A major issue with crypto custody is that if crypto assets are lost by a third party such as a crypto custodian, the owner can’t go to a bank or intermediary and say, “reverse that transaction, that was an error.” There’s no safety net in that regard; once a mistake is made and it’s a catastrophic mistake, there is very little recourse, and significant amounts could be lost as a result. In addition, with decentralised finance, there have been several protocols that have had security deficiencies and led to a loss of funds. Ultimately, the risks in storing crypto assets are significant, and I think this is an area which needs to a lot more work.
There needs to be a lot more work done in terms of providing custody solutions that are battle-tested and can be relied upon for significant holdings of crypto. Although fraud, percentage wise, is lower in the crypto industry than in TradFi, there is still a significant risk of fraud, as evidenced by the recent disaster with FTX, which appears to be displaying the tell-tale signs of fraud. Given the sheer scale of that event, I think a lot of eyes are going to be on ways of reducing the risk of fraud, especially with major exchanges. So, a lot of work does need to be done to safeguard consumers, and I think over time, regulatory frameworks and improvements in the technology will play a massive part.
If crypto exchanges manage to meet the aforementioned challenges and implement all the different measures, what is awaiting them at the other end of the rainbow?
Increased adoption! The safer people feel with crypto, the more likely they’re going to open an account with an exchange and start procuring crypto.
Ultimately adoption requires a certain amount of trust and this needs to be established over time, and so by opening the crypto market to those individuals who currently feel safer within the confines of TradFi, you’re going to see increased volume come to your exchange once there is a shift in perception.
Although the overall equities, commodities, derivatives, and other markets are huge in comparison with the crypto asset market, which is currently hovering around the trillion-dollar market cap level, if you want to have a bigger piece of the quadrillion dollar derivatives market for example, you’re going to need to establish yourself as a trusted asset class, and that will take time.
Why do you think online gambling and crypto has struck up such an unhealthy relationship?
The online crypto gambling industry started in 2012, with an online casino called SatoshiDice (a homage to the creator of Bitcoin, Satoshi Nakamoto). It was the first online casino to feature bitcoin payments and soon became highly popular.
Part of the attraction of SatoshiDice was that by using Bitcoin instead of traditional payments mechanisms, those who chose to gamble online could do so with relative privacy. For those bad actors who are intent on using crypto for money laundering have long viewed this privacy aspect to be advantageous. However, most platforms nowadays mandate KYC which, when implemented effectively, reduces the risk of illicit activity.
What crypto trends do you envisage for 2023?
What is happening and will continue to happen is a lot of people who operate in crypto will fully migrate to decentralized finance, as DeFi is fully transparent; you can’t hide financials in DeFi platforms.
As there is instant proof of reserves and the code is auditable, DeFi is the most transparent way of transacting in the crypto market. Many of the major brands that have gone under are centralized crypto operators, not decentralized crypto operators.
Interested in more Fintech Spotlight Interviews, and more insights in how to operate safely and securely in a crypto world? Check out our interview with Brandi Reynolds, CAMS-Audit, CCI, CCCE at Bates Group.
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