Cryptoasset regulation 2022: Where it stands, where it’s going

Crypto and DeFi regulation is likely to take center stage in 2022, as regulators work to provide investors with the clarity they need to feel confident when participating in the crypto economy.

While crypto regulation is considered a gray area by many within the wealth management space, there have been several instances in which regulators provided commentary specific to this asset class. The following highlights the current state of regulatory affairs and the most important updates financial advisors should be aware of as the landscape evolves.

SEC on top
In the regulatory turf war over the crypto and DeFi ecosystem, the SEC has, broadly, come out on top as the regulatory agency leading the charge on cryptoasset oversight thus far.

In early 2021, the SEC provided financial advisors with much of the information necessary to prepare their practices for the future of cryptoassets. The SEC’s February 2021 Risk Alert outlined six main areas of risk the commission will be examining specific to registered investment advisors. (The alert also covered separate guidelines for broker-dealers). Main topics include: portfolio management, books and records, custody, disclosures, pricing client portfolios and registration issues. It is a must-read for any financial advisor looking to get involved in the crypto space in any capacity.

There is a gray area when it comes to classifying altcoins, stablecoins, decentralized lending platforms, exchanges and more. In what many crypto proponents consider a step in the right direction, SEC staff hit the books to learn more about cryptoassets, blockchain technology, industry leaders, etc. They even went so far as to host conversations with crypto executives to better understand the space. All in all, this is likely setting the stage for a year in which the industry receives more definitive guidance.

FINRA prioritizes guidance
While guidance offered by FINRA in the past has amounted to little more than encouraging transparency by member firms participating in the crypto economy, FINRA recently announced that it will prioritize the asset class in 2022.

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Robert Cook, FINRA’s president and CEO, clarified that the organization will continue to defer to the SEC, CFTC and other regulatory bodies when it comes to widespread oversight of cryptoassets and DeFi.

However, with the continued growth of the asset class, FINRA plans to release a notice of its own that provides member firms with guidance on the sale, disclosures and advertisement of cryptoassets within their businesses. The organization’s anticipated regulatory notice will provide more definitive guidance to member firms and affiliates on various crypto-related activities, including, but not limited to, the following: custody of cryptoassets; mining of cryptoassets; acceptance of cryptoassets from customers; purchases, sales or executions of transactions in cryptoassets directly, within a pooled fund investing in cryptoassets, in derivatives tied to cryptoassets or participation in an initial or secondary offering of cryptoassets; providing or facilitating clearance and settlement services for cryptoassets; and recommending, soliciting or accepting orders in cryptoassets.

Cook’s concerns center around promoting transparency and improving investor protections. More specifically, he cited the fact that many investors are purchasing cryptoassets from member broker-dealers. In doing so, investors may not realize the difference between investments that do and don’t constitute securities under the regulatory framework as it currently stands. So, FINRA’s upcoming notice is also likely to explore whether there is a need for enhanced requirements that help investors understand when their investments are regulated versus if they fall outside of the current broker-dealer regulatory framework.

On the Hill 
A flurry of pro- and anti-crypto politicians and regulatory representatives have become increasingly vocal about the future of the asset class’ oversight, even going so far as to draft explicit statements and proposals of their own.

In November, SEC Commissioner Caroline Crenshaw issued an article she authored on the risks, regulations and opportunities of DeFi. The scope of the DeFi ecosystem is sizable, operating across many protocols, applications and blockchains and has led to confusion around who regulates DeFi in the United States. Crenshaw’s article attempts to provide a framework for grappling with this issue in the present while looking ahead to the challenges that DeFi could face in the future.

In December, U.S. Sen. Cynthia Lummis announced she will be writing a comprehensive policy bill outlining her recommended procedures for cryptoasset regulation. Many issues pertaining to crypto and DeFi are regulated at the state level today, but Lummis’ bill is expected to contain rules at the federal level for stablecoins, tax guidance and consumer protections.

A specific area of Lummis’ proposal for advisors and investors to keep an eye out for is the creation of a self-regulatory organization solely responsible for crypto oversight. While the idea itself could be a bit of a stretch and has drawn widespread controversy, it could solve some of the issues regulators currently face by trying to apply traditional regulatory guidelines to a modern new asset class built on blockchain technology.

First up
The most immediate regulatory clarifications will likely be centered around stablecoin regulation and classification, broadening investor protections within decentralized markets and increasing pressure on crypto exchanges to cooperate — and even potentially register — with the SEC.

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Stablecoins have been top of mind for regulators investigating the crypto space given their importance within the DeFi ecosystem, essentially serving as a “crypto dollar” that facilitates lending, borrowing and trading with decentralized markets. SEC Chair Gary Gensler has long believed that stablecoins should be classified as securities and regulated as such. Why? Because stablecoin value is, in most cases, based on more traditional assets. In November 2021, the President’s Working Group on Financial Markets also issued a report that called for stablecoin regulation.

In addition to stablecoins, the SEC stated that crypto exchanges will be a primary focus in 2022. Gensler has stated on numerous occasions that platforms facilitating the trading of cryptoassets, some of which could be categorized as securities at some point in the future, should take steps to be more directly overseen by regulators.

The areas of focus cited above highlight the importance of promoting regulatory clarity for the ultimate benefit and protection of the end investor. It is no secret to those paying attention that, due to its decentralized nature, the crypto and DeFi ecosystem as it stands today has gaps in investor protection frameworks. In remarks before the SEC’s Investor Advisor Committee last December, Gensler said that the crypto asset class “belongs inside public policy frameworks of looking after investors, guarding against illicit activity and protecting our financial stability.”

The majority of crypto industry leaders are open to the idea of investor protection laws; however, they do want to be included in conversations with regulators to educate them on the new challenges they face. Investors and advisors learning about the crypto and DeFi ecosystem can expect to see ongoing developments in the coming months as regulators ponder ways in which this asset class can and should be regulated.