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The Automation and Productization of Knowledge Work

By Blog, Featured

As digital services proliferate, we’re entering a new age of commercial opportunity: one where the digital world increasingly reflects changes similar to the physical world of the past 100 years. The efficiency gains between the two (an exponential decrease in the marginal cost of the offered product) is now taking hold in digital services as they become productized.

We are quickly shifting from a variable cost economy to a fixed cost production economy where such investment is prioritized, resulting in higher and more permanent returns to capital. This transformation has led to multiple new types of business models, ranging from SaaS to Knowledge-as-a-Service.

Here, we look at how services have become “productized” over time, and how the automation and productization of human knowledge is revolutionizing today’s economy.

Legacy Businesses: Services and Products

There are two types of legacy businesses: those that render services and those that sell specific products. Product companies evolved from service businesses as a result of mass production. Prior to the ability to scale production of a service, everything was unique, niche, and one-off. Product companies generally represent physical goods, though as we’ll see in a moment—this understanding is shifting today.

SaaS (Software-as-a-Service) — 1990s

SaaS, at its core, is a delivery vehicle: it is a container that holds some form of data, insights, or knowledge, often generated by the consumer. The popularity of SaaS businesses is due to its recurring billing model that extracts additional rents from consumers. SaaS is still limited: it is often a set of intelligently organized containers, intended to hold and distribute some set of data, produced by the customers, to the customers. At its core, SaaS is the productization of distribution: using the internet to repeatedly deliver a software “product” that was previously sold on shelves via a shrink-wrap license. Today, there is a growing emphasis on the quality of what SaaS companies can do (e.g., data, insights, or knowledge) to provide value to customers.

DaaS (Data-as-a-Service) — 2000s

As the SaaS market matured, customers began to seek opportunities. Enter data companies. Data-as-a-Service models may be sold via a containerized set of data (stand-alone), or input into a piece of software (often via API or direct embedding). The primary difference between a DaaS business and a SaaS business: in a SaaS business makes money from distributing that content, rather than generating content. Take for example Salesforce and ZoomInfo. Salesforce is the container that can be used to hold known industry contacts, while a DaaS vendor like ZoomInfo might be used to enrich that contact data with better address or phone details. DaaS’s value is in the data produced, not the container it sits in.

IntaaS (Insights-as-a-Service) — 2010s

Data can be sliced, diced, analyzed, and cut into many different views, revealing profound insights. These insights are now packaged and sold to consumers through the Insights-as-a-Service model. An example of businesses that productize data into insights include companies like Nielsen, who have built a business around a straightforward set of metrics. IntaaS firms attempt to provide customers with insights from proprietary sets of data, thus reinforcing their competitive moats. These businesses represent a step toward the productization of knowledge, and their ability to provide insights on proprietary data is the differentiated product.

KaaS (Knowledge-as-a-Service) — 2020s

Much like a factory in the early 1900s, KaaS relies on an assembly line of knowledge that has a set of repeatable steps to create knowledge as a product. AI will often be the tool of choice in these businesses; they are the machines in the digital factory. In these businesses, both distributing a product (SaaS), and building a product (KaaS) are one-time fixed costs. This means more up-front capital required, but higher-back end margins.

As an example, Stitchfix, a modern personal styling service, invested a fixed amount of capital into building algorithms that create knowledge about each user to target a better fit for consumers and reduce the volume of misfits and returns. Stitchfix has thus turned a variable cost (rate of return per customer) into an up-front fixed cost which builds knowledge about its customer, and thus massively reduces variable cost. The “knowledge” product that Stitchfix sells is “optimal fit.”

Ascent as a KaaS provider | Ascent is a KaaS company that creates regulatory knowledge to help financial firms manage their regulatory risk more effectively than traditional methods. Traditionally, firms have used a mix of in-house compliance staff and outsourced resources like consultants or lawyers to analyze this text and determine which regulatory obligations are actually applicable to the business. Ascent has created an assembly line of engineers, data scientists, and compliance officers to build, train, and optimize intelligent algorithms that identify a firm’s exact obligations at a fraction of the time and cost. Only about 35 percent of any body of regulatory text contains an actual obligation (the rest consists of definitions, clarifications, and other ancillary information) and an even smaller percentage of those obligations apply to any particular business. Our algorithms are trained to spot the difference, and immediately get to work parsing out the text into obligations and non-obligations. To learn more about the granular information produced by Ascent, contact us.

 

What This Means for The Economy

Society is just beginning the shift towards the KaaS business. Up-front investments that yield productive first-to-market traction will mean more long-term revenue. The stickiness of KaaS businesses should be far superior to SaaS businesses when fully integrated. As algorithms become smarter, knowledge will be easier to generate, and the price of knowledge and expertise will decrease. As a result:

1. Expertise will become ubiquitous. The unlocking of human capital will be astounding: people will be able to create, accelerate, and design, while machines will calculate, advise, and build. For the first time in history we will be able to give people all over the world access to knowledge for free.

2. The Expansion of Human Potential: These knowledge machines will enable us to dramatically expand our abilities in areas like medicine, law, finance, and other knowledge disciplines. As the cost of knowledge drives to zero, people will be able to freely consume it. This will result in enormous consumer surplus, and benefit to society.

3. Returns to Labor will Remain Under Pressure: Shifting from variable costs like human labor to fixed cost like technology (built via capital investment) will create challenges as the economy transitions. Job dislocations will occur, but will be temporary. Similar forms of automation happened to blue-collar manufacturing work in the 50s and 60s. It is likely we will see similar automation and disruption to knowledge work in the 2020s, and more prolifically in the 2030s.

This shift is already underway. As knowledge is commoditized via algorithms, these business models will continue to evolve in a way that creates benefits for consumers and businesses alike. While temporary disruption will occur, the ultimate promise of knowledge products will usher in an era of productivity and growth, the likes of which we see once in a generation.

About the Author | Brian Clark is the President and Founder of Ascent. He has a wide breadth of regulatory compliance experience including derivatives exchanges, market investigations, clearinghouse compliance, and registered brokerage businesses. He is a former Chief Compliance Officer and General Counsel, and is passionate about entrepreneurship and technology. Connect on LinkedIn.

 

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A ‘Token’ for Their Thoughts: Digital Finance from a Regulatory Perspective

By Blog, Featured

In Part 1 (DiFi or Die Trying: A Quick and Dirty Overview of Digital Finance), we discussed the digital financial ecosystem that grew from the ashes of the financial wildfire that spread across the world in 2008. 

Here in Part 2, we discuss how regulators are grappling with the task of keeping weeds out of the digital garden. Since their approaches and speed by which they tackle this task differ and are evolving, it is as important to stay focused on the regulators, as it is to stay focused on the innovators. Regulatory Knowledge Automation from Ascent can rapidly bring both into your clear line of sight. Keep reading for a better understanding of the regulatory landscape around DiFi.

INFOGRAPHIC: Regulatory Knowledge Automation, Explained

 

Regulation in the United States

Although ‘digital assets’ is a broad term applied across economic sectors, this discussion focuses on the financial services sector and, within that sector, crypto assets. This is because crypto assets (and specifically cryptocurrencies) have been given the most attention by regulators to date. Here’s a rundown of major events in recent weeks:

» May 17th — The FDIC issued a Request for Information and Comment on Digital Assets to learn how depository institutions interact with the cryptocurrency sector, how they might interact with the sector in the future and what, if anything, the FDIC should be doing about it. Questions the FDIC posed included ones relating to digital asset custody, coin issuance, trading, settlement and payment and regulatory supervision of digital finance activities.

» May 19th — In testimony before the U.S. House Financial Services Committee, OCC Acting Comptroller of the Currency listed adapting to digitalization as the third of four challenges requiring the OCC’s immediate attention. She emphasized that disintermediation is occurring in bank payments processing by FinTechs and technology platforms utilizing application programming interfaces, machine learning and distributed ledgers. Proof positive is OCC approval of two national trust charters for crypto platforms (Protego and Anchorage) within the past six months, and applications pending for at least two more (BitPay and Paxos).

» May 20th — Federal Reserve Chair Jerome Powell discussed the Fed’s response to technological advances driving rapid change in the global worlds of payments, banking and finance (including allowing FinTechs access to the Fed’s payment system under proposed guidelines).

On the other side of the house of federal regulators in the United States, the chairs have been rearranged, but who has jurisdiction over digital assets remains a persistent question. Breakdancer (pause while you check out the YouTube video)  and former CFTC Gary Gensler is now chairing the SEC, while Rostin Behnam is acting chair of the CFTC.  

While it is clear that the SEC regulates Initial Coin Offerings (ICOs), whether a digital asset in a specific use case should be treated as a security, a currency, a commodity or something else is more murky, despite recent SEC guidance on how to apply the long standing “Howey” test for defining a security.

Read More: Crypto Regulation and Changing of the SEC Guard

 

SIFMA’s May 20th reaction to SEC guidance on applying broker-dealer custody rules to digital assets addresses work in other critical areas of securities regulation that remains to be done i. Meanwhile, the CFTC launched its LabCFTC in 2017, both to encourage fintech innovation and inform CFTC thinking about its regulation. To date, LabCFTC has made the agency’s guidance more accessible, but it has been no substitute for consensus among regulators and a coordinated approach. 

Despite deliberate efforts by federal regulators to modify their rulesets for a digital world, important questions remain, including whether, how and who should regulate digital asset platforms, exchanges, traders, managers and advisers, asset repositories and transmitters, pooled products, derivatives and associated sales and marketing activities (especially those directed at retail consumers).

Further, at least some activities involving digital financial assets are regulated at the state level, where answers are distinct and could differ materially from answers at the federal level. As this March 2020 article explains, state money transmitter rules are an especially acute pain point for digital marketplace participants.

Read More: A Look at Money Transmission Laws + How To Know Your MTL Obligations

 

Regulation Outside of the United States

In 2014, the United States Law Library of Congress published a report on the regulation of cryptocurrency across forty countries and the European Union. In 2018, the report was expanded to cover 130 countries. The report seeks to determine how various countries are responding to the fast-growing cryptocurrency market, discern regulatory trends and organize data for region-specific comparisons. 

In 2019, a separate, more focused, report was published discussing regulatory approaches in the context of financial market and investor protection laws in 46 jurisdictions, as well as providing updated information on relevant tax and AML/CFT laws. These reports reveal a number of countries are applying existing rulesets to crypto assets, while at least a dozen countries have enacted new laws specifically governing crypto assets

In April 2020, China became the first major economy to pilot a central bank digital currency (CBDC) with the number of pilots in other countries surging to 19 as of May 2021. 

 

Stay ahead of the curve with Ascent

Meanwhile, the digital asset industry is not standing still while regulators work to catch up.  Instead, they are shifting from ‘pushing back’ to advocating for ‘smart’ regulation that can be operationalized cost-effectively and aligned with developing industry best practices and principles.  

Both innovation and regulation within the digital ecosystem are likely to occur at a rapid pace for the foreseeable future, making Ascent an essential tool for those seeking to discern and understand complex and challenging compliance obligations. 

Ascent’s AI-driven technology rapidly and accurately maps obligations to your specific business and automatically keeps them updated as rules change. By automating the tedious process of regulatory research, analysis, and change management, Ascent gets you 90% of the way there in knowing what you need to do in order to stay compliant. That means your team can focus on the most critical, most human, 10% — reviewing and interpreting the output and strategic decision-making.

Interested in learning how Ascent can help you eliminate risk with a single source of regulatory truth? Contact us for a custom demo.

 

About the Author | Jilaine Bauer is Senior Compliance Consultant at Ascent. Previously, Jilaine worked as a Compliance Officer responsible for regulatory change management at one of the world’s largest providers of financial market data and infrastructure, as an independent regulatory consultant within the financial services industry sector and as general counsel and compliance officer to multi-faceted financial services firms.  She holds a law degree from Loyola University (Chicago) and a degree in psychology from the University of Illinois Urbana-Champaign.  She also has corporate, advisory and nonprofit board experience. Connect on LinkedIn.

 

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DiFi or Die Trying: A Quick and Dirty Overview of Digital Finance

By Blog, Featured

Emerging from the ashes of the financial wildfire that spread across the world in 2008, the seeds of a new digital financial ecosystem germinated from an email sent by Satoshi Nakamoto to a group of techies that November:

“I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party. The paper is available at bitcoin.org/bitcoin.pdf.”

Two months later, Satoshi created 50 Bitcoins with the very first transaction on a blockchain on January 3, 2009. Today, there are some 4,000 cryptocurrencies in the digital ecosystem with a  total market cap reaching $2.2 trillion last month. As of June 2020, at least 45 central banks were reported to be researching payments technology and applications, known as Central Bank Digital Currencies (CBDC), and in October 2020 the Bank for International Settlements as well as seven central banks (including the Federal Reserve, the European Central Bank and the Bank of England) published a report laying out key requirements for CBDC

Fast following on the heels of cryptocurrency innovation, other forms of digital tokens were created, and the use of blockchain and “blockchain – like”  technology was expanded in the public and private domains. This facilitated the transfer of a broader range of units of value, digitized other types of tangible and intangible assets and enabled the satisfaction of counterparty obligations under smart contracts wholly unrelated to assets.  

In part one of our two-part series, we discuss what “digital assets” are, the blockchain infrastructure that supports them and the emerging products, applications, processes and organizations that use them,  known as digital finance (DiFi). 

PART TWO: A Digital ‘Token’ for Their Thoughts — Digital Finance from a Regulatory Perspective

Digital Financial Assets

In the broadest sense, the term “digital asset” refers to anything that exists in a digital format, including photos, documents, audio, electronic records, websites, data related to individuals or accounts and cryptocurrencies. Physical assets can be converted to digital assets when they are scanned and uploaded to a computer. Digital assets are stored (carried) on digital appliances/storage devices that function like a filing cabinet (eg, computers, telecommunication devices and other modalities).

“Digital tokens” are financial digital assets that refer to a unit of value, which can be owned, assigned (traded) or redeemed later. Because tokens serve different purposes, they can be treated differently under the law and the law governing tokens and blockchains is not uniform across jurisdictions. For a more technical discussion, see this article published in Digital Asset Management (DAM) News.

Cryptocurrencies (digital coins) are the most common form of digital token and are used as a means of payment for goods or services and are “native” to a specific blockchain with a related name (e.g., Bitcoin/Bitcoin BC; Ether/Ethereum BC; NEO/NEO BC). Central Bank Digital Currency (CBDC) refers to a digital representation of fiat money issued by a Central Bank. Stablecoins are privately issued cryptocurrency with a mechanism to minimize price fluctuation to “stabilize” its value, such as linkage to a reserve of stable real assets such as currencies or commodities. For a discussion on CBDC and stablecoins, see this white paper published by law firm Clifford Chance.

They may be stored in “digital wallets” earning interest and may increase in value for later use.  Sometimes, they earn dividends (e.g., NEO pays dividends called “GAS”). In some cases digital coin owners also have a say in the design and function of the associated blockchain (e.g., DASH). Also, the sponsor of a blockchain platform (e.g., Ether and NE) may allow other tokens to be transferred on its platform subject to payment of a user fee. For a  “crypto” glossary and a list of cryptocurrencies, including their individual and aggregate market cap, see Coinmarketcap.com

Other tokens serve different purposes, but typically they all function as part of a platform that sits on top of an existing blockchain. The benefit to the token issuer is the savings in time and money required to launch and operate their own blockchain. Anyone can create a token paying the blockchain sponsor to create and validate (“mine”) transactions in his/her/their token.  Tokens may be created to activate features in another application (“utility” tokens) called a decentralized application (dApp) or may represent an underlying security (stock, bond, ETF) commodity, loan or other asset (“asset-backed” tokens). In 2020, the commercial real estate firm, Red Swan, partnered with the blockchain sponsor, Polymath, to tokenize real estate. There also are “hybrid” tokens. 

Non-fungible tokens (NFTs) represent ownership of something unique (identification code and metadata) for a particular user that can be bought and sold but, unlike cryptocurrency, they are non-interchangeable and do not have any inherent value. They can be used to represent people’s identities, property rights, and artwork. Many are built on the Etherium blockchain (e.g., cryptokitties).

WATCH NOW: [Compliance Over Coffee ft. Val Dahiya, Partner at Perkins Coie] Inside the Complicated World of Digital Assets

 

Smart Contracts are misnomers as they are neither “smart,” nor are they necessarily “contracts”! Rather, they are “business rules” translated into computer code (software algorithms) that “run the blockchain” (trigger actions) when predetermined conditions are met.  They serve as the basis for transference of a token, but they can also trigger actions that do not involve token transfers, including actions required under a legal contract. 

Distributed Ledger Technologies (DLT). A Distributed Ledger is a database that exists across a network of computers at multiple locations or among multiple participants eliminating the need for a central authority or intermediary to process, validate or authenticate transactions or other types of data exchanges. The design eliminates the “single source of failure” present with a centralized or intermediated system, and is quicker, more efficient and cost-effective. The DLT transaction only comes to rest on the ledger when consensus is reached  among the parties that it is real and valid. Transaction files are then timestamped and protected with a unique cryptographic signature providing a verifiable and auditable history. DLTs can be public or permissioned (invitation-only) and they can operate solely by smart contracts or governed by an entity.

Blockchains are a type of DLT distinguished by the fact that units of data are displayed in a sequence (blocks on a chain) with each unit dependent upon a logical relationship to all prior units. Public blockchains are used to process peer-to-peer (non-intermediated) anonymous transactions in digital assets (e.g., cryptocurrency) which, when verified, become immutable and cannot be changed.  Some blockchains, like Ethereum, will support token applications running on top of the blockchain, in addition to the cryptocurrency (payment token) that is embedded within it. 

Digital asset management systems (DAMs) incorporate software, hardware and services that together are designed to manage, store, ingest, organize and retrieve digital assets. 

READ MORE: A Quick Look at Money Transmission Laws (+ How to Know Your MTL Obligations)

 

Ascent is your partner in digitally transforming compliance

Wherever you are in your digital transformation journey today, the pace of that journey will accelerate in the months to come thanks to new possibilities enabled by rapid developments in technology, infrastructure and regulation. Using Ascent’s AI-driven technology to identify and evaluate the impact of existing and emerging regulations across jurisdictions and business activities, you can bring strategy into focus, improve business process velocity, and optimize your business.

Contact us for a custom demo to see how Ascent helps you comply with changing regulation more efficiently and accurately than ever before. 

 

About the Author | Jilaine Bauer is Senior Compliance Consultant at Ascent. Previously, Jilaine worked as a Compliance Officer responsible for regulatory change management at one of the world’s largest providers of financial market data and infrastructure, as an independent regulatory consultant within the financial services industry sector and as general counsel and compliance officer to multi-faceted financial services firms.  She holds a law degree from Loyola University (Chicago) and a degree in psychology from the University of Illinois Urbana-Champaign.  She also has corporate, advisory and nonprofit board experience. Connect on LinkedIn.

 

Inside the complicated world of digital assets

By Blog, Compliance Over Coffee

[Feat. Val Dahiya, Partner, Perkins Coie] — As the former Branch Chief of the Division of Trading and Markets at the SEC, Val Dahiya knows a thing or two about risk exposure and the  impact of regulatory change. Now as a Partner at global law firm Perkins Coie, Val focuses on helping broker-dealer firms comply with regulation and navigate new transactional developments such as digital assets, NFTs, and blockchain technology.

In this episode of Compliance Over Coffee, Val draws from her time at FINRA and the SEC to show how these innovations are disrupting financial regulation. Here’s a clip of what she had to say:

“Innovation moves at the speed of light. And regulation, it’s responsive. It’s reactive. It oftentimes moves at the speed of a sloth.”

Watch as Ascent President and Founder Brian Clark and Val discuss how firms can reduce their risk exposure even in the face of unprecedented change. 

Also in this chat:

  • Gary Gensler and the new Administration
  • The role of social media in regulating markets
  • Environmental Social Governance (ESG) disclosures

Perkins Coie is a leading international law firm that is known for providing high value, strategic solutions and extraordinary client service on matters vital to our clients’ success. Visit Perkins Coie to learn about the firm’s full array of corporate, commercial litigation, intellectual property and regulatory legal services.

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SEC Priorities: Cryptocurrency Regulation and a Changing of the Guard

By Blog

Despite the pandemic, Reuters reports that the U.S. Securities and Exchange Commission (SEC) has had a banner year, with more than 700 cases and enforcement actions. As of November, that number represented over USD $4.7 billion in penalties, fines, and disgorgements assessed. The ratio of fines to penalties is a bit askew, considering that one fine alone represented a USD $1.2 billion settlement.

Still, the agency has been particularly busy with disclosure and regulatory-related penalties, in contrast to a mere seven enforcement actions by the Financial Crimes Enforcement Network (FinCEN). Of course there is an issue of the remit of the respective agencies that would need to be taken into consideration, but one priority of the SEC has seemed to remain squarely in the initial coin offering (ICO) / cryptocurrency-related space. Here’s a look back at SEC cryptocurrency regulation from this year and what’s to come from SEC leadership in 2021.

ICOs Strictly Subjected to Howey Test

The SEC announces its enforcement priorities annually, and 2020 was no different, if only in that respect.  At the start of the year, the Office of Compliance Inspections and Examination (OCIE) released its 2020 Examination Priorities, and in it the agency noted that “digital assets” would be a priority. Many of the enforcement actions that occurred throughout the year were related to either ICOs, either as fraudulent schemes or due to poor regulatory disclosures.

The SEC has treated ICOs fairly strictly over the past few years, perhaps punctuated by the Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (the “DAO”), released in mid-2017. This report galvanized the agency’s approach to tokenization and ICOs, noting that strict adherence to the Howey test (i.e., an investment of money and expectation of profit as the result of a common enterprise, with the profits coming from the efforts of a third party) would apply to ICOs.

To that end, ICOs who tested the SEC’s resolve found that the failure to register or seek an exemption to the Howey criteria would result in multi-million dollar penalties.  In one enforcement action in particular, the SEC noted that the ICO in question—though it knew or had reason to know that it was a security based on the DAO report and prongs of the Howey Test—continued to sell its offering without making appropriate disclosures to its investors.  

READ MORE: The Most Telling Guidance of 2020: Corporate Compliance Programs, AML & More

 

Changing of the SEC Guard

The current chairman of the SEC, Jay Clayton, has publicly stated that he intends to step down from the position, leaving the incoming administration to make a nomination. Clayton’s tenure was remarkable, and has seen lauding from both sides of the aisle.  The two current names being floated to replace him are Gary Gensler, former chairman of the Commodities Futures Trading Commission (CFTC), and former prosecutor Preet Bharara. Already named to President Elect Biden’s transition team, Gensler has no shortage of experience dealing with both regulators and the private sector.

During his time at the CFTC, Gensler pushed for sweeping regulation of swap trades and has been viewed as someone who—as a former partner at Goldman Sachs—could potentially deliver diplomatic regulatory outcomes. Bharara, on the other hand, poses a far more significant shift in regulatory tone. Bharara is known, and well-respected, for his work on major insider trading and white collar cases.

Despite the significant number of actions under Clayton’s tenure (over 3,000 examinations in 2020 alone), Bharara’s appointment would signal a no-nonsense approach to both civil and regulatory engagements.

Preparing for What (and Who) is Next

Other names circulated are Dodd-Frank contributor Michael Barr, as well as Allison Lee (a former securities law practitioner and currently an SEC commissioner) and Kara Stein (a former SEC commissioner) who would both bring senior-level, hands-on experience to the position. There are innumerable variables still at play after the outcome of the November 2020 election. Needless to say, the SEC and other high-profile regulatory positions will keep Wall Street waiting with baited breath, and those of us in the bleachers a lot to consider. 

READ MORE: What are “granular” obligations in RegTech, and how do they reduce your risk?

 

No matter who takes the helm at the SEC (and at other U.S. regulators), it’s important for financial institutions to keep tabs on regulation at both the national and state level. It’s within these agencies that incremental changes occur and often catch organizations off guard. Be sure that your firm is ready for what’s next. Shore up your compliance and risk strategy by identifying all of your key risk factors, including any potential gaps in your firm’s regulatory obligations / requirements.

READ MORE: Regulatory Change Management: A Tech-Based Approach

 

Ascent helps banks and other financial firms stay above the rising tide of regulation, from the SEC and other regulators. Learn more about our regulatory coverage here.

Crypto Compliance is Still a Global Conundrum

By Blog

Read Update: 2021 SEC Priorities – Cryptocurrecy Regulation

 

Major cryptocurrencies like bitcoin and ether represent a class of financial instrument that is here to stay. Here we discuss the emerging issues they pose for finance-industry compliance officers.

For the time being, these digital mediums of exchange have a “black box” quality that worries institutional investors and appears to hold unfortunate appeal for criminals and fraudsters.

Unsurprisingly, the explosion of cryptocurrency as a means of raising capital for startup businesses and a spate of fraudulent ICOs has attracted the attention of regulators around the world.

Cryptocurrency Overview

The term “cryptocurrency” is shorthand for a wide and evolving range of “digital” mediums of exchange.

The two foundational concepts of a cryptocurrency are “decentralization” (there is no sovereign central bank creating it or controlling its supply) and “scarcity” (there is a predefined maximum number of “coins” that may exist for any given currency, thereby giving the coins their “value”).

Most cryptocurrencies rely on blockchain technology, a “distributed ledger” of ownership for every unique coin (to put it simply, blockchain is simply a clever way to have many different people create one version of something on the internet). A copy of the distributed ledger is available to all users of the currency at once and essentially prevents counterfeiting by tracking and confirming the existence, transfer, and ownership of each coin.

New cryptocurrencies are created through a process that has come to be known as an “initial coin offering” or ICO. In an ICO, the issuer creates a new unit of currency (often referred to as a “coin” or “token”) that can be purchased in exchange for an existing, more widely-traded currency like bitcoin or ether.

The purpose of an ICO is to raise capital for the issuer. The token issued in an ICO may have a variety of attributes, from serving as a new medium of exchange for certain goods and services to representing a bundle of rights (to vote, to receive a future benefit, etc.). It may also appreciate or depreciate, and thereby serve as a means of speculative investment in its own right.

Global Compliance Challenges

Given the description above, any financial compliance officer will immediately wonder whether a cryptocurrency issued in a capital-raising ICO is a security subject to regulation. The answer is, it depends. The global regulatory community remains unsure of how to characterize cryptocurrencies. It does not help that no two digital currencies are identical in their attributes. Some regulators even dispute that cryptocurrencies are currencies or assets at all.

Compliance officers cannot afford to wait for the global regulatory community to reach consensus on how to characterize ICOs. They must familiarize themselves and stay on top of the regulatory climate.

And yet, ICOs offer a potentially attractive means of raising capital. They are becoming easier by the day to launch and, for the time being, involve substantially less upfront expense than the roughly-comparable process of raising capital through an IPO or a private placement. Compliance officers cannot afford to wait for the global regulatory community to reach consensus on how to characterize ICOs. They must familiarize themselves and stay on top of the regulatory climate in their relevant jurisdictions, such as the following:

— United States

In the U.S., the dominant regulatory stance as of early 2019 appears to be a suspicion about the potential for ICOs to be used as a means of money laundering or for funding criminal enterprises and terrorism. For now, the SEC (Securities and Exchange Commission) has contented itself to applying existing U.S. securities laws and anti-money laundering regulations to evaluate the legitimacy of ICO transactions. Regulators have also expressed, but have yet to resolve, concerns about the potential for front-running and manipulation in cryptocurrencies that do not trade on regulated exchanges.

— United Kingdom

Amidst continuing Brexit chaos, U.K. regulators have remained largely aligned with their E.U. counterparts (and the U.S.) in warning of the potential for bad actors to abuse cryptocurriences and ICOs. The FCA had previously signaled its plan to issue guidelines on cryptocurrencies by the end of 2018, but as of this writing has yet to do so. There is little doubt, however, that the U.K. plans to step up regulation in the future.

— Australia

Down Under, the Australian Securities and Investments Commission (ASIC) has issued guidance alerting the public to the potential for cryptocurrencies to be subject to regulation as financial products under Australia’s existing financial regulatory schemes (although ASIC has stated its view that bitcoin is not a financial product). Regardless of whether a cryptocurrency represents a “financial product” under Australian law, issuers may not engage in misleading or deceptive conduct toward consumers.

— Singapore

According to Bitcoin Magazine, local regulators in Singapore historically took a relatively laissez-faire view of cryptocurrency issuance and trading. As reported in the Singapore Business Review in January 2019, however, Singapore regulators have more recently moved to tighten regulation to protect investors from fraud and money-laundering risk.

— China

China exercises strict regulatory oversight of cryptocurrencies. It has banned ICOs, and in August 2018, its central bank likened cryptocurrencies to a ponzi scheme. In early January 2019, government cyberspace regulators issued sweeping regulations applicable to Chinese blockchain platforms requiring them to censor content, give authorities access to their data, and confirm the identity of users.

— Japan

Having initially embraced cryptocurrencies, Japanese regulators have also exercised tighter control over the industry of late after a high-profile hack of crypto exchange Coincheck. As reported recently in The Japan Times, the Financial Services Agency (FSA) effectively stopped issuing licenses for exchanges in 2018, and only recently issued new licenses while signaling that new rules are coming that will protect cryptocurrency investors.

Vigilance is Paramount

As the examples above show, cryptocurrency regulation is in a state of increasing flux around the globe. Worries about fraud and money laundering bedevil the industry. Compliance officers confronting the prospect of their firm investing in, facilitating, or even raising capital through ICOs should take extreme care to apprise themselves of the latest regulatory guidance in their relevant jurisdiction(s).