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Sarah Twohig of William Fry discusses the current landscape of crypto regulation and the legal status of cryptocurrencies in Ireland.
Regulation and legislation in the cryptocurrency space has been a hot topic recently. Last month, the EU approved the Markets in Crypto Assets (MiCA) legislation, establishing a set of common rules around the supervision of crypto assets and cryptocurrencies. With the approval of MiCA, the UK announced its own crypto regulation proposals spearheaded by the Rishi Sunak administration.
Across the pond, crypto exchange Coinbase filed an action in US federal court against the Securities and Exchange Commission (SEC) to receive clarity around digital assets being identified as securities. The petition claimed that the US does not have a functioning market in digital asset securities due to “the lack of a clear and workable regulatory regime”.
In short, regulation in crypto is currently a legal grey area of uncertainty that’s only just beginning to take form. To gain some insight into the situation, we spoke to Sarah Twohig, a senior associate at William Fry.
What are the major challenges facing regulators in defining and regulating crypto assets?
Much of what is attractive to investors and businesses about crypto assets and blockchain technology, such as anonymity and cross-border reach, pose challenges from a regulatory perspective. Regulators must reconcile legal certainty with crypto assets’ libertarian roots.
On the one hand, regulators need to present clear, legal definitions regarding crypto assets that are flexible enough to allow innovation. On the other hand, prospective regulations must provide firm legal safeguards for consumers and address perceived threats to monetary sovereignty and financial stability. This presents a delicate balance for regulators between innovation, legal risk and consumer protection.
What is the legal status of cryptocurrencies in Ireland?
In Ireland, the legal status of cryptocurrencies remains unclear and there is currently no dedicated domestic regulatory regime regarding cryptocurrencies or assets. However, this will change with the enactment of MiCA in 2024. The Central Bank of Ireland (CBI) has issued consumer warnings on risks associated with virtual currencies and has explicitly stated that they are not legal tender in Ireland or guaranteed by the CBI or any other European central bank.
The Irish courts have yet to hand down a written judgment on the area of cryptocurrencies and whether they are considered property. So far in Ireland, cryptocurrencies have formed the factual backdrop to legal cases before the Irish courts but whether crypto is property remains unresolved as the Irish courts have yet to definitively rule on this issue.
This contrasts with other jurisdictions around the world, where we have seen through various landmark judgments in New Zealand, Singapore and England that there is now a concrete legal consensus that cryptocurrencies are a new form of intangible property asset.
However, the Irish courts have been proactive in adapting traditional legal remedies and existing legislation, such as freezing orders and disclosure orders, in cases concerning cryptocurrencies. It is only a matter of time before legal issues involving cryptocurrencies are substantively litigated before Irish courts, and the question of whether crypto is a new form of property will be directly addressed.
How do existing laws and regulations in Ireland apply to crypto assets?
At a domestic level, MiCA will apply from 2024 but there is currently no specific regulatory regime in place regarding crypto assets and there has been no definitive clarification by Irish regulators as to the extent of how existing regulatory regimes, such as Markets in Financial Instruments Directive (MiFID), apply to crypto or digital assets.
For example, MiFID regulates investment services and markets in the EU regarding financial instruments such as transferable securities. It is unclear if crypto assets come within the existing regulatory regime under MiFID and, if so, to what extent. The CBI tends to take a pragmatic approach in determining whether existing regulation such as MiFID should apply to crypto assets.
Irish Revenue issued specific guidance on the tax treatment of cryptocurrencies and assets in transactions in April 2022. While no specific Irish tax regime exists for cryptocurrencies or assets, Revenue has previously indicated that the general rules and principles of Irish tax law apply to cryptocurrencies and assets, so it will take a fact-based approach in assessing whether transactions involving crypto assets are liable for capital gains, income or corporation tax.
The Fifth Anti-Money Laundering Directive (AMLD5), which was transposed into Irish law by the Criminal Justice (Money Laundering and Terrorist Financing) (Amendment) Act 2021 also imposes anti-money laundering and counter terrorist financing obligations on virtual asset service providers, who are also required to register with the CBI under the act.
What are the implications of the lack of clarity around the legal status of crypto assets?
Recent crypto frauds and insolvencies such as FTX, Terraform Labs and Three Arrows Capital have added fresh impetus for harmonised rules for issuers of crypto assets and crypto asset service providers at EU level. In the meantime, the absence of clear legislation and regulation has a tangible effect on investors and businesses because it may limit the extent of legal protections or legal remedies available to them, which in turn may undermine consumer protection and market integrity.
From a business’s perspective, the lack of clarity around the legal status of crypto assets and the rights and duties of issuers of crypto assets and crypto assets service providers leaves them vulnerable in instances of crypto or financial crime, which is on the increase.
The courts have been pragmatic and will adapt existing legal remedies to help protect rights in cases of crypto fraud in the absence of clear regulation or legislation. For example, recently the English courts allowed service of legal proceedings by NFT against crypto exchanges, which ensured that investors could assert their legal rights to issue legal proceedings.
MiCA will help close legal loopholes that have developed without clear regulation. It will go some way towards ensuring regulatory compliance and limiting crypto fraud in a currently unregulated space.
How do you see the regulatory landscape for crypto assets evolving in the coming years?
2022 saw some of the largest cryptocurrency frauds uncovered and crypto bankruptcies to date globally. The crypto frauds that made headline news recently placed the legal fallout from the ‘crypto winter’ firmly on the agenda. Some of these high-profile crypto insolvencies highlighted the failures of certain crypto businesses to retain or ringfence client assets.
Closer to home, increased legal and regulatory oversight of cryptocurrencies and crypto assets is on the horizon in 2023 with MiCA, which will introduce new legal obligations and greater levels of regulatory enforcement. In the US, heavy investment has been put into regulatory resources to tackle crypto fraud, so regulatory enforcement and disputes concerning crypto assets will be a major theme in the coming years.
2023 is shaping up to be a defining year for regulatory investigations and disputes involving crypto, with record levels of investigations by US enforcement agencies against crypto exchanges and notable judgments handed down in crypto court cases.
We are entering an era of heightened regulatory supervision for crypto assets and the regulatory landscape will be dominated by enforcement at a global level with some regulators taking transnational steps to enforce crypto regulations.
How can individuals and businesses protect themselves from legal risks associated with crypto assets?
Businesses such as crypto exchanges should prioritise operational screening, such as anti-money laundering and know-your-client checks, to satisfy themselves that assets in their custody are not the proceeds of crypto fraud and to ensure operating resilience to financial crime.
There is growing importance on enhanced due diligence investigations and cryptocurrency compliance at the outset for crypto businesses, who should satisfy themselves that they have adequately traced and identified the source of crypto funds so that any bad actors who have gained funds from illicit activities can be identified.
A recent decision of the English Court of Appeal suggests the possibility of blockchain developers owing legal and fiduciary duties to cryptocurrency owners in cases of crypto fraud. Therefore, businesses should ensure that compliance is not simply a box-ticking exercise.
A challenge for crypto businesses is to scale up their compliance functions with their growing business. Recent crypto court cases show that the old rules still apply, and there is no substitute for due diligence.
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