Last week was a big week for the "crypto" industry. The SEC approved 11 spot bitcoin ETFs, allowing them to trade legally in the U.S. on Jan. 10; however, it was not without controversy as the day before the official announcement, a fake announcement was posted to SEC's X account which was later attributed to a hack – a dramatic start indeed.

For better or worse, the regulators are here now, and Wall Street-wrapped crypto ETFs saw record-breaking Day 1 trades of over $4.6B. So what happens next? On one hand, JPMorgan's recently released forecast expects that $36B of other crypto investments will move to the ETFs, while on the other many firms are refusing access to invest in these products to their clients.

Katherine Kirkpatrick Bos, chief legal officer from CBOE Digital, takes us through what's next for 2024 and crypto now that the U.S. regulators are here.

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– S.M.

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In 2022, “crypto winter” arrived with a blizzard of fraud, overreliance on bad debt and bankruptcies. These painful events led to two things that are now being keenly felt across crypto – the maturation of the industry and regulatory backlash. First, projects are more circumspect. The lateral market for crypto legal and compliance remains active. Gray hair is often no longer seen as an entirely bad thing, particularly with respect to institutional engagement.

Second, there was already a natural increase in regulatory scrutiny aligned with the growth of the industry. Much was made of the SEC’s announcement of the allocation of 20 additional positions in the newly renamed Crypto Assets and Cyber Unit (formerly the Cyber Unit) in May 2022, shortly before the collapse of Terra/Luna, but that was the commission’s way of addressing the explosion of crypto markets. Now, in response to the active enforcement environment and overall scrutiny levied towards any activity or entity engaging with digital assets, projects are either looking to “go offshore” in an attempt to immunize themselves from U.S. regulatory pressure, or doubling down on compliance and best practices onshore.

2023 was a year of both challenge and stabilization in crypto. Traditional financial services (“tradfi”) entities scaled back their engagement with crypto and DeFi, exploratory partnerships never materialized, legislators cheered and raged at the industry, and more entities and individuals sought safe, trusted choices in crypto. Now, with the recent spot BTC ETF approval bringing more institutional and lower-risk investors into at least tangential engagement with crypto, what will the 2024 U.S. regulatory environment bring to bear, and how will that affect investment and engagement with crypto?

Regulatory Focus

Regulators have indicated that they will continue to focus on anti-money laundering, DeFi, financial intermediaries and conflicts of interest. To potentially avoid enforcement, regulated entities in crypto will need to have best-in-class transparency and compliance, and unregulated entities in crypto must either have a clear justification for the lack of regulation or must have no ties whatsoever to the U.S. – or, at the very least, no engagement or marketing to prospective U.S. clients and affirmative steps to block such activity.

2024 brings great promise to the growth of institutional and tradfi engagement with crypto, and the regulatory scrutiny will force projects to take a hard look at their risk, compliance and legal infrastructure. Look to the following crypto-tradfi growth areas and their regulatory risks:

Crypto custody – an ongoing area of investment for foreign banks in response to client demand, this is an underserved area in the U.S. in heavy part due to the regulatory concerns. As technology advances, more promising solutions for safety and security are emerging – but those solutions must pass regulatory and ultimately legislative muster.

Tokenization – The research and development in this area from both crypto and tradfi exploded in 2023. Regulators have seemingly been more welcoming to tokenization as blockchain or fintech as opposed to crypto, and banks have been increasingly leading the charge in this arena. Thus, this will likely continue to get scrutiny because of the big names involved, but it should also get legitimacy because of the big names involved.

Anti-Money Laundering – This is an existential risk area for crypto (unregulated or regulated), so parties should continue to focus on engaging with entities with best practices in rigorous know-your-client processes and sanctions screening. Look to more sophisticated advances in technology, such as the use of zero-knowledge proofs and identity verification on-chain, to help facilitate. Regulators will continue to demand accountability on this front even from “decentralized” entities.

This year promises a continued flurry of activity from U.S. regulators. The best thing that can happen is ongoing and ever-growing engagement between the industry, regulators and legislators, who are all working to improve and build upon the status quo.

- Katherine Kirkpatrick Bos, Chief Legal Officer, CBOE Digital

What are the main regulatory hurdles for businesses engaging in the crypto market in 2024?

The impact of regulatory changes on crypto businesses is significant but varies depending on the nature of the business. Key regulatory challenges this year will include compliance with evolving global AML standards and understanding the nuanced differences in crypto-asset classifications across regions. For instance, a digital token might be considered a commodity in one jurisdiction but a security in another, necessitating a diverse approach to compliance. Businesses need to invest in robust compliance frameworks that are both flexible and responsive to these varying regulations, including financial crime prevention, asset classification, and market integrity. There will be a range of approaches to regulatory implementation in these areas.

How can businesses navigate the varied international crypto regulations effectively?

Navigating international crypto regulations effectively requires a strategy that blends global compliance principles while adapting to local regulatory requirements. TradFi institutions have operated in a global landscape with fragmented regulation for years. In contrast, crypto firms must mature in a fraction of the time to continue operating in the borderless environment they inhabit. This involves continuous monitoring of regulatory trends in key markets, deploying a skilled compliance team and leveraging technology to streamline compliance processes. Success in this area often hinges on how well a business can integrate these compliance strategies into its broader operational framework, enabling agility in responding to regulatory changes while maintaining a firm understanding of the global regulatory landscape.

— Andrew Price, chief compliance officer, Zodia Markets

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