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Smarsh: As Regulation Catches up to Crypto, Where Do Firms Stand on Compliance?

Further regulation in the cryptocurrency and non-fungible token (NFT) space is all but inevitable. Firms need to define crypto strategies now — small mistakes today could mean big consequences in the future.

Robert Cruz is vice president of information governance at Smarsh
Robert Cruz

The wild west days of crypto are numbered, and the firms that survive in the future will be the ones that are preparing for the arrival of new regulations now. This is according to Robert Cruz, who throughout the length of this guest-authored piece, paints a detailed picture of what those preparations might look like.

Cruz is vice president of information governance at Smarsh. He leverages 20 years of experience in the domains of regulatory compliance, e-discovery, and risk management to lead Smarsh’s efforts in presentations, content and customer advocacy surrounding these complex use cases.

Cruz has spent his entire career in Silicon Valley and holds an MBA from the Stanford University Graduate School of Business.

Here, Cruz discusses how firms can get ready for the inevitable arrival of new crypto regulations:

If you just read headlines or scan social media feeds, you might think the explosion of interest in digital assets is all risk and no reward.

Amid the ongoing fallout of the pandemic, there’s been a rise in crypto scams and growing hesitation toward the digital asset space. In the first few months of 2022, we’ve seen seemingly lucrative NFT projects tank in value overnight and expensive digital art gets stolen from owners with dubious tactics. Cryptocurrency and related tech has become so tied to the pop culture lexicon that they have been parodied on Saturday Night Live and achieved meme status.

All of this noise might seem far off from the more traditional investment strategies and vehicles, but it couldn’t be further from the truth. As regulators look to crack down on the type of crime that’s making headlines — rug pulled NFT projects and stolen digital art among them — they’ll also be setting precedents for how firms can and should interact with crypto in the future. And given the early-March executive order issued by the Biden administration that seeks to establish governance of the digital asset space, that future isn’t far away.

Leaders can’t ignore the impact and potential of cryptocurrency — as unstable and noisy as the space may seem now. There are more than 330 million people globally in the $2trillion digital assets market today — ignoring crypto now means alienating a growing number of investors and falling behind firms that are actively expanding business into new asset classes.

How can firms prepare for looming regulation?

To date, there is no comprehensive charter characterising digital assets, establishing digital asset classes and creating clear regulatory frameworks and oversight in the cryptocurrency space. Still, there’s been more than $2billion worth of fines assessed for crypto-related deals since 2013.

As more clarity and definition is given to oversight, firms think carefully about how they will seize a multi-trillion-dollar opportunity without facing multi-million dollar consequences. The following are the best ways for firms to be proactive as regulations loom:

  • Shore up compliance resources. The fines already assessed in the crypto space stemmed from incidents that were less fantastic than digital art heists. In fact, according to Cornerstone Research, the most common allegation of wrongdoing has involved unregistered securities offerings. This kind of oversight can easily be caught when a firm has professionals that understand how to speak compliance and how to navigate the ambiguity of under-regulated spaces like crypto.
  • Empower compliance to be agile and proactive. The majority of enforcement in the digital asset space so far has been ‘regulation by enforcement’ — or the levying of fines and penalties against firms without a set of spelt out rules. This kind of environment is unpredictable and isn’t compatible with strict rules and bureaucratic policies within compliance. Instead, compliance functions need to be given the resources to audit and modernise operations now.
  • Shed the popular notion of digital assets. NFTs and meme coins make for funny late-night fodder and Twitter jokes, but dismissing them as a novelty is a mistake. The hype is certainly real, but so is the opportunity. New asset classes and cryptocurrencies are attracting younger and less traditional investors, who have different risk tolerances, incomes and lifestyles.
    They’re also influenced differently. A growing community of young investors is turning to TikTok for their financial advice, and Reddit has been a driving factor for interest in cryptocurrency. The challenge for traditional firms is how to reach this new audience while being careful to consider potential compliance implications — no matter how unusual. Are TikTok messages subject to rules that demand copies of financial communications are kept? These are the sort of details and questions firms need to start thinking about now.
  • Digital assets need traditional records, too. Cryptocurrency and the blockchain infrastructure that makes it possible are often lauded for their transparency and decentralised ownership, but it doesn’t make them exempt from more traditional standards. Whatever the outcome of oversight of digital assets, the rules that govern the recordkeeping, storage and supervisory obligations are likely to closely resemble other investment categories. Firms need to modernise their compliance operations to make sure they are able to capture all relevant communications, documents and contracts surrounding digital assets.

Strong financial leaders will be able to capitalise on the reward of new audiences and expanded asset offerings digital assets have to offer. By being diligent now, firms can adapt new regulations as they come — and open doors to new currency and investments for their customers.

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