The Future of FINRA Cryptocurrency Regulation

Cryptocurrency regulation is constantly evolving, and recent updates from FINRA have caught the attention of industry players and investors alike. FINRA has made significant strides in addressing the challenges posed by digital assets. These developments have an impact on how cryptocurrency is perceived, regulated, and integrated into mainstream financial systems.

This blog delves deeper into FINRA’s latest approach to cryptocurrency regulation and its implications for the industry, including:

• emerging trends in member firm involvement with digital assets
• the regulatory hurdles FINRA faces
• FINRA’s response to these challenges
• what it means for the future of cryptocurrency in regulated markets

By understanding these updates, firms will have the tools to better navigate the changing crypto landscape.

FINRA’s Strategic Approach to Cryptocurrency Regulation

Establishment of the Crypto Hub

FINRA took a significant step in enhancing its oversight capabilities by developing the Crypto Hub. This initiative was designed to ensure FINRA’s readiness to fulfill its regulatory mission regarding cryptocurrency-related activities of member firms and associated persons. The Hub serves as a nerve center, managing FINRA’s regulatory work related to digital assets. It brings together representatives from nearly every FINRA department, creating a comprehensive approach to address the evolving digital asset regulatory landscape.

Collaboration Across FINRA Departments

The Crypto Hub has an impressive scope, involving 28 different departments across FINRA. This collaboration extends beyond regulatory operations to include the Office of General Counsel, Corporate Communications, People Solutions, Training, Office of Government Affairs, and Technology. This enterprise-wide effort ensures a holistic approach to digital asset regulation.

The Hub oversees a group of individual projects and initiatives linked by shared organizational goals and objectives. This structure provides synergy, consistent management, and greater visibility to FINRA’s executive leadership team, compared to individually managed projects.

Data Collection and Analysis Efforts

FINRA has implemented several specialized units to enhance its data collection and analysis capabilities in the digital asset space. These include:

1. Crypto Asset Investigations (CAI) team: This unit conducts complex investigations related to crypto asset fraud and collaborates with FINRA’s exam program. They perform risk-based examinations of firms’ compliance with FINRA rules and federal securities laws and regulations related to crypto assets.
2. Blockchain Lab: Serving as a central point for blockchain-related regulatory initiatives, the Lab helps build or source technology solutions to facilitate oversight of blockchain-related activities.
3. Crypto Asset Surveillance Team (CAST): Recently established, CAST works in collaboration with the Hub to support FINRA’s ability to conduct surveillance of the crypto asset markets.

These efforts have allowed FINRA to identify numerous associated persons engaging in crypto asset-related activities through outside business activities or private securities transactions.

FINRA also continues to make referrals to other regulators and agencies on fact patterns related to crypto that may fall outside its jurisdiction.

Emerging Trends in Firm Cryptocurrency Involvement

Direct and Indirect Cryptocurrency Activities

FINRA has identified approximately 200 member firms with direct or indirect involvement in cryptocurrency activities. These activities range from proprietary trading to distributed ledger technology initiatives. Notably, many of these touchpoints are indirect, with the activities being conducted by member firms’ affiliates or parent companies rather than directly by the firms themselves.

Some member firms have engaged in various digital asset-related activities, including:

• Acting as placement agents, wholesalers, or distributors of private placements of digital assets or companies involved in digital asset activities
• Operating Alternative Trading Systems (ATSs) to facilitate trading in digital asset securities
• Providing custody services for digital asset securities
• Facilitating customer digital asset transactions through affiliates or third parties
• Engaging in blockchain and distributed ledger technology initiatives
• Offering other services, such as introducing institutional customers to third-party digital asset custodians and providing digital asset-related investment banking and advisory services

Partnerships and Affiliations

Many member firms have established relationships with unaffiliated third parties to grant their customers access to digital asset activities. These partnerships extend beyond the member firm level to include parent companies and affiliates. Some notable arrangements include:

• Providing customers with access to digital asset trading and custodial services
• Creating training and educational materials
• Facilitating digital asset liquidity
• Utilizing distributed ledger technology for certain types of transactions

At the parent company or affiliate level, strategic investments and exploratory relationships have been formed. These include referral arrangements, the use of distributed ledger technology platforms, and providing traditional banking services to digital asset trading and lending platforms.

Associated Persons’ Crypto-Related Endeavors

FINRA has also identified hundreds of associated persons engaged in a range of digital asset-related activities through outside business activities or private securities transactions. These activities include:

• Proprietary trading of digital assets
• Operating investment funds that invest in digital assets
• Selling private placements or digital asset offerings
• Participating in crypto mining operations

These emerging trends highlight the growing intersection between traditional financial services and the cryptocurrency industry. FINRA remains vigilant in monitoring and regulating these activities to ensure compliance with applicable securities laws and regulations.

Regulatory Challenges and FINRA’s Response

As cryptocurrency gains prominence in the financial sector, FINRA has encountered various challenges in regulating member firms’ digital asset-related activities.

Identified Rule Violations

FINRA has observed potential violations of multiple rules, including:

1. Rule 2210 (Communications with the Public): Misrepresentations regarding the extent of protections offered by federal securities laws or FINRA rules for digital asset-related activities
2. Rule 3110 (Supervision): Failures to conduct adequate due diligence on digital asset private placements and implement effective supervision of digital asset activities
3. Rules 3270 and 3280: Violations related to the disclosure, approval, and supervision of digital asset-related outside business activities (OBAs) and private securities transactions (PSTs)
4. Rule 3310 (Anti-Money Laundering Compliance Program): Inadequate AML programs for detecting and reporting suspicious digital asset transactions
5. Rule 2010 (Standards of Commercial Honor and Principles of Trade): Dissemination of promotional materials containing material misstatements or omissions related to digital asset businesses

Compliance With Evolving Cryptocurrency Regulations

Oyster Consulting’s regulatory compliance experts can provide invaluable assistance to firms navigating the complex world of cryptocurrency and blockchain technology. By leveraging our extensive knowledge and experience, we help firms:

• Develop a comprehensive crypto or digital asset strategy aligned with business goals
• Implement robust security measures to protect digital assets
• Navigate the evolving regulatory landscape
• Conduct thorough due diligence on crypto investments
• Train staff on digital asset best practices and compliance
• Establish effective risk management protocols
• Stay ahead of emerging trends and technologies in the crypto space

By partnering with Oyster Consulting, your firm can confidently tackle these action items, mitigate risks, and capitalize on the opportunities presented by the rapidly evolving cryptocurrency ecosystem.