Regulating Cryptocurrencies through Regulatory Sandboxes

A regulatory sandbox could be described as a “framework set up by a financial sector regulator to allow small scale, live testing of innovations by private firms in a controlled environment under the regulator’s supervision”.278 The concept was developed after the financial crisis 2007-2008 in a time of rapid technological innovation in order to adapt the compliance of innovative companies with financial regulations without smothering the FinTech sector rules or diminishing consumer protection.279 Lately the concept has become more interesting and current partly because technology per se is thriving and partly because ”for the first time blockchain technology is creating a divide between the world where securities are issued, offered and sold, and the world where law is enforceable; or, to put it differently, this is because for the first time blockchain is increasing the transaction costs of financial operations in a setting that cannot be either understood or ’cured’ only within the boundaries of traditional financial regulation”.280 Regulatory sandboxes have been used in countries such as the UK281, Switzerland282, Singapore283, the Netherlands284 and are also a part of EU’s FinTech Action Plan285.

278 _{Jenik - Lauer 2017, p. 1} 279 _{Ibid., p. 1}

280 _{Mangano 2018, p. 733}

281 _{In 2014, the UK Financial Conduct Authority (FCA) launched the project ”Innovate”. The aim of the project} is ”to support innovation that offers new products and services to customers and challenges existing business models” and ”to remove unnecessary regulatory barriers to innovation” by creating regulatory sandboxes where companies can test their technological development without immediately incurring the regulatory consequences of the activity. More information on this project can be found in FCA’ Regulatory sandbox paper 2015.

282_{The Swiss Financial Market Supervisory Authority FINMA has also created a licence exempt area (sandbox)} for new FinTech startups. See FINMA 2016.

283 _{The Monetary Authority of Singapore has two different FinTech Sandbox options. See Monetary authority of} Singapore 2020.

284 _{See AFM-DNB 2016.}

285 _{The European Commission launched a fintech action plan in March 2018 that sets out different steps to} enable innovative business models to scale up, support the uptake of new technologies, increase cybersecurity

There are different reasons for the establishment of sandboxes, but the most common one is to promote competition and efficiencies in financial services markets through innovation.286 The advantages of the sandbox is that a more regulatory and controlling approach is replaced with a problem-solving approach, which aims at exploring and investigating new technologies and their effect on the markets without actually causing harm to these markets.287 In addition, it allows regulators to observe what regulation is necessary or whether regulatory change is required at all. The sandboxes have to be designed carefully, though, since general consumer protection laws does not necessarily apply and since they trigger the risk of regulatory winners and losers in the markets. Since they are only available for a certain amount of participants, they cannot be used as a broad regulatory strategy for an entire sector.288

Although there are different kinds of regulatory sandboxes, some common features that they generally share are that they “are not limited to a specific part of the financial sector but are cross-sectoral”, they “are open to both incumbent institutions […], new entrants […], and other firms” and they “are not limited to the testing of regulated financial services, but may also include other products or services that enable or facilitate the provision of regulated financial services by another party or facilitate compliance solutions […], or new products and services that are relevant for customer protection or financial stability reasons (e.g. the use of crypto-assets to enable access to blockchain technologies)”.289 _{They typically involve} different phases, such as the application phase, preparation phase, the testing phase and the evaluation phase.290

The regulatory sandboxes first emerged in the FinTech context, but have now been embraced also in other domains, such as data protection.291 Cryptocurrencies, blockchain and its effect on financial stability is a common object of the regulatory sandboxes, but it is not impossible that regulatory sandboxes could be used as a tool in finding the issues and the right regulatory responses to cryptocurrencies and blockchain in the insolvency law in the future. They could bridge the divide between cyberspace and the world where law is enforceable, so that it will be possible to apply to courts and to successfully enforce the law for an IP who intends to

and the integrity of the financial system, such as the earlier mentioned EU Blockchain Observatory and Forum and regulatory sandboxes. See European Commission Press Release 2018.

286 _{Jenik – Lauer 2017, p.1} 287 _{Mangano 2018, p. 728} 288 _{SMART 2018/0038, p. 112} 289 _{ESA 2019, p. 17} 290 _{Ibid., p. 22} 291 _{ICO 2019}

make the crypto-assets available to the creditors and enforce both post-commencement avoidance rules and fraudulent transaction avoidance rules.292

One of the challenges that have been mentioned regarding the sandboxes, however, is the cross-border cooperation. At the moment, most states are facilitating their sandboxes on domestic level. In addition to limiting the test-entities, different facilities applying different rules creates the risk for forum shopping and regulatory arbitrage. One further development of the regulatory sandboxes should therefore be the enhancement of cooperation.293