Creating trust and safety for crypto

Long-awaited and rebuffed by authorities for a decade, exchange-traded funds (ETFs) that can hold cryptocurrencies but be traded on normal stock markets finally came into being in January this year.

That month, the US Securities and Exchange Commission (SEC), the body that regulates investing, approved some 11 applications, including from Ark Investments/21Shares and better-known names such as BlackRock, Fidelity, Invesco and VanEck.

The significance of this move is twofold: firstly, cryptocurrency enthusiasts see it as proof of legitimacy; and secondly, it means that ordinary retail investors can buy cryptocurrency.

Previously, complex derivatives funds based on cryptocurrency futures had been created, but these lacked mainstream appeal. Larry Fenelon, a partner at law firm Ogier, said that the greater significance, however, was that the existence of ETFs that hold cryptocurrency would drive institutional investment in it as an asset class.

“The US regulators have led the charge, recognising that crypto isn’t ‘going away, you know’, that it is an asset class. What the crypto ETFs allow is institutional investment instead of just retail,” he said.

For the moment, EU-based investors, whether individual or institutional, are left in the cold, but this is likely to change with the EU’s Markets in Crypto-Assets (MiCA) Regulation concerning stablecoins coming into force on 30 June, with further parts of the regulation coming online later in 2024.

As a result, the prospect of UCITS-compliant ETFs traded in EU-based exchanges does not seem distant anymore, Fenelon said: “It [cryptocurrency] could be seen as a speculative asset. Yes, it’s volatile, but it has to be regulated: regulation breeds confidence.”

Global Banks

Fenelon said confidence is also driven by the growing interest banks have in playing a role in the cryptocurrency ecosystem.

“The second element comes into place from four global banks now teaming up with crypto firms to act as custodian [of crypto assets for their owners]. That is analogous to having your gold bullion in a bank vault, so they are saying: ‘You can trust us to look after it; you trust us with your financial planning and you trust us with your pensions, so you can trust us with your crypto,” he said.

Of course, it is impossible to discuss cryptocurrency without noting the legal issues that have grown around it, from high-tech heists, to scams, to, in the highly-publicised case of the failed cryptocurrency exchange FTX, fraud.

James McDermott, a senior associate at Ogier, said that the approach taken by foreign courts has set a precedent that will ripple out to other countries, Ireland included.

“Fraud cases like FTX undeniably left victims. In the absence of any framework, courts had to be agile and decide how to define and deal with crypto assets. It seems settled law now that crypto assets are property, like any other asset. We’re past that question now,” he said.

Irish courts will doubtlessly follow suit, he said.

“In a sense they already have – by applying proprietary remedies to crypto assets, there’s a recognition that crypto assets are ‘property’. They [typically] take their lead from the English courts and while we haven’t yet had a groundbreaking Irish judgement, I am sure that we will.”

Growing acceptance of cryptocurrency also has implications for the Irish financial services sector, Fenelon said, noting that the interest from banks in taking on the role of custodian represents a step-change: hitherto, cryptocurrency exchanges acted both as exchange and as custodian, thus increasing risk. The reduction of this risk will likely lead to cryptocurrency developing a broader mainstream appeal, he said.

As Ireland is home to more than 60 per cent of the UCITS-compliant ETFs that investors in the EU can buy and sell on their home exchanges, regulation and guidance will be necessary.

“We will, most likely, have European ETFs trading, domiciled in Ireland, and it follows that if an Irish bank currently offers life assurance, pension, house insurance, savings and so on, particularly the wealth management side, it will incorporate some level of crypto advisory, even if just for market share purposes,” he said.

The Central Bank of Ireland, Fenelon said, will doubtlessly seek to ensure any Irish-domiciled ETFs adhere strictly to the rules, something that could itself drive interest in the funds.

“They don’t hand out financial service provider licences lightly.

The consequence of that is that there is a certain responsibility gained from having a conservative central banking authority. I think the Central Bank of Ireland is very cognizant that [when it comes to approving domiciliation of investment funds] it wants quality rather than quantity.”

In terms of the wider legal picture, the courts are adapting traditional legal reliefs to deal with new challenges.

An example is the growing use of Norwich Pharmacal Orders – orders that compel an innocent third party to disclose information to help an applicant identify wrongdoers.

The US regulators have led the way, and recognise that crypto is an asset class

Irish courts routinely issue Norwich Pharmacal orders to help victims identify anonymous parties, giving a route for victims of crypto theft to unmask fraudsters.

“What we’re seeing is a realisation from the courts that when dealing with fraud, it’s not sufficient to say ‘who has taken my Bitcoin?’, but victims must also have a way to find out where it went. The Norwich Pharmacal relief has been expanded by the Irish courts to provide more information in cases of fraud, and that makes it a very important tool for asset tracing,” McDermott said.

According to Fenelon, this adaptability from the courts should be understood as another factor that could see Ireland become not only a key location for domiciliation but a jurisdiction for court cases.

“The Irish courts are not indifferent to the regulatory and economic environment. They are actively courting international disputes, and it is certainly the case that Ireland has been the choice of law for large tech companies,” he said.