New crypto regulations are coming. Here are the technology steps to get ready

Both cryptocurrency firms and the government agencies newly tasked with regulating them are finding themselves in uncertain times: The fast expansion of crypto markets and the cautionary example of FTX’s downfall have increased pressure for regulatory oversight, but delays in finalizing new rules mean stakeholders on each side of the compliance equation are struggling through a period of logistical limbo — one that will likely continue for much of 2023.

Fortunately, despite these ambiguities there are still plenty of things both the regulated and regulating entities can do to prepare for the inevitable rollout of stricter rules over the next year or so. Let’s take a closer look at what both sides can do now in anticipation of tighter digital asset regulation for the 2023 and 2024 tax seasons.

Bringing regulatory structure to a “wild west” cryptocurrency ecosystem

The compliance push in crypto markets is focused on bringing more structure and transparency to what has thus far been a wild west environment of heavy activity and relatively light regulation. All of this is happening in the shadow of the FTX scandal that lost $8 billion in customer and investor funds and demonstrated how, as cryptocurrencies gain more widespread adoption, it’s increasingly crucial to ensure they are traded in a safe and transparent manner.

These highly-anticipated regulations represent both an opportunity and a challenge for government. The opportunity is that considerable fiscal revenue will come from new tax-reporting rules taking effect across a busy ecosystem of crypto and digital asset exchanges, NFT marketplaces and DeFi platforms. The challenge is that rolling out such rules in a sector that’s already operating at scale can be exceedingly complex for the enforcement entities, and exceedingly confusing for industry players trying to understand the new regulatory landscape and comply with it.

Adding to the confusion is that, since the Treasury department failed to finalize regulations before the end of 2022, agencies and crypto investors alike are unsure of what information they should be collecting in 2023 and plan on reporting in 2024. These conditions make it hard to clarify, much less communicate, best practices and compliance guidelines that will govern the way digital assets are used and regulated.

Leveraging technology to prepare for upcoming regulations

Unlike traditional financial assets, cryptocurrencies are decentralized and operate outside of established financial frameworks, so officials are seeking to craft crypto-specific regulations that promote transparency and trust in the market — including enhanced Know Your Customer (KYC) and Anti-Money Laundering (AML) measures, as well as requiring exchanges to provide regular audits and financial statements.

Given that the rules will be rolling out to an already bustling ecosystem of crypto trading and investment firms, the right technology tools and techniques are essential for successfully introducing and complying with these new regulatory frameworks at scale. This requires preparation and modernization steps for public sector agencies and cryptocurrency firms alike.

Government entities should be starting now with efforts to modernize their IT systems and processes initially designed to meet paper-based requirements, to also handle digital-native processes as well. Indeed, Congress recently passed the Inflation Reduction Act of 2022 awarding the IRS more than $40 billion over the next ten years to update its antiquated IT systems.

Meanwhile, crypto platforms that were originally built without compliance and information sharing in mind should be taking steps now to re-architect their IT infrastructure so that necessary information is more easily accessible to meet compliance needs. Although the imminent regulatory scheme is tax focused, platforms should be thinking about how IT investment to meet those needs can also include requirements to meet other likely-forthcoming regulations such as heightened KYC and AML compliance, as well counterparty identification for asset transfers. Such platforms should be up to date on the latest tax and accounting practices, backed by certifications like U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards, along with the highest data and systems security standards such as SOC 1, SOC 2 and ISO 27001.

Strategic technology partners will play a key role for both sides. The coming wave of regulatory compliance is going to require standardized data. These strategic partners already operate as intermediaries servicing multiple entities and can use their insights to help facilitate the standardization of data for easier compliance. For instance, XBT and BTC are ticker symbols used to represent the same cryptocurrency on different trading platforms. Regulatory compliance will require not only an understanding of these nuances but also the ability to assimilate data into the necessary form, which is a gap that strategic partners can help bridge among industry platforms and governmental agencies.

The bottom line

While government doesn’t operate in the crypto landscape, understanding how blockchain-driven crypto markets behave is important for the public agencies tasked with developing and applying new rules for the sector. At the same time, firms dealing in cryptocurrency will benefit from having the right technology tools and processes in place to comply with the new regulations.

As this happens, we’ll likely see a wider evolution of emerging best practices that — having been developed out of necessity for regulating crypto markets — will spread to the broader compliance landscape at large. Organizations across government and the entities they regulate will increasingly find themselves using technology-driven efficiencies to make auditing and compliance overall much more efficient, accurate and automated.

Miles Fuller is head of government solutions at TaxBit.