How the “Brussels Effect” is influencing crypto regulation around the world

How the “Brussels Effect” is influencing crypto regulation around the world

The right to data protection and privacy is firmly anchored in the legal traditions of many countries. In the USA, for example, it is enshrined in the Fourth Amendment and in the European Union it is included in Article 8 of the European Convention on Human Rights. While the precise definition varies by country and region, almost everyone has the right to demand a certain level of privacy protection.

In the 1970s, companies, families and individuals began to generate more data than ever before, which is why it quickly became unclear whether and how it was protected by existing data protection laws. This information overload was first recognized as a problem in the late 1970s and only really understood in the decades that followed. In response to this, the EU issued the first data protection directive in 1995, which protects certain fundamental rights with regard to one’s own data.

In this regard, it should be borne in mind that EU directives leave leeway for the member states when transposing the requirements into national law. So these are more of a kind of recommendations, rather than binding regulations that act as laws.

Nonetheless, since 1995, privacy has had a firm place in European law. What started as a directive back then has now been transformed into the General Data Protection Regulation (GDPR), which has been mandatory since 2018.

Die GDPR was so successful that it has become an international standard for data protection, which has now also been adopted in other countries, including the USA, for example. The legal scholar Anu Bradford calls this phenomenon the “Brussels effect”, which means nothing other than that legal requirements formulated in the EU later become the global standard. In addition to data protection, this effect could also be observed in environmental protection and the fight against hate speech, among other things. Ironically, in the United States, such standards are in turn favored by the “California effect,” which, on a similar principle, carries new norms from progressive California to the rest of the United States.

And now the next field is looming, in which the EU could set the global standard for regulation with a directive.

This concerns the case of Tornado Cash – a blockchain project specifically designed to obfuscate financial transactions and thereby provide more privacy, but which has been widely abused by criminal actors and therefore banned by the authorities – which shows why regulation is so urgently needed in the field of decentralized financial services (DeFi). The infrastructure of the sector must be built along legal demarcation lines.

Similar to the increasing flood of user data in the 80s, the adoption of digital assets and the DeFi industry is inevitable. Regulation will therefore be essential to foster innovation, protect investors and enable large-scale global trading of digital assets.

In the USA, trading in digital assets is currently still in a legal gray area, as neither the SEC nor the CFTC feel compelled to take on the responsibility of supervision.

After all, the regulation of cryptocurrencies is already being hotly debated in California, with observers assuming that a corresponding amendment to the California finance law will soon be presented, which could regulate the handling of digital assets from 2025.

The EU is once again a step ahead and is already dealing with DeFi. Above all, the German Federal Financial Supervisory Authority (BaFin) is trying very hard to promote such innovation and is thus painting a blueprint for the legal handling of DeFi in the rest of the world. For example, cryptocurrencies are treated quite similarly to traditional securities under German law.

Crypto regulation is also taking shape in Brussels. The much-noticed EU regulatory framework Markets in Crypto-Assets (MiCA) is expected to come into force from the fourth quarter and must then be implemented in all member states within 18 months. In addition, the Financial Stability Report 2022 shows that the EU understands the crypto market. The ECB is even pleading for a changed regulatory approach that should be action-oriented.

Despite everything, the regulation of DeFi is still in its infancy, but an EU directive to that effect could have a similar effect GDPR. Brussels is now in favor of an action-oriented approach, which could possibly be formulated in a future directive and become part of the MiCA for the new regulation for DeFi.

With a tangible example of DeFi regulation and the advance of decentralized financial services as an influential arena to which large parts of the financial markets will sooner or later be relocated, other regulators will have to follow suit at some point. Countries like Israel have already shown themselves open to doing so. However, it remains to be seen whether the USA will first be influenced by the “Brussels effect” or the “California effect” in its regulatory decisions.

Philip Pieper is co-founder of the regulated German DeFi platform Swarm.

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