What is Regulatory Arbitrage?
Regulatory arbitrage is a strategic practice by crypto-currency markets and exchanges, whereby these institutions cash in on loopholes in the regulatory systems of a government in order to get past unfavorable regulations. Such practices in crypto-currency are usually punctuated by the applications of super-smart tactics by firms. Such tactics include, but are not limited to, financial engineering, transaction restructuring and physical or what is known as geographical relocation. Worldwide, regulations on cryptocurrency trading run the gamut when we speak of complexity. However difficult it is to prevent, its prevalence can be tamed by closing the most obvious loopholes, which would in turn increase the costs associated with evading the regulation.
Why Use Regulatory Arbitrage?
Crypto businesses may apply regulatory arbitrage strategically to utilize regulatory breaks, such as taking advantage of tax havens. But how do these firms accomplish this? Well, they may either incorporate their companies or establish some other subsidiaries in the states and jurisdictions that offer crypto-currency regulatory advantages. For example, while some states like China are banning the practice of crypto-currency trading, The Cayman islands are allowing crypto exchange businesses to form there and not pay any tax on revenue earned from outside the country. So, rather than remit taxes, businesses dealing in crypto exchanges preferred to relocate their premises their, in order to pay only the licensing fee. This clearly explains why the island has of late experienced an influx of new businesses setting up its headquarters there. The island has been frequently chosen by many crypto trading businesses because of the regulatory break in the state.
Recently, many other countries apart from China have banned crypto trading because they believe that their citizens now have little confidence in their currency, a factor that is making them to constantly circumvent in-country regulations. When such tough regulations are implemented by the governments, crypto exchanges and businesses relocate to Switzerland, Gibraltar, Malta and Cayman Islands, which are now the leading countries in cryptocurrency adoption.
Benefits of Regulatory Arbitrage
There are a range of advantages that entice individuals and institutions to practice regulatory arbitrage, such as:
1. Reduced regulatory burdens and enhanced privacy on income have made such opportunities even more attractive to crafty individual traders and institutions.
2. With regulatory arbitrage, companies can now establish their subsidiaries in small jurisdictions to meet the criteria so as to cash in on regulatory discrepancies across the world.
3. Investors in crypto exchanges can structure transactions to their advantage. A good example is the Blackstone investment company. While trying to negotiate tax regulations, the company sought to utilize a potential regulatory arbitrage between the economic substance and the legal definitions of the tax code.
The reason as to why regulatory arbitrage continues to persist is because there is a heated clampdown on crypto currencies in some countries. Industry experts have consistently advised that this could encourage regulatory arbitrage as more resources and talent are now relocating to more favorable jurisdictions, such as Venezuela, Belarus, Estonia among others, that view this as an opportunity rather than a threat in order to attract talent and craft investors in their countries.