What is a Regulatory Sandbox and How Does it Apply to Crypto?

In software development, “sandbox” is a term commonly used to describe an isolated testing environment for new apps or programs. Similarly, a regulatory sandbox is “a framework set up by a financial sector regulator to allow small scale, live testing of innovations by private firms in a controlled environment”.

Innovators have historically had a tough time with regulators, so the sandbox has become a bridge between the people trying to solve problems and the people trying to prevent those problems from ever repeating.

The term has particular relevance for the crypto industry, with a number of countries creating regulatory sandboxes to deploy new technology in a fast and scalable manner.

• In June 2018, the UK's Financial Conduct Authority (FCA) gave 11 blockchain and distributed ledger technology-related companies access to its regulatory sandbox.
• In July 2018, Mick Mulvaney, acting director of the Consumer Financial Protection Bureau (CFPB) announced the launch of a regulatory sandbox to encourage cryptocurrencies and blockchain technology in the US.
• In April 2019, the Reserve Bank of South Africa put out a call for submissions from companies working with blockchain technology and cryptocurrencies to form part of its regulatory sandbox.

Advantages of the regulatory sandbox

• Innovation happens faster when businesses can test new ideas without the cost of overheads such as compliance and exhaustive protection of consumer interests.
• Innovation is better when it is tested in a live environment with real consumers on a trial basis.
• Proof from experimentation improves access to capital for innovators.
• Consumers benefit because new and beneficial technology products are brought to market sooner.
• Direct communication between fintech developers, businesses and regulators creates a more cohesive and supportive industry.
• Successive trial-and-error testing within a controlled environment mitigates the risks and unintended consequences such as unseen security flaws when a new technology gains market adoption too quickly.

Cautious rather than hostile

The real advantage of a sandbox environment is that it allows regulators and innovators to work constructively together when the alternative would be hostility and stifled innovation.

Source: Cryptofinder (2018)

In 2018, the Reserve Bank of India (RBI) announced that it would no longer provide services to any person or business that deals with cryptocurrencies. Since then, a number of crypto exchanges operating in the world’s largest democracy have had to close operations due to bank account closures, denial of payment services and decreased trade volume.

This approach, echoed by countries like China, Bolivia and Ecuador, highlights the work that still needs to be done on an international front in order to leverage the advantages of cryptocurrencies and blockchain technology while effectively managing the risks they present.

The drawback of the hostile approach is that it arguably only serves to push away legitimate businesses that are already pro-compliance and denies the market access to real innovation.

In a time of rapid change within fintech, the regulatory sandbox introduces the potential to change the nature of the relationship between regulators and those working in the crypto and blockchain industry toward a more open and active dialogue.

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