What Is a Crypto Regulatory Sandbox?

A crypto regulatory sandbox is a live-like testing environment used to ensure regulatory compliance and security checks for financial operations, including cryptocurrencies and blockchain-based systems.

Key Takeaways

  • The crypyo regulatory sandbox is a metaphor to describe a space where financial technology companies are exempt from some kinds of regulation so that they can innovate new products without fear of breaking the law.
  • The sandbox metaphor is borrowed from the tech world. It is a development environment where coders can test their code before deploying it globally.
  • A fintech regulatory sandbox was proposed in 2018 by Mick Mulvany, the acting head of the U.S. Consumer Financial Protection Bureau.

How Crypto Regulatory Sandboxes Work

A sandbox is a commonly-used term in the field of software development. A sandbox refers to an isolated—but fully functional—testing environment where software, apps, and programs can be tested. If a programmer writes a new piece of code, they may use a sandbox to test it.

For instance, if a programmer working on updating the Uber ride-sharing app adds a new feature to more accurately locate the passenger using GPS, or a team of developers at Facebook enhances the site's functionality, before such updates and features are launched, they may be tested in an isolated and controlled environment called the sandbox.

Beyond testing features and functionality, a sandbox also allows security aspects of new code to be verified.

Special Considerations

Regulatory Sandbox in Financial Technology

Because companies in the financial technology sector are regulated by securities and banking laws in many countries, regulatory compliance is a must. The functions that come under compliance scrutiny include monetary transactions, lending, payments, insurance, and trading processed through straight-through-processing (STP) technology. Many regulatory authorities want to nurture innovation and balance consumer protection, which is why regulators in many nations have adopted a “regulatory sandbox” based approach.

The use of a regulatory sandbox allows authorized businesses to test their innovative products, services, business models, and delivery mechanisms in the real market, with real consumers, on a trial basis. It helps reduce the time to market at low cost, improves access to capital, and ensures adherence to compliance requirements. Such regulatory sandboxes allow room for direct communication between fintech developers and businesses and regulatory officials while mitigating the risks of unintended negative consequences such as security flaws. 

As blockchain technology and various cryptocurrencies have gained popularity, adherence to regulations, and the security of digital assets is gaining importance. Repeated incidents of cryptocurrency thefts, hacking attempts, and scams are also acting as a deterrent to mass adoption.

The concept of a regulatory sandbox is now being extended to the virtual world of cryptocurrencies, where financial regulators are offering authorized businesses the possibility of testing blockchain products. For instance, in June 2018, the UK's Financial Conduct Authority (FCA) gave 11 blockchain and distributed ledger technology-related companies access to its regulatory sandbox service. 

In the U.S., Mick Mulvaney, the acting director of the Consumer Financial Protection Bureau (CFPB), in July 2018 announced the launch of a regulatory sandbox aimed to encourage cryptocurrencies and blockchain technology. In early 2020, before he dropped out of the presidential race, then-candidate Michael Bloomberg called for a "fintech sandbox" to promote innovation.