DEFINITION of 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.

BREAKING DOWN Crypto Regulatory Sandbox

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

For instance, say a programmer working on updating the Uber 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 to restrict users from sharing posts that may have been flagged as fake news. Before such updates and features are launched, they may be tested in an isolated and controlled environment, the sandbox. Beyond testing features and functionality, a sandbox also allows security aspects to be verified.

Regulatory Sandbox in Financial Technology

The fintech sector is exploding with new, innovative products and services. Since it covers monetary transactions belonging to the areas of lending, payments, insurance and trading mostly processed in a straight-through-processing (STP) mode, regulatory compliance is a must. Nurturing innovations without the overheads of over-regulation and protection of consumer interests needs a balanced approach, for which regulators of many nations have adopted a “regulatory sandbox-” based approach. 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 thes risks of unintended negative consequences such as security flaws. 

As blockchain technology and various cryptocurrencies gain 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, 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, acting director of the Consumer Financial Protection Bureau (CFPB), announced in July of 2018 the launch of a regulatory sandbox aimed to encourage cryptocurrencies and blockchain technology.