Principles vs. Rules Based Regulatory Philosophies — Why Crypto Firms Need to Know the Difference

Not long ago, crypto operated in a world with no rules or regulators. Just traders, believers, and hope. However, the industry has since then come a long way, leaving those days behind. 

Digital assets moved from the edges of finance to the mainstream faster than anyone expected. Now, regulators around the world face the same question: how to oversee an industry that changes faster than the laws meant to control it?

Different countries answered this question in very different ways. Some chose strict, detailed rules. Others picked flexible guidelines. For crypto firms trying to navigate this landscape, this difference matters.

The distinction is not theoretical. It directly influences how a virtual asset business structures its compliance team, prepares for regulatory inspections, and manages its exposure during enforcement actions. In many cases, it can determine whether a firm withstands its first major regulatory investigation.

The Two Regulatory Philosophies Shaping Crypto Oversight

Rule-based jurisdictions want everything written down. Detailed rules, specific steps and exact dollar amounts along with set reporting formats. A firm either follows the rule or it doesn’t. Simple and clean.

Think Germany, Japan. Places where knowing the exact rules matters more than having room to adapt.

Principle-based jurisdictions work differently. They set big goals—protect consumers, manage risk, keep markets fair—and let firms figure out how to reach them. Regulators care about results, not whether someone checked every box.

The UK’s Financial Conduct Authority works this way. So does the Monetary Authority of Singapore and the Commodity Futures Trading Commission in the US, at least for some areas.

Former CFTC chairman Heath Tarbert explained it simply. Principle-based rules give firms “high-level standards” to meet. Then firms figure out the rest. The idea is simple: firms get room to move. Regulators can adjust without rewriting everything each time technology shifts.

For crypto, this matters more than most people realize.

Why Crypto Breaks Rule-Based Systems

Crypto never stops moving.

DeFi, NFTs, stablecoins, staking, cross-chain bridges, zero-knowledge proofs, and a lot more didn’t exist when most securities laws and money-laundering rules were drafted. Strict rules from five years ago often miss the mark completely today.

Industry watchers have observed that rule-based jurisdictions have struggled with this reality. A firm shows up with a legitimate business that doesn’t fit any existing category. Regulators freeze. They have no box for it. So they can’t approve it.

Companies end up rebuilding their products to match rules designed for traditional banks and brokerages. Rules that often make little sense are applied to blockchain businesses.

Across several markets, many industry participants have argued that they were forced to spend months restructuring their entire business models simply to fit into licensing categories originally designed for traditional financial institutions. Most of these frameworks were designed with traditional banking and investment systems in mind rather than with decentralized networks or blockchain custody solutions.

Consequently, some digital asset exchanges and virtual asset services were required to change their governance structures, product offerings, and redesign their compliance programs – not only due to risk-related issues but also in order to be consistent with the definitions stipulated by regulators that never originally considered digital assets.

Principle-based jurisdictions are likely to handle this situation more effectively. They ask different questions. What risks does this activity create? Can this firm manage those risks? Do the people in charge understand what they’re building? When answers work, regulators find a way forward.

How Different Jurisdictions Compare

Getting Licensed: Licensing Reality: Two Very Different Journeys

Firms encounter very different obstacles depending on where they register.

In rule-based jurisdictions, requirements are clear. For example, St. Vincent asks for a five-year business plan, audited financial statements, fit and proper checks on directors as well as proof of professional indemnity insurance. The British Virgin Islands wants registration, compliance officer appointments, and solid internal controls. Failure to comply with these requirments may lead to fines up to US$100,000.

Clear enough.

But here’s the problem. If a business doesn’t fit existing categories, approval becomes difficult. Companies have reported spending months reshaping operations to match rules designed for traditional finance. Rules that had nothing to do with what they actually did.

In principle-based jurisdictions, the experience differs. Regulators sit with applicants. They examine the actual business. They ask questions. Does this person understand their risks? Do they run things properly? Can they handle what they’re building?

Firms get more room to explain themselves. But they also carry more uncertainty. If regulators don’t like how a firm thinks, the application fails.

Checking Boxes vs. Having Conversations

The real difference between rules and principles isn’t just the law—it’s the relationship. Rules-based supervision is a cold audit: a checklist of “yes/no” requirements. If you miss a box, it’s a violation. End of story. For crypto firms, this creates a mountain of paperwork and “check-the-box” compliance that often ignores the actual risks of new technology.

Principle-based supervision replaces the checklist with a conversation. Regulators don’t just look at what you did; they ask why you did it. How are decisions made? Walk us through your thinking. This approach demands higher accountability. In June 2025, Singapore’s MAS exemplified this by requiring firms to monitor order flow for wash trading and spoofing. They didn’t dictate the software; they set the standard—”fair markets”—and let firms innovate the solution.

Anti-money laundering (AML) reveals the sharpest contrast. Rules-based AML relies on rigid KYC and fixed monitoring levels, often drowning firms in false alarms while real criminals slip through the cracks.

Conversely, principle-based AML focuses on effectiveness. Regulators ask: Do you actually understand how a criminal would use your specific platform? This catches more illicit activity but requires a sophisticated compliance team.

The FATF Travel Rule is the ultimate test of this divide. While 85 of 117 jurisdictions—including St. Vincent and the Grenadines—now mandate the collection of sender names and account numbers, the reality on the ground is messy. With $21.8 billion in laundered funds linked to DEXs and bridges, the gap between “rules on paper” and “on-chain reality” remains the industry’s biggest hurdle.

The goal of principles-based regulation is to bridge that gap, ensuring that as technology shifts, the oversight remains as fluid as the assets themselves.

Set Penalties vs Looking at Context

Rule violations trigger set penalties. Simple and predictable.

Numbers tell the story. Over $1.06 billion in fines by the third quarter of 2025. Most from North American regulators. They aren’t playing games.

Principle violations depend on circumstances. Were senior leaders trying? Did governance fail? Did the firm fix problems?

Some firms have avoided massive fines by showing up, owning mistakes, and proving they willing to improve. Other firms faced severe consequences not because they broke a specific rule, but because their entire approach showed carelessness.

The British Virgin Islands Financial Services Commission published detailed guidance in November 2025. The documents spelled out registration requirements and pushed for strong internal controls to stop money laundering. The message was clear. Regulators are watching.

Innovation Follows Regulatory Philosophy

In rule-based jurisdictions, the regulatory perimeter is tightly defined. Detailed requirements specify capital thresholds, governance structures, custody mechanics, reporting formats, marketing restrictions, and operational processes. From a supervisory perspective, this reduces ambiguity. Firms know exactly what is expected. Regulators know exactly what to inspect.

However, innovation in crypto rarely develops in straight lines. Many models do not fit neatly into categories originally designed for banks, brokers, or payment institutions. When a framework is highly prescriptive, businesses must either restructure their model to comply or abandon the jurisdiction entirely.

Only projects with sufficient funding, legal support, and long development timelines can survive the regulatory adaptation process. As a result, rule-based systems tend to produce fewer but more institutionally structured players.

Principle-based jurisdictions operate on a different axis. Instead of asking whether a firm fits into a predefined legal box, supervisors focus on outcomes:

• Are client assets properly safeguarded?
• Are financial crime risks controlled?
• Is governance effective?
• Are conflicts of interest managed?

This allows businesses to design new structures, provided they can demonstrate robust internal controls and risk management. Innovation does not need to wait for a new rulebook category.

The trade-off is complexity. Firms must invest heavily in compliance architecture because the burden of proof shifts to them. They must show that risks are understood and mitigated. Regulatory uncertainty can also increase, particularly during inspections or enforcement actions where interpretation becomes decisive.

The broader pattern is clear:

• Rule-based systems create stability and predictability.
• Principle-based systems create adaptability and speed.

Innovation does not disappear under stricter regimes. It relocates.

The Mixed Reality

No jurisdiction operates purely on principles or purely on rules anymore. Most have moved toward mixed models that combine:

• Clear rules for basic risks like holding client money and AML basics
• Principles for emerging areas like DeFi, cross-chain activity, and new products
• Guidance that shifts as markets change
• Regular discussions with industry participants

This mixed approach reflects how complex virtual assets are. Certainty serves some purposes. Flexibility serves others. Getting the balance right remains difficult for even the most sophisticated regulators.

What This Means for Crypto Firms

For firms operating across different jurisdictions, several lessons stand out.

In rule-based jurisdictions, precision matters. Documentation must be complete. Requirements must be followed exactly. Checklists must be satisfied thoroughly.

In principle-based jurisdictions, judgment matters. Governance must be demonstrably effective. Risk understanding must be substantive. Regulatory engagement must be thoughtful and transparent.

Firms that succeed long-term do both. They meet explicit rules. They embody underlying principles. They demonstrate effectiveness. They evolve as risks change. They maintain governance that withstands scrutiny regardless of supervisory approach.

Compliance is no longer about following instructions. It’s about understanding what you’re doing, why you’re doing it, and proving it works. That’s the game now.

Bottom Line

The debate over whether crypto should be regulated is finished. Crypto is regulated. Increasingly across all major jurisdictions. The real question now is how rules get applied and enforced.

Principle-based frameworks test firm judgment and governance. Rule-based frameworks test structure, and consistency. Both approaches expose weaknesses eventually.

Firms that understand both models and operate effectively under either will survive scrutiny. They will earn institutional trust and scale globally. Meanwhile, the firms that treat compliance as a checkbox exercise will get found out.

In digital asset markets, getting found out tends to be expensive.

FAQ

Q: What’s the simple way to understand the difference?

A: Think about raising children. Rule-based means “be home by 11 or you’re grounded.” Clear, specific, no exceptions. Principle-based means “make good choices and respect the household.” More freedom. More responsibility. Both want the same thing. They just get there differently.

Q: Which approach serves crypto innovation better?

A: Principle-based approaches generally give more room for innovation. They adapt faster to new technology. The CFTC makes this argument directly. Principles let regulators stay ahead without constantly rewriting rules. But firms trade certainty for flexibility.

Q: What happens if a firm in a principle-based jurisdiction guesses wrong?

A: That’s the risk. Principle-based regulation means regulators use judgment. If they decide a firm’s interpretation was wrong, or governance was weak, consequences can be severe. Sometimes worse than breaking a specific rule because it shows deeper problems with how the firm thinks about risk.

Q: Are any jurisdictions purely one way or the other?

A: No. Every jurisdiction mixes both approaches. Even heavily rule-based systems have principles underneath. Even heavily principle-based systems write clear rules for high-risk areas like client fund custody or AML requirements. It’s always a blend.

Q: How should firms prepare for licensing in a principle-based jurisdiction?

A: Don’t bring checklists. Bring thinking. Be ready to explain the business, risk views, governance structures, and decision-making processes. Regulators want to see that firms understand what they’re building and can handle risks without hand-holding.

Q: How should firms prepare for licensing in a rule-based jurisdiction?

A: Bring documentation. Lots of it. Business plans. Financial projections. Policies. Procedures. Audit reports. Insurance proof. Capital verification. If St. Vincent asks for a five-year plan and EC$300,000 capital, bring exactly that. No surprises.

Q: What is the Travel Rule, and why does it matter?

A: The FATF Travel Rule requires crypto firms to collect and share sender and receiver information for transactions above certain thresholds. It aims to stop money laundering and terrorist financing by making crypto moves more like regular bank wires. Implementation varies by jurisdiction but is becoming standard worldwide.

Q: How do regulators handle DeFi?

A: Carefully. Some distinguish between truly decentralized protocols with no central control and projects where identifiable developers retain control. Fully decentralized protocols might stay outside regulatory scope in some jurisdictions. But where control exists, regulators treat those running things as service providers. Europe has seen DeFi activity decline as rules tighten.

Q: What trends characterize 2026?

A: Gradual harmonization continues through FATF Travel Rule implementation. Regional differences persist, with distinct frameworks in the EU, the US, the UAE, and Asia. Cross-chain compliance is emerging as a major challenge. Enforcement is getting faster and more coordinated across borders.

Q: For a startup with limited resources, which approach is harder?

A: Both are hard in different ways. Rule-based jurisdictions require resources for comprehensive documentation and meeting specific thresholds. Expensive but straightforward. Principle-based jurisdictions require sophisticated thinking about risk and governance. Less costly upfront, but easier to get wrong. Neither offers an easy path.