2022 has proven to be a devastating year for crypto investors, especially following the collapse of the world’s second-largest crypto exchange, FTX, and the Terra crash in May. Investors, crypto-based businesses, and financial institutions are still coming to grips with the fallout of these events and what they may mean for the future of digital currencies and exchanges.
While there will no doubt be many more discussions and proposals related to the prevention of future collapses, one thing is clear: something needs to be done. Federal Reserve Vice Chair Lael Brainard told Bloomberg in a recent interview that the turmoil in the market clearly indicates that the cryptocurrency market should be as firmly regulated as traditional finance. She stated that despite claims that these markets are deregulated, they are, in fact, “highly concentrated and highly interconnected,” which results in a “domino effect of failures from one platform spilling over into elsewhere.” According to Brainard, because the risks in crypto are no different from traditional finance, it should fall under the same regulatory perimeter.
These large and high-profile collapses have been unfathomable in terms of their speed and brevity. FTX CEO Sam Bankman-Fried went from being a billionaire several times over on a Friday to having negative assets within a week. This is largely due to many of the well-known poor practices in the industry, including the lack of proper governance and the transfer of client funds without explicit approval or knowledge. Actions that would be considered criminal in Wall Street are carried out prima facie in the crypto industry - with devastating consequences for venture capitalists, hedge funds, and, sadly, small retail investors, as well.
What is the way forward?
There has been a lot of finger-pointing and accusations between organizations such as the SEC and CFTC about which parties should be ultimately responsible for governing cryptocurrencies in the wake of the FTX collapse, but these discussions are not conducive to change.
In truth, there will be no meaningful resolution or change until clear regulations governing the sector are laid out, with proper alignment across global regulators, including those in the European Union, United States, and key Asian markets.
The European Council has taken the first steps towards comprehensive and accountable crypto regulations by approving the Markets in Crypto-Assets (MiCA) Regulations, a decent starting point that takes steps towards aligning different jurisdictions. It includes a comprehensive layout and statement of the purpose of the legislation, the proposed approach, governance, and requirements for crypto businesses, including consumer protection, anti-money laundering (AML) compliance, and the accountability of crypto companies.
MiCA has passed through all the stages of the EU’s legislative process, except approval in the EU Parliament. It may pass before the end of 2022 and come into full effect in 2024.
If MiCA is accepted (and all indications are that it will be), it will be a positive step towards preventing market abuse and upholding the integrity of crypto markets while addressing market manipulation, money laundering, terrorist financing, and any other criminal activity. It will also ensure the EU’s financial services legislation is ready for the new digital age.
What regulators must keep in mind
The framework in MiCA is extremely promising, and we hope that other markets will follow its lead. However, there are a few things that regulators and governments must keep in mind as they bring the crypto sector into the regulatory fold:
1. Regulations should not curb innovation
Regulations should, rightfully, eliminate bad actors and prevent illegal criminal activities, including money laundering, terrorist financing, and sanctions violations. However, regulations should not be stringent in that it prevents genuine innovation and hinders the beneficial evolution of the financial system through decentralization and digital currencies. Think of how Edison and Tesla campaigned for the use of direct versus alternating currencies. Edison made several attempts to introduce direct currents as the standard and held many compelling pitches and convincing campaigns to achieve this goal. However, regulators did not accept his proposal as they did not want to curb innovation for the sake of all mankind. Thanks to their foresight, the entire world has access to electricity. Imagine where we would be if that did not happen? The entire planet would be several centuries behind where we are now. The financial sector has to be given the freedom to evolve - responsibly.
2. There should be greater transparency
There should be greater transparency and governance in order to protect consumer interests. Every investor should be informed about the risks, costs, and charges involved in crypto assets.
There should also be clarity for different variants and sectors within the crypto ecosystem. There are several risks brewing in the stablecoin sector that have to be checked to avoid (possibly imminent) collapses. Stablecoins have always been thought to be more stable as they are supposedly backed by reserves, but is it really so? We’ve already witnessed the collapse of Terra this year, and others will follow if regulators do not step in with an actionable framework soon.
3. Bailouts should not be on the table
Regulators should not go overboard in protecting crypto ventures with bailouts. We’ve seen the negative consequences of bailouts in the formal financial sector as regulators continue to support failing businesses and bad actors, creating far-reaching complications and moral hazards. There should be clear rules, guidelines, and support, but no bailouts.
4. Privacy should not be a weapon, or an excuse
Privacy is probably the most hotly contested point when we discuss crypto regulations. Some crypto proponents believe that all governments are bad actors and that no data should be shared. Of course, we already know that some criminals have exploited the anonymity of crypto networks to carry out nefarious deeds, from money laundering to purchasing nuclear weapons or breaking global sanctions.
An effective framework requires a delicate balance. Governments should not become over-interfering and extract submissions from participants through data collection and analysis; crypto companies and asset holders should not insist on so much privacy that they become a haven for criminals.
Recent events are truly harrowing and concerning for serious crypto investors and businesses. However, if sound and sensible regulations are introduced that can cut out bad actors and risky investments while helping the industry and honest participants innovate and grow, we will soon enter a safer, more responsible, and more beneficial era of cryptocurrency acceleration and adoption.