Crypto: A Regulatory Headache – Investors’ Chronicle

The brutal ‘cryptocurrency winter’ has taken hold of the cryptocurrency market. Bitcoin has lost 70 percent of its value, stable coins have come loose from the dollar pegs, and last week cryptocurrency lender Celsius Network filed for bankruptcy, after facing a modern banking run, which most likely resulted in customers losing billions of dollars.

Is crypto dead? In a speech last week, Sir Jon Cunliffe, Deputy Governor of the Bank of England, said that “the lesson we should not learn from this episode is that crypto is somehow over and we do not have to worry about it anymore.” In fact, crypto may already be more mainstream than you think – Cunliffe compared it to the dotcom bubble, in that the early stages came with very high risk, but the general shift in technology would continue.

According to the Financial Conduct Authority (FCA), around 2.3 million Britons currently have crypto assets, and PwC’s senior blockchain specialist, Haydn Jones, has claimed that we are not near the top of crypto yet. This can be good: the underlying blockchain technology has incredible potential for use in retail and wholesale payments, and can make financial infrastructure more efficient and accessible. But crypto also has the potential to cause significant damage: think financial crime, misappropriation and even financial contagion. How can regulators handle this?

First, cryptocurrencies are a broad bunch. There are stack coins (whose values ​​are pegged to US dollars), more established cryptocurrencies such as Bitcoin (see chart), and around 10,000 more speculative tokens. Crypto is a multidimensional product that creates multidimensional problems. And it needs a multidimensional regulatory approach.

For stack coins, the picture is starting to get clearer. According to the Bank of England, 75 per cent of all trading on cryptocurrency trading platforms involves a stack coin, and they are now integrated into the functioning of the crypto markets. But while they may be stable by name, they are not necessarily stable by nature – two of the three largest stable coins so recently that confidence in their ability to maintain the link to the dollar was eroded, leading to a run on the coin and a price collapse.

PwCs Jones explained that if customers quickly withdraw stack coins, they are actually redeeming from a bank – even though stack coins are not yet large enough to trigger a financial contagion, in theory they could. This means that banks’ balances will receive increasing attention: internationally, the Basel Committee on Banking Supervision provides guidance on the treatment of cryptocurrencies held by banks.

Domestically, “the UK authorities have made it clear that they are prepared to see stack coins operating in the UK, provided they are properly regulated and monitored,” said BoEs Cunliffe. The safer regulatory environment may eventually open the door to more widespread use of stack coins.

The direction of travel for more speculative tokens is unclear. The FCA is already publishing a list of unregistered crypto exchanges, and there will soon be stronger rules around crypto-active campaigns, which are often aimed at new investors using celebrities on social media. But how much further should regulation go? There are other unregulated speculative activities – after all, investors can buy gold, commodities and obscure collectibles that also have a chance of loss. Crypto is equally risky – Cuncliffe emphasized that technology alone did not make assets “without intrinsic value a safe or one-way effort”.

So the argument is that by regulating these investments, the FCA may end up giving them an unintended “halo” effect, which encourages false expectations of consumer protection. Over a tenth of crypto investors already believe that they will be compensated by the FCA or FSCS if something goes wrong with their investment. They will not.

The FCA also emphasizes that regulation requires information. “We are not going to give FCA registration or authorization to companies that will not explain fundamental issues, such as who is responsible for key functions or how they are organized,” the regulator said. But crypto’s place outside the banking industry is a magnet for investors in some economies – especially if they fear a collapse of the banking industry or the allocation of money from the government. Speculative tokens are created in a decentralized way – will they be willing to submit to regulatory oversight?

These problems may prove to be temporary. Cunliffe argued that “the first use cases of the technologies developed in the cryptocurrency world, such as speculative cryptocurrencies, may have a limited future”. He remembered the dotcom bust, and pointed out that the valuation and revenue generation from early network companies was very speculative – and collapsed. But the technology did not disappear, it reappeared in the form of the platforms that now dominate the trade. Will the crypto winter see the decline of speculative tokens and the emergence of smarter crypto-technology-driven payment methods?

Cunliffe argued that good regulation was in everyone’s interest: after all, a series of crashes will do little to help the wider use of crypto-technologies. Nevertheless, we are still struggling with how to regulate the internet 20 years later: the balance between regulation and innovation is always particularly difficult to find.