Robust regulatory key to limit fallout from repeat crypto winters

The world of digital assets is still reeling from the “crypto winter” – a massive collapse in asset valuations in early 2022 triggered by the failure of a major stablecoin, which resulted in the insolvency of some institutions.

The episode shared many of the hallmarks of the global financial crisis – hubris around high-yield, allegedly low-risk strategies, excessive leverage and systemic risk due to institutions’ mutual exposure. Fortunately, it was on a smaller scale, and since the digital asset industry is fairly self-contained, it had far less of an impact on the wider economy.

But the crypto winter has done little to dampen the dynamism of the sector, and while valuations remain down, innovation and development continue apace. The possibilities for new models of economic activity enabled by a digital asset ecosystem remain equally exciting for businesses and creators, even if the speculative froth of a $2.8 billion market cap has been blown away.

A digital asset ecosystem, built on decentralized infrastructure, promises a means to monetize digital products independent of traditional mediating institutions. While in regulated industries many of these intermediaries will have roles that cannot be easily removed with new technology, there is still a compelling opportunity to improve efficiency and add new capabilities.

OMFIF’s ‘Digital Assets’ report examines the economic opportunities digital assets present, looking at different types of digital assets and the opportunities they offer for businesses and individuals to deliver value and generate revenue.

One of the most exciting areas where the digital asset ecosystem can stimulate change is the infrastructure of the financial markets. In the course of researching the report, we have observed a convergence between the architecture of crypto-investment and decentralized financial worlds and traditional finance.

As the crypto world learns policies and regulations for sound risk management, traditional finance uses the technology underlying cryptocurrency to tokenize and fractionalize financial instruments, expand the investor base, improve liquidity, and add functionality.

A functioning digital asset ecosystem cannot develop overnight. For it to work effectively, there are a number of technical services that must become common. Some, such as cloud services, are already in place. Others, like digital identity, still require a lot of work before they are able to underpin a systemically important digital asset ecosystem.

The report also examines the evolving legal framework for digital assets. As digital assets increase in importance, the consequences of a repeat crypto winter become more severe. Accordingly, regulators are scrambling to develop the regulatory architecture required to make the digital asset class a healthy, safe marketplace. Achieving financial stability, investor protection and preventing financial crime without diminishing the efficiency and privacy features that digital assets can provide is a huge challenge for regulators.

Finally, we are proud to present OMFIF’s regulatory tracking of digital assets, produced in partnership with Bittrex Global. The tracker provides an overview of the most important areas of digital asset regulation in 23 key jurisdictions around the world. It allows users to see if a jurisdiction has adopted tailored regulation for cryptoassets or if it uses existing securities regulation. The tracker also allows users to see where different jurisdictions stand on issues such as cryptocurrency mining, exchanges, derivatives trading and more.

Developments in digital assets are moving quickly and the opportunities are only just beginning to become apparent. We haven’t seen the last crypto winter, but robust and well-worked regulation will mitigate any damage. The benefits that a digital asset ecosystem offers will prove worthwhile.

Lewis McLellan is editor of OMFIF’s Digital Monetary Institute.