Why global coordination of crypto regulation is essential
Following the collapse of crypto exchange giant FTX, national authorities are speeding up the process of putting crypto regulations in place. Many “crypto hubs” are rethinking how to leverage the benefits of the technology while proactively mitigating risk. Notable examples of jurisdictions where regulators are making progress – and grabbing headlines – include those in the US, EU, UK, Hong Kong and Singapore.
But the race to regulate crypto may actually be a problem, according to supranational regulators. The Financial Stability Board (FSB) and the International Monetary Fund (IMF) are advocating the establishment of globally coordinated crypto regulatory standards before national governments are locked into different, even incompatible, frameworks.
According to the FSB, the potential for consistency and comprehensiveness in the regulation of cryptoassets is expected to “enhance international cooperation, coordination and information sharing.” To achieve that, the FSB is advocating for similar regulations for digital assets and intermediaries that perform the same function as their traditional financial (TradFi) counterparts.
Meanwhile, on the user side of the equation, investors are now prioritizing self-sustaining crypto wallets and shifting towards decentralized exchanges, seeking greater transparency and control. This ongoing shift towards decentralized finance (DeFi) is causing national and supranational regulators to take a second look at the benefits of decentralization, just as they set out to coordinate a global regulatory approach to crypto.
Lack of centralized finance
As the FTX debacle revealed, the shortcomings and drawbacks of centralized exchanges (CEXs) reflect certain opaque characteristics of TradFi, where much activity behind closed doors is accepted as a matter of course. In addition to the lack of transparency associated with balance sheets and client funds, centralized financial organizations keep their systems and records off-chain.
Meanwhile, DeFi offers permissionless financial products that offer high transparency regarding client funds and non-custodial wallets. In short, the undetected abuse of user funds we saw at FTX could never happen in DeFi. Built on public blockchains, the composability of smart contracts also provides significant room for fintech innovation. For example, right now, we are seeing a large increase in efforts to improve DeFi’s user experience and user interface (UX/UI), especially since simple, user-friendly interfaces are the primary benefits of most centralized exchanges.
Due to the FTX scandal and the resulting increase in interest in DeFi platforms, regulatory bodies and TradFi institutions are taking a closer look at DeFi. Our team at SynFutures recently discussed the relative merits of DeFi with the IMF, highlighting the benefits of decentralization, such as on-chain transparency, as well as non-custodial and trustless solutions as a viable alternative to TradFi.
As we pointed out to the IMF, DeFi is about more than just the cryptocurrency asset class. DeFi’s goal is to democratize access to all types of investment products and services. Where market trust has been lost to intermediaries and distracted by strong marketing fronts, DeFi reintroduces the real operational backbone: solid code and permissionless systems.
DeFi’s potential to improve TradFi
Given its open source nature, DeFi has been able to iterate and innovate rapidly, improving existing TradFi infrastructure at a remarkable rate. However, the uncertainty that remains around DeFi is hindering its mass adoption.
First, lack of authorization can be exploited by bad actors, enabling money laundering and illicit financing. Second, the absence of clear regulatory guidelines also means that customers are more vulnerable to becoming targets of Ponzi schemes or otherwise deceptive activities. Third, smart contracts can be subject to exploitation and hacks, especially when they are not audited.
While DeFi prefers to separate itself from TradFi, it is important for DeFi to build on and implement the existing security measures prevalent in TradFi, such as risk control, financial management and regulatory frameworks. DeFi’s mass adoption depends on accountability and consumer protection in the same way that TradFi globally has relied on regulatory and self-regulatory practices for functional stability. Going forward, public trust in the industry will depend on government regulation and reliable blockchain applications.
My expectation is that efforts to establish a global crypto framework will likely start by replicating TradFi’s efforts. This next step in establishing a pattern of proactive cryptocurrency regulation illustrates the global community’s continued efforts to provide a clear framework for crypto services. Borrowing management methods from an already known TradFi network can also have a wider impact on how authorities go about implementing regulatory measures. This will require all parties within the crypto industry, as well as within national and supranational regulatory bodies to work togetherto ensure that the rules do not limit innovation, and to support and protect both consumers and firms across national borders.
