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Whither Crypto Regulation?

By Charley Cooper, Managing Director, R3

Charley Cooper, R3

The story so far

The size and scope of the crypto industry is growing rapidly. Today, the global market cap of the crypto industry is $2.1 trillion, while a recent NBC poll found that one in five adults in the US has invested in, traded or used cryptocurrencies. At the same time, an increasing number of corporates have integrated digital assets into their business models, with the likes of PayPal and Facebook having expanded their crypto offerings over the past twelve months.

Cryptocurrencies are no longer on the fringes of financial services, but are rather poised to play a long-term role in today’s payment and investment infrastructure. In response to this rise, governments around the world have been setting out various approaches towards regulating digital assets.

In March, President Biden signed his long-awaited executive order on the responsible development of digital assets, directing federal agencies to begin meaningful research with an eye towards the ultimate regulation of cryptocurrencies, CBDCs, stablecoins, and decentralized finance. The UK government recently followed suit in April, announcing plans to make Britain a ‘global hub’ for crypto through a variety of measures, including the regulation of stablecoins. 

Given the concerted nature of the impending regulatory push, now is the time to take stock of the current state of regulation and its potential impact on cryptocurrencies moving forwards. In doing so, the industry can wake up to the fact that regulation – when crafted in a collaborative and careful manner – will play a vital role in the evolution of crypto.

The importance of regulation

The issue of regulation is one that divides the crypto community. Some in the crypto space ardently oppose greater oversight. The implementation of new rules, they argue, would stifle innovation and contradict the very decentralised principles that cryptocurrencies were built upon.

While these arguments should be considered carefully, the truth is that as much as some members of this community want this technology to exist outside of the existing financial system, it can’t. The disruption that the original, fully decentralised model seeks to cause will simply not be permitted by government stakeholders whose job it is to ensure orderly and stable market conditions.

Although the aforementioned efforts by the UK and US treasuries are a step in the right direction, in many ways governments have been slow to wake up to the need for regulation. The volatility of cryptocurrencies threatens retail investors with huge losses. Decentralized networks undermine the effective functioning of market infrastructure providers – such as clearing houses and exchanges – that have critical roles to play in ensuring the orderly functioning of markets. Central banks risk losing influence over their own monetary policy as crypto adoption replaces traditional fiat currencies.

Additionally, there is some truth in Bank of England Governor, Andrew Bailey’s, recent warning that cryptocurrencies are emerging as the new “front line” of fraud. In 2021 alone, crypto scammers took home a record $14 billion. It is these types of statistics that have caused crypto to elicit trepidation from governments and financial institutions, who have continually viewed the digital asset space with a degree of mistrust.

The implementation of regulation will go a long way in tackling this lack of trust, helping to unlocking the huge potential of digital assets while ensuring investors are protected – just like in any other financial market.

A careful, collaborative approach is key

As governments like the US and UK begin to embrace digital assets, it is clear that crypto is here to stay. Regulation is now on the horizon, with it looking increasingly likely that the future of cryptocurrencies will involve some form of regulatory framework.

It is no longer a matter of whether to regulate or not. Instead, the questions facing policy makers are what form regulation should take and how should it be enforced?

It is vital for governments to take a balanced approach to regulating crypto. Heavy-handed regulation has the potential to negatively impact many of the core benefits of cryptocurrencies – such as faster, more efficient payments as well as greater accessibility to finance.

The absence of any regulation at all, however, would be even more damaging. Failure to regulate crypto would handicap the state’s ability to control monetary policy and install the necessary safeguards to protect consumers at a basic level. In this scenario, crypto volatility and fraud would pose a serious risk to consumer protection.

The appropriate balance can only be reached by the public and private sectors working closely together. Only through a collaborative approach – whereby regulation is crafted to fit the unique attributes of the crypto market – will consumers be able to reap the full benefits of cryptocurrencies.

The global financial system has evolved slowly over millennia, and improvements to the way money and assets flow through it have almost always been achieved by successfully integrating a new technology with the existing infrastructure and institutions within it. Responsible and balanced regulation – that protects consumers but at the same time offers crypto the freedom to evolve and innovate – can play a central role in ushering in the next era of digital finance.