Caveat emptor does not apply to crypto

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The writer is a member of the Executive Board of the European Central Bank

Last year marked the collapse of the crypto market as investors went from fear of missing out to fear of not getting out.

TerraUSD, a stablecoin that was stable in name only, was among the first to fall in a chain of meltdowns that brought down several lending platforms, a hedge fund, a major crypto asset exchange and, more recently, a major US-listed crypto mining company. More crypto companies are likely to be added to this list in the coming months.

These failures came in quick succession, reflecting the incredibly high leverage of crypto players, their interconnectedness across the crypto ecosystem, and their inadequate governance structures.

Yet, remarkably, the crypto market rout left the financial system largely unscathed. Many therefore believe that it is better to let the cryptos burn than to regulate at the risk of legitimizing the cryptos. Allow me to express two important reservations about this view.

First, despite their fundamental flaws, it is not certain that crypto assets will eventually self-combust.

Take unbacked crypto assets, for example. They perform no socially or economically useful function: they are rarely used for payments and finance neither consumption nor investment. As a form of investment, unbacked cryptos also have no intrinsic value. These are speculative assets. Investors buy them for the sole purpose of reselling them at a higher price. In fact, they are a gamble disguised as an investment asset.

But it is precisely for this reason that they cannot be expected to disappear. People have always played in different ways. And in the digital age, unbacked cryptos will likely continue to be a vehicle for gambling.

Second, the cost to society of an unregulated crypto industry is too high to ignore. For one thing, the crypto market crash this year caught millions of investors off guard. Uninformed investors ended up with significant losses. It’s not just the cryptos that are being burned.

Additionally, unregulated crypto assets can be used for tax evasion, money laundering, terrorist financing, and sanctions evasion. They also have high environmental costs.

This is why we cannot afford to leave cryptos unregulated. We need to build safeguards that close regulatory loopholes and arbitrage and tackle the significant social costs of cryptos head-on.

It’s easier said than done. Regulators have to walk a tightrope. Like Ulysses, they must resist alluring crypto sirens to avoid falling prey to intense industry lobbying. And on their journey, they must avoid the Scylla of poor regulation and the Charybdis of legitimizing weak crypto models.

The EU regulation on crypto-asset markets is an important step. It is crucial that it is implemented as soon as possible. However, further work needs to be done to ensure that all industry segments are regulated, including decentralized financial activities such as crypto asset lending or non-custodial wallet services.

Furthermore, regulation should recognize the speculative nature of unbacked cryptos and treat them as gambling activities. Vulnerable consumers should be protected by principles similar to those recommended by the European Commission for online gambling. They should be taxed according to the costs they impose on society.

To avoid the risk of regulatory delays due to the time required for legislative processes, regulators and supervisors must be empowered to keep pace with crypto developments.

And to be effective and prevent regulatory arbitrage, regulation must be global in scope. The Financial Stability Board’s recommendations for the regulation and oversight of crypto-asset activities and markets should be urgently finalized and enforced, as should the Basel Committee’s recently published rules for the treatment of banks’ exposures to crypto. .

However, regulation and taxation alone will not be enough to close the gaps in cryptos. To build a solid foundation for the digital finance ecosystem, we need a risk-free and reliable digital settlement asset, which can only be provided by central bank money. This is why the ECB and central banks around the world are working on retail and wholesale central bank digital currencies. By preserving the role of central bank money as the anchor of the payment system, central banks will preserve the trust on which private forms of money ultimately depend.

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