Something must be done! The challenge of crypto regulation for 2023

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Given their commitment to stakeholder capitalism and globalisation, it was no surprise that delegates to the World Economic Forum in Davos were not taken in by the threat to international harmony allegedly posed by the ecosystem. anarchic crypto. Nor is it shocking that the preferred solution has been a universal, comprehensive and standardized regulatory system based on the existing financial regulatory architecture, applying to all market participants, governments and customers.

The underlying regulatory principle should be same business, same risk, same regulation, echoing calls from financial stability boards for regulatory equivalence between conventional and crypto financial instruments. It also undoubtedly has the unintended consequence of cementing the existing advantages of industry incumbents. All of this has interesting echoes of British attempts as the owner of the world’s largest navy in the mid-1800s to prevent the development and introduction of the submarine.

Obviously, this would require new regulatory agencies, more supervisors, and a host of new laws and regulations. At best, it would be a global, technocratic system that trumps the inconvenient rough edges of national borders and political preferences, not unlike the European Union’s regulation of crypto-asset markets under Spring, which aims to set the global standard for crypto regulation. . The Committee on Banking Supervision of the Bank for International Settlements goes one step further by making crypto business unattractive to existing regulated financial institutions. He suggests that in extreme cases, reserve asset requirements for holding cryptoassets should be 1,250%. The EU could also seek to introduce it.

In Davos, much was said about the risks posed to good order by the scale of money laundering, scams and various financial crimes perpetrated through cryptocurrencies. Losses suffered by investors, risks posed to gullible retail customers, potential threats to the stability of the global financial system and a general inability to track down and bring wrongdoers to justice also figured on the balance sheet.

Estimates of the amount of money laundered globally through the use of crypto in 2022 ranged between $8 billion and $20 billion. In January 2023, four offenders were convicted in the UK of fraudulently obtaining and laundering approximately $27 million in crypto obtained from an Australian cryptocurrency exchange. That sounds huge, but it’s a rounding error from the United Nations Office on Drugs and Crime’s estimate of $1.7 billion, or up to 5% of the world’s gross domestic product, have been laundered in 2022. agreements on anti-money laundering and anti-terrorist financing regulation and enforcement, will have been perpetrated through the financial system conventional.

The crypto winter of 2022, in which the crypto markets grew from an estimated value of $3.1 billion to $1 billion and several major industry players such as FTX, Terra Luna, and Genesis lost their shirts, provided ammunition to both sides in the regulatory debate. For those demanding regulation, crypto has been proven to pose a significant threat not only to investors’ wealth, but also to the health of the financial system itself. But then, in 2022, most investments did not contribute to wealth: according to Bloomberg, $18,000,000,000 was wiped off the value of global stocks. Previously, stellar companies such as Meta and Tesla saw their stock prices slashed by nearly two-thirds, the MSCI World Stock Index fell 20% and bond markets posted their worst returns in a century.

All of this seems to demonstrate that crypto, far from being an alternative investment as many of its proponents like to claim, is closely correlated to the conventional financial system. Moreover, despite the enormous destruction of value, the industry is limping inside its own walls and the collapse has sent no dangerous shockwaves through the global financial system. The corporate and retailer losses were painful for some, but manageable for the system as a whole.

This may be because the sector was not large enough and insufficiently integrated into the global system to pose a great danger of transmission. Its links to conventional finance may have been sufficiently well controlled by public and private actors that much harm was done. Or it could be that, since the financial crisis of 2008, the belts and suspenders of the global financial system have tightened considerably and the whole system is now much more resilient to shocks.

The most notorious victim of the crypto winter has been the once $32 billion crypto exchange FTX, which filed for bankruptcy in November 2022. Its founder, Sam Bankman-Fried, has been accused by several US agencies. of orchestrating massive financial fraud, misusing client funds and defrauding stock investors. The former billionaire has pleaded not guilty. Interestingly, these alleged crimes are prosecuted by existing state agencies, in existing courts, under existing laws.

While the possible inattention of some of the FTX regulators may be in the spotlight, from a broader regulatory perspective and regardless of the outcome of the case, there is little in the FTX history to date that suggest a massive new regulatory infrastructure is needed to control the world of cryptocurrency and assets.

Some commentators have gone further and suggested that since crypto instruments are not currencies, commodities, securities, or units of account, they should be left to their own devices with a big stake sticker. in custody/no visible widows and orphans. It has even been suggested that since regulating crypto instruments would actually legitimize them, efforts to do so may do more harm than good.

Nevertheless, there are undeniable gaps in the coverage of existing laws, regulations and institutions. One, recently addressed by the UK Law Commission (and covered by an OMFIF roundtable), is the amorphous definition of property rights, particularly in relation to digital assets and non-fungible tokens. In the United States, the cash market for cryptos that have not been officially determined to be securities is not monitored. The Financial Stability Supervisory Board has urged Congress to legislate to close this loophole. Although bills have been proposed to Congress, we are still awaiting developments.

These shortcomings could be filled by the creation of a self-regulatory agency for crypto markets. However, there is some debate over whether it would have as much authority as a traditional regulatory agency, and it would involve making crypto companies responsible for regulating themselves.

From a range of perspectives, 2023 is shaping up to be a defining year for cryptocurrencies, crypto-assets, and central bank digital currencies. The regulatory debate around this will be large and dynamic with passionate advocates for each of the major options. These include: strangling crypto through regulation; creating a low-key regulatory regime for crypto; integrating crypto into the existing financial system; and identifying and filling existing gaps in the laws, but otherwise relying on caveat emptor. Needless to say, OMFIF and its members are delighted to be at the center of this debate.

Philip Middleton is Chairman of the Digital Monetary Institute, OMFIF.

This article originally appeared in the 2023 Annual DMI.

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