Crypto Regulation

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9 Nov 2022
18


Crypto assets have been around for more than a decade, but it’s only now that efforts to regulate them have moved to the top of the policy agenda. This is partly because it’s only in the past few years that crypto assets have moved from being niche products in search of a purpose to having a more mainstream presence as speculative investments, hedges against weak currencies, and potential payment instruments.
The spectacular, if volatile, growth in the market capitalization of crypto assets and their creep into the regulated financial system have led to increased efforts to regulate them. So too has the expansion of crypto’s many different products and offerings and the evolving innovations that have facilitated issuance and transactions. The failures of crypto issuers, exchanges, and hedge funds—as well as a recent slide in crypto valuations—have added impetus to the push to regulate.
Applying existing regulatory frameworks to crypto assets, or developing new ones, is challenging for several reasons. For a start, the crypto world is evolving rapidly. Regulators are struggling to acquire the talent and learn the skills to keep pace given stretched resources and many other priorities. Monitoring crypto markets is difficult because data are patchy, and regulators find it tricky to keep tabs on thousands of actors who may not be subject to typical disclosure or reporting requirements.

Playing catch-up

To complicate matters, the terminology used to describe the many different activities, products, and stakeholders is not globally harmonized. The term “crypto asset” itself refers to a wide spectrum of digital products that are privately issued using similar technology (cryptography and often distributed ledgers) and that can be stored and traded using primarily digital wallets and exchanges.
The actual or intended use of crypto assets can attract at once the attention of multiple domestic regulators—for banks, commodities, securities, payments, among others—with fundamentally different frameworks and objectives. Some regulators may prioritize consumer protection, others safety and soundness or financial integrity. And there is a range of crypto actors—miners, validators, protocol developers—that are not easily covered by traditional financial regulation.
Entities operating in financial markets are typically authorized to undertake specified activities under specified conditions and defined scope. But the associated governance, prudence, and fiduciary responsibilities do not easily carry over to participants, who may be hard to identify because of the underlying technology or who may sometimes play a casual or voluntary role in the system. Regulation may also have to reckon with the unwinding of conflicting roles that have become concentrated in some centralized entities, such as crypto exchanges.
Finally, in addition to developing a framework that can regulate both actors and activities in the crypto ecosystem, national authorities may also have to take a position on how the underlying technology used to create crypto assets stacks up against other public policy objectives—as is the case with the enormous energy intensity of “mining” certain types of crypto assets.
In essence, crypto assets are merely codes that are stored and accessed electronically. They may or may not be backed by physical or financial collateral. Their value may or may not be stabilized by being pegged to the value of fiat currencies or other prices or items of value. In particular, the electronic life cycle of crypto assets amplifies the full range of technology-related risks that regulators are still working hard to incorporate into mainstream regulations. These include predominantly cyber and operational risks, which have already come to the fore through several high-profile losses from hacking or accidental loss of control, access, or records.
Some of these might have been lesser concerns if the crypto asset system had remained closed. But this is no longer the case. Many functions in the financial system, such as providing leverage and liquidity, lending, and storing value, are now emulated in the crypto world. Mainstream players are competing for funding and clamoring for a piece of the action. This is all leading to greater calls for the “same activity, same risk, same rule” principle to be applied, with the necessary changes, to the crypto world—piling pressure on regulators to act. It is posing another conundrum for public policy, too. How closely can the two systems be integrated before there is a call for the same central bank facilities and safety nets in the crypto world?

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