In view of their commitment to stakeholder capitalism and globalisation, it was unsurprising that delegates at the World Economic Forum gathering in Davos were not enamoured of the threat to international harmony allegedly posed by the anarchic crypto ecosystem. It is also hardly shocking that the preferred solution was a universal, comprehensive, standardised regulatory system based on the existing financial regulatory architecture, applying to all market participants, governments and customers.
The underlying regulatory principle ought to be ‘same activity, same risk, same regulation’, echoing the Financial Stability Board’s calls for regulatory equivalence between conventional and crypto financial instruments. This also has the no doubt unintended consequence of cementing the existing advantages of industry incumbents. It all has interesting echoes of Britain’s attempts as the owner of the world’s largest navy in the mid-1800s to prevent the development and introduction of the submarine.
Clearly this would require some new regulatory agencies, more supervisors and a raft 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 – something not dissimilar to the European Union’s Markets in Crypto-Assets regulation due in spring, which aims to set the global standard for crypto regulation. The Bank for International Settlements’ Committee on Banking Supervision goes a step further in making crypto activity unattractive for existing regulated financial institutions. It suggests that in extreme cases the reserve asset requirements for holding cryptoassets should amount to an eye-watering 1,250%. The EU may also seek to introduce this.
At Davos, much was made of the risks posed to good order by the scale of money laundering, scams and assorted financial crime perpetrated through cryptocurrencies. Also on the charge sheet were losses incurred by investors, the risks posed to gullible retail customers, potential threats to the stability of the global financial system and a general inability to trace and bring malefactors to justice.
Estimates of the amount of money laundered globally through the use of crypto in 2022 amounted to between $8bn and $20bn. In January 2023, four offenders were sentenced in the UK for fraudulently obtaining and laundering around $27m in crypto obtained from an Australian cryptocurrency exchange. This seems egregious but is a rounding error compared with the United Nations Office on Drugs and Crime’s estimate that $1.7tn, or up to 5% of global gross domestic product, was laundered in 2022. The overwhelming bulk of this, despite far reaching international regulatory accords on anti-money laundering and countering terrorist financing regulation and enforcement, will have been perpetrated through the conventional financial system.
The ‘crypto winter’ of 2022, during which crypto markets slumped from an estimated value of $3.1tn to $1tn and several leading industry players such as FTX, Terra Luna and Genesis lost their shirts, has provided ammunition for both camps in the regulatory debate. For those demanding regulation, it is evidence that crypto poses a significant threat not only to investors’ wealth, but also to the health of the financial system itself. But then in 2022 most investment was unhelpful to wealth: according to Bloomberg, $18tn was wiped off the value of global stocks. Previously stellar companies such as Meta and Tesla saw their stock prices reduced by almost two-thirds, the MSCI World Stock Index was down 20% and bond markets saw their worst returns for 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. Furthermore, despite the huge destruction of value, the industry limps on within its own walls and the collapse transmitted no dangerous shockwaves into the global financial system. Losses both corporate and retail have been painful for some but manageable for the system as a whole.
This may be because the sector was not big enough and insufficiently integrated into the global system to present much transmission danger. It may be that its links to conventional finance were sufficiently well-policed by both public and private actors for much harm to be done. Or it may be that, since the 2008 financial crisis, the belts and braces of the world’s financial system have been considerably tightened and the whole system is now far more resilient to shocks.
The most notorious victim of the crypto winter has been the crypto exchange FTX, once valued at $32bn, which filed for bankruptcy in November 2022. Its founder, Sam Bankman-Fried, has been charged by several US agencies with orchestrating massive financial fraud, misusing customers’ funds and defrauding equity investors. The former billionaire has pleaded not guilty. Interestingly, these alleged crimes are being prosecuted by existing public agencies, in existing courts, under existing laws.
While the possible inattention of some of FTX’s regulators might come under the spotlight, from a broader regulatory perspective, and irrespective of the outcome of the case, there is little in the FTX story to date that suggests a massive new regulatory infrastructure is needed to police the world of cryptocurrency and assets.
Some commentators have gone further and suggested that, since crypto instruments are neither currencies, commodities, securities nor units of account, they should be left to their own devices with a large ‘caveat emptor/no widows and orphans’ sticker prominently placed on them. It has even been suggested that, since regulating crypto instruments would in effect ‘legitimise’ them, efforts in that direction might do more harm than good.
Nevertheless, there are some undeniable gaps in the coverage of existing laws, regulations and institutions. One, recently addressed by the UK Law Commission (and covered in an OMFIF panel session), is the amorphous definition of property rights particularly with regard to digital assets and non-fungible tokens. In the US, the spot market in cryptos that have not been officially determined to be securities is unpoliced. The Financial Stability Oversight Council has strongly recommended that Congress legislate to close this loophole. Though bills have been proposed in Congress, we still await developments.
These gaps might be closed by the establishment of a self-regulatory agency for crypto markets. However, there is debate over whether this would have as much authority as a traditional regulatory agency, and it would involve making crypto firms responsible for regulating themselves.
From a whole spectrum of perspectives, 2023 looks set to be a defining year for cryptocurrencies, cryptoassets and central bank digital currencies. The regulatory debate surrounding this will be far-reaching and vibrant with passionate advocates for each of the main options. These include: strangling crypto through regulation; creating a discrete regulatory regime for crypto; bringing crypto within the existing financial system; and identifying and plugging existing gaps in laws but otherwise relying on caveat emptor. Needless to say, OMFIF and its members look forward to being at the centre of that debate.
Philip Middleton is Chairman of the Digital Monetary Institute, OMFIF.
This article was originally published in the DMI annual 2023.
