In October 2021, the Deputy Governor of the Bank of England, gave a speech in which the same identified the “justifiable and growing concerns around investor protection, law enforcement and market integrity” in relation to cryptocurrencies. The Deputy Governor then proceeded to outline “a plausible scenario” which involved “a massive collapse in the price of unbacked cryptoassets.”
To mitigate against such an event, the Deputy Governor referenced calls recently made by securities regulators on both sides of the Atlantic such as the CEO of the Financial Conduct Authority and the chair of the U.S. Securities and Exchange Commission – that there is a need for regulation as a “matter of urgency”.
While the Deputy Governor of the Bank of England customarily avoids extravagant language and is invariably understated in his public commentary of all financial matters, these are indeed strong words. Although the same confirmed that the risk of contagion from a cryptocurrency crash was presently low, that could change in the near future, and a future cryptocurrency collapse could quickly spread through markets, the Deputy Governor warned.
“A large fall in crypto valuations could affect investor risk sentiment more broadly, causing investors to sell other assets that are judged to be risky and those perceived to have a similar investor base. Interconnectedness creates the possibility that shocks are transmitted through the financial system,” the Deputy Governor added.
Similar warnings have been issued by prominent US figures. Among them is Treasury Secretary, who has repeatedly highlighted the dangers that cryptocurrencies pose both to investors and to the wider public. The Treasury Secretary argued that there are important fundamental questions about their legitimacy and stability. In July, the same said that these questions “underscored the need to act quickly to ensure there is an appropriate US regulatory framework in place.” This month, the Treasury Secretary turned her attention to stablecoins, a type of digital asset pegged to traditional fiat currencies, urging Congress to pass legislation that would require stablecoins to be issued by banks subject to federal banking laws.
These remarks from prominent figures in the financial sector come against a backdrop of near exponential growth in the size of the digital currency market globally. Over the past year, it has grown by nearly 200% from $800bn to $2.3tn. To put this in context, the aggregate value of global cryptoassets five years ago was just $16bn. The industry’s sudden maturity has reached a critical point where it is attracting an increasing amount of attention at a legislative level – not least because of concerns over the risk of cryptocurrencies being used to carry out fraud and money laundering. Nevertheless, we are still some way off from seeing new crypto-specific legislation being passed.
On any view, devising a regulatory regime for cryptoassets in the UK, the US, or in other major jurisdictions, will be an incredibly complex process that will take considerable time to implement. Most likely, according to expert commentators, crypto will be designated either as a form of security or as electronic money with appropriate new legislation and regulation.
Arguably, if these are to succeed at a practical level, the legislative net must be cast wider. This could be achieved by adopting a holistic approach to crypto, which considers its myriad ramifications for taxation, IT, data privacy, fraud, money laundering prevention and environmental concerns, among other areas.
From a financial regulatory perspective, whatever the rhetoric might suggest, progress will likely be incremental. The crypto industry wants clarity, business wants clarity, and so do investors. At some point, therefore, regulatory clarity will become imperative so that investors and businesses can make decisions and deploy capital. Critically, this will require striking a balance between regulatory clarity and regulatory flexibility aimed at maintaining the technological advancement that crypto can bring to the payments and financial services field.
The crypto space is global by nature. It is further complicated by the potential of Central Bank digital currencies, which are currently being proposed by both the European Central Bank and by the Bank of England (BoE). When implementing regulations, they will need to be undertaken in such a way that is consistent with respect to privacy, not least because this is at the heart of distributed ledger technology which underpins the cryptocurrency ecosystem.
These considerations are critical in this space because uncertainty serves to deter innovation. The overwhelming desire for regulation by the BoE and others could create potential pitfalls. Overly stringent regulation may determine the cryptocurrency market to move underground in order to evade/mitigate regulatory scrutiny. Rigid regulation might even dampen innovation which is so pivotal for the future development of FinTech. Potentially, this could have a significant negative impact on various business sectors and on future opportunities that entrepreneurs and innovators might provide.
To avoid these pitfalls, regulators should consult players in the digital currency markets, legal and financial advisers in order to fully understand the intricacies and application of the technology underpinning cryptoassets, their impact on a large number of key fields and the future innovations that might span from the same. Such approach should help regulators to steer clear of simply adapting current regulatory concepts, which may be prove to be ineffective and outdated in relation to cryptoassets.
It’s a two-way street, of course. In a recent interview with the FT, the chair of the US Securities and Exchange Commission warned that cryptocurrency trading platforms are jeopardising their own survival unless they heed the call to work within the US regulatory framework. Big market players therefore need to focus on advocacy and education by actively engaging with policymakers and regulators.
Open dialogue on both sides will allow regulators to develop a legal framework that not only delineates the conditions to be followed when issuing or trading cryptocurrencies – which protect investors and preserve financial stability – but also ensures that such digital currencies will continue to play an important role in technological advancement and innovation.