Since its inception, cryptocurrency has been a challenge for regulators. Existing regulatory frameworks were created in a centralised, paper-based world with country borders. Crypto ignores all of these by design.
The crypto ecosystem is constantly evolving, so it’s hard to fully understand its nature and the risks that come with it, which makes building a regulatory framework difficult. Combine too many unknowns and too few regulations, plus pressure and some resistance from traditional financial institutions who feel threatened by crypto, and it’s no surprise that governments often take a heavy-handed approach.
So, can crypto be successfully regulated? Or by doing so, will the industry be stripped of all the benefits that it set out to offer investors in the first place?
Regulation Gone Wrong
Different states take very different approaches to imposing rules and regulations on crypto, with some opting for much more stringent measures than others. Countries like Algeria, Bolivia, Ecuador, Nepal, Nigeria and China have opted for a total ban.
Elsewhere, South Africa has prohibited cross border transfers, so every exchange that wants to operate in this jurisdiction needs to be registered as a South African company to allow regulators to monitor all transactions. But is this the right approach?
Regulation to protect investors is essential if crypto is ever to reach the mainstream. In fact, a recent survey by Fortunly actually found that nearly 30% of investors believe that crypto regulations will increase its value, reduce volatility, and curb the risk of scams.
However, South Africa’s approach seems to be more about protecting the current financial system than investors. Digital currency adoption continues to accelerate worldwide – without regulation that serves investors, countries risk leaving their investors (and economies) in the dark ages.
There Is More at Risk Than Financial Losses
Ultimately, there is no denying that additional regulation around crypto could significantly benefit both individual investors and the industry overall if carefully planned and rolled out. More regulation will help quell fears around crypto scams and hacks. This will build trust, and with more trust comes more retail and institutional investors. However, government bodies are also aware that there is more at risk than financial losses if additional frameworks and rules are not implemented sooner rather than later.
The European Union recently set new draft rules around crypto with two main aims in mind. Firstly, protecting consumers by safeguarding against market manipulation and financial crime. Secondly, making sure crypto becomes far more sustainable. Research by Selectra found that Bitcoin’s energy consumption is up 16x from 2017 levels, equivalent to the amount of energy used annually by 15 million people. With an energy consumption equal to that of some small countries, the crypto industry has the potential to do severe damage to the planet (and its reputation) without more stringent regulation and guidance.
Of course, the answer here is not to ban crypto altogether, but for regulators to work with the industry to create careful regulatory pathways that allow innovation to thrive while protecting both end consumers and the planet.
Always Playing Catch-Up
Many government bodies require more time to assess and implement new regulations around crypto. While some have made the cutthroat decision to ban the currency altogether, other countries are yet to offer any guidance.
Unfortunately, with an industry that’s constantly growing and evolving at a rate of knots, it’s a relentless game of catch up, and many are lagging. The fact that some think crypto is a tool for money laundering shows just how far we still must go. A fundamental element of blockchain is transparency – cryptocurrencies are actually more transparent than the traditional markets – single transactions can be easily traced back to the bank account they came from. This means that the days where you could use crypto to get away with things you shouldn’t be doing, such as money laundering and buying and selling illegal items, are long gone.
And the compliance tools are only becoming more advanced. Take Ethereum – the second largest crypto – for example. In 2016, a hacker managed to drain 3.6 million Ether from its crowdfunding mechanism, which is still the largest theft to date and would be worth around $9 billion (£6.9 billion). The identity of the hacker has always remained a huge mystery for those in the space. However, earlier this year a powerful forensics tool by Chainalysis successfully traced the stolen funds to the point at which they were cashed out – allegedly unmasking the hacker after six years of mystery.
If regulators explored this element of the technology, perhaps it could be applied to create a more sophisticated and transparent regulatory environment across the board, not just for crypto?
A Challenge, and an Opportunity
By taking advantage of blockchain’s security and transparency, we could build a new ‘smarter’ regulatory system, where regulation and compliance is automated. Rather than the lengthy process of institutions maintaining their own records and reporting to regulators as required, regulators could use blockchain to create a system where transaction records are made accessible to both industry and regulators. This could cut cost, minimise risk in the compliance process and increase trust between regulators and businesses.
Cryptocurrencies and their underlying technology have come a long way since Bitcoin was first created in 2010. If regulators prioritise understanding of the technology rather than protection of the existing financial system, they will not only ensure consumers are protected from any potential crypto scams, but also could uncover a tool which could create a more transparent, easier to monitor regulatory environment beyond crypto.
By Tristan Roozendaal, CEO, Centralex.