Making Digital Asset Investment Safe – How Regulation will Disrupt the Industry | The Financial Technologist

In 2009, Bitcoin, the world’s first cryptocurrency, was born out of frustration following the financial crises that dominated the early days of the new millennium. Trust in the banking system was at an all-time low, and to combat this, an electronic cash system was created, eliminating the need for middlemen. Instead, it relied on immutable, encrypted peer-to-peer transactions that didn’t involve bank or government governance or control, providing an alternative to fiat currency. Over the next few years, the number of cryptocurrencies grew and, with them, the digital assets market. Today there are an estimated 9000 coins in circulation, and the global market cap (current total value) stands at $1.17 trillion. As a comparison, the global market cap for silver is currently around $1.3 trillion. As the crypto market grew, so did its reputation as a safe haven for criminals. The system’s intentional anonymity and lack of centralised control attracted money laundering and other illicit activity. Cybercriminals sought to steal crypto from exchanges and wallet providers, leaving investors with empty pockets. The crypto industry provides none of the safeguards available to those who invest in traditional finance, such as deposit insurance which protects consumers’ money should a bank fail. A series of high-profile hacks and business failures eroded confidence in the crypto industry and attracted the attention of regulators around the globe. Those involved in crypto security have long considered the introduction of regulation to be a positive disrupter that will encourage mass crypto adoption, allowing the industry to mature and achieve its full potential. Increased trust and confidence Providing clear rules and guidelines for businesses to follow, especially around protecting investors’ funds, makes investment a more attractive proposition. Traditional finance organisations will be more inclined to diversify into digital assets if they feel it is properly governed. In the United States, the Securities and Exchange Commission (SEC) has started to make inroads into regulating parts of the digital asset industry. While some of its actions were seen as controversial, they have gone some way towards clarifying the regulatory landscape, especially their decision to classify Bitcoin and Ethereum as commodities, which has legitimised them in the eyes of investors. Risk reduction A framework that requires organisations to put the safety of investor funds at the forefront of their strategy, implement security measures and provide compensation should customers suffer a loss will mitigate risk and provide a safer place for both consumers and businesses to operate. In the EU, the first piece of legislation to bring uniform rules for crypto has been passed. Markets in Crypto-Assets (MiCA) Regulation will provide protection for investors, reduce the risk of lost funds, and ensure financial stability. The rules will also provide clarity for crypto service providers, making it easier for them to comply with regulations. Mass adoption Crypto is no passing fad. While some people mistrust digital assets thanks to sensationalised news stories of hacks and theft (in 2022, illicit activity was less than 0.24% of all crypto transfers) and don’t understand the mechanics behind them, the adoption rate has increased year on year since 2008. With the global ownership rate sitting at around 4.2%, regulation can play a substantial part in helping to increase mass adoption. A secure environment for businesses and consumers will improve confidence and trust in the sector, encouraging the acceptance of crypto as a legitimate investment and payment option. The Japanese regulator, the Financial Services Agency, has established a registration system for crypto exchanges. The result? Increased transparency in the market as investors find it easier to identify and invest with reputable crypto service providers. Japan now has one of the highest rates of ownership in the world. Don’t put a round peg into a square hole More and more crypto service providers are coming out in support of regulation. However, they are united in the opinion that those implementing it must consider the nuances of crypto rather than trying to fit it into current frameworks that are not fit for purpose. For example, traditional financial regulations regulate activity in a particular jurisdiction. Crypto is borderless; transactions can be made anywhere across the globe. This makes it challenging for regulators to enforce and track regulations. The legal status of crypto is yet to be determined and remains unclear in many countries, leading to confusion about what regulatory bracket they fall under, for example, commodities or securities. Many are of the opinion that crypto should have its own category and be regulated differently from traditional financial offerings. Cryptocurrency was itself a disrupter in the world of finance, and, ironically, traditional finance control mechanisms are now disrupting the digital asset ecosystem. Arguments about whether regulation will stifle innovation or protect the integrity of the crypto market will continue for the foreseeable; what is clear, however, is that a middle ground must be found quickly for the sector to flourish and prosper. Read more articles like this in The Financial Technologist. Download your free copy here.