Crypto and Regulation: Challenging but Inevitable

The idea that crypto belongs or deserves to be outside of regulation is naive and outdated. Regulation is necessary, and there is a huge difference between something being challenging and it being impossible.

In our three-part series on the relationship between crypto and regulation, We’ll be examining how different nations are approaching regulation and what can be done to improve that process. But first, we wanted to explain why we believe a regulated crypto/blockchain industry is both needed and inevitable.

The debate over how to regulate the crypto industry feels never ending.

The discussions are getting ever more heated as the industry grows, and there are growing concerns from the regulators.

What started off in the early days as an academic discussion about how to classify Bitcoin or Ethereum, was later quickly shadowed by the ICO boom. Since then the industry has grown both vertically and horizontally. Most of the services you find in the traditional "fiat" financial world, you can now find replicated on the blockchain too; exchanges, stablecoins, FX trading, lending services -to name just a few. The list is growing, as is its popularity.

While some companies have tried to align their services with existing regulations or expected upcoming regulations, other companies have taken steps to avoid regulation. These steps have been as dramatic as relocating the business to a new country, or less severe, taking measures such as tweaking an existing offering, removing the ability for derivatives to be used during cryptoasset spot trading, adding more KYC or KYB measures, changing the narrative in the marketing etc.

Good financial regulation is hard to get right, and there is a fine distinction between too much regulation, which may stifle innovation, and too little, which may lead to harm for investors. In the traditional financial world we often uncover a lack of regulation only once a scandal or a crisis takes place. What seemed to be a good, conservative approach in the 70s can result in a crisis in the 80s. Or a well intended liberalization of regulation in the 90s can end with a financial crisis in the 2000s.

The key here is to look at the intent.

In liberal democracies regulation is meant to balance the occasionally competing forces of encouraging innovation, competition, and fair market access, with those of protecting consumers from unintended risk and maintaining market stability.

When the bank denies you a home loan, the intent is to protect you as a consumer as much as it is to protect the society from a new housing bubble, while also making sure the bank stays in operation, safeguarding your savings. The regulator’s role is to make sure we all can trust the institutions we are depending on and the companies we are dealing with. There is a reason why aviation, firearms, alcohol and pharmaceuticals are heavily regulated.

All these regulations have taken time to get in place, and to get right. They aren’t perfect, but they’re better than any other alternative.

The discussions we need to be having

The headlines lately have been very much dominated by the approach of the US and Chinese regulators.

Whilst China has taken drastic measures to ban crypto and crypto-related services, US regulators have gone into battle demanding crypto-related companies adapt to regulations the regulator deems relevant for them. So the discussion in the US resembles the healthy discussion all functioning democracies must have. Questions like, who needs to be regulated? What activity falls under what regulation ? What should the regulation be for that activity? And even, which regulator is responsible for the activity in question?

We are still in the early days, and mistakes will be made by all sides.

An interesting aspect of the discussion is the relationship between what can be done and what should be regulated. For example, data protection was not discussed much when the internet was launched. The challenges back then were very different. How to organize data, how to search for content, giving people access to the internet, how to deal with copyrights etc, were more pressing. It was only later, when these issues had abated and several market conditions matured, that we were in a position to start looking at data protection. Before we could be concerned with how the likes of Google, Apple and Facebook deal with personal data, they first had to come into existence.

Regulatory difficulty cannot nullify crypto/blockchain opportunities

With the vast opportunities blockchain technology represents, there’s an incredible amount of innovation taking place.

While some of these new products and services only appeal to the very few, services such as smart contracts, decentralized services and exchanges are impacting the way we consume products and services, and further challenging the established institutions such as banks and brokers. And with such impact, you naturally attract the interest of the regulators.

For example, why would anyone set up a savings account at their bank at 1% interest rate, when Decentralized Finance (DeFi) platforms offer 5x to 10x of that? Why miss out on the growth of Amazon, just because you can’t afford the price of a single share? Why not buy a fraction of a share? Why accept paying high fees and late settlement times when you’re sending money to your loved ones in need, when you can do it much cheaper and faster on the blockchain?

And on the flip side, what happens when the DeFI platform cuts your access, and your savings are gone? Or when the virtual broker never fulfilled your share purchase order? Or when terrorists are financing their operations in exactly the same way you are transferring money to your loved ones?

James Burnie, Financial Services Regulation and FinTech Partner at Gunnercooke.

With new opportunities, new threats emerge.

The question is not if we “need” regulation. Indeed, the existing legal framework of every jurisdiction is itself a form of regulation prohibiting bad actors, for example, from committing fraud. The idea that there is somehow a place “outside” the law is a naive one, and one which was debunked as different courts took jurisdiction over the internet.

Rather, the key question is how the regulation should work, and how it should be developed and enforced. These are not easy questions to answer, but as we have shown with the internet, it can be done - and there are plenty of jurisdictions trying a variety of approaches. A greater level of communication between crypto and blockchain businesses, traditional financial institutions and government bodies/regulators can allow us all to reap the benefits of innovation while making no sacrifices on safety and security.

Look out for part two and three in this series, where we’ll explain in more detail the current state of crypto regulation around the world, and how regulation can act as a catalyst for growth in the crypto industry.

By Dr. Ozan Özerk, Founder of OpenPayd and James Burnie, Financial Services Regulation and FinTech Partner at Gunnercooke.