Controlling the virtual border – OMFIF
The cryptocurrency debate is starting to resemble the longstanding war on drugs. Each of the main options – ban, decriminalize or legalize, regulate and leave it to the market – has its steadfast and vocal supporters. The clamor is growing louder and, like drugs, is apparently no closer to a consensus, let alone a solution.
Over the past few weeks, we’ve heard from Christine Lagarde, President of the European Central Bank, and Janet Yellen, US Secretary of the Treasury, who are far from enthusiastic about the role of cryptocurrencies in the financial system. Federal Reserve Chairman Jerome Powell was a little more equivocal and announced that the US authorities “did not intend” to ban them.
Chinese authorities have banned them, although at the time of writing, possession of crypto is not a crime in China, but trading is. Also in the United States, Gary Gensler, chairman of the Securities and Exchange Commission, told a Senate committee that the $ 2.2 billion crypto market is a “wild west … riddled with frauds, scams and abuse ”, and could therefore be subject to extensive regulation. accompanied by a stern policy, preferably from the SEC.
So what are the concerns of the official sector? Recently expressed fears about the potential for widespread money laundering seem irrelevant and there is little data available to suggest that the scale is anything but marginally small. This is probably because many other fungible tools and asset classes in fiat instruments are widely available, and the ramps in and out between fiat and crypto are already closely watched. It is therefore somewhat counter-intuitive to deploy an immutable and transparent network for transactions that one wishes to hide from the authorities. Similar objections apply to the major financing of terrorist threats, reinforced by the likelihood that the majority of significant terrorist financing is currently perpetrated by sovereign states using US dollars.
What about existential threats to the global financial infrastructure requiring major interventions by sovereign states and central banks? If the entire cryptoversy of coins, payment instruments, non-fungible tokens, crypto assets and other instruments were to implode overnight, it would undoubtedly be financially embarrassing and even terminal for many businesses. and individuals operating in the market, from large banks and brokers to investors of all types. But it is doubtful that this would lead to a global financial crisis commensurate with 2008.
Issuing a large volume of trustworthy stablecoins – digital payment instruments fully backed by fiat assets – could potentially pose a threat to monetary sovereignty. This is partly why nearly 100 central banks around the world are engaged in central bank digital currency feasibility studies with varying degrees of depth and enthusiasm. This is also undoubtedly the reason why the Chinese authorities recently took drastic measures against cryptocurrencies. It is, however, important to maintain the distinction between proxy tokens with backing of real-world assets and digital fingerprints whose full value is self-referential.
Investor protection is another major threat, which resonates most with politicians and their constituents. If the crypto markets are the lawless Wild West, shouldn’t we ask heavily armed sheriffs to watch the perimeter? Libertarians and true believers in the real purpose of cryptocurrency would consider it paradoxical to expect authorities to control a payment system explicitly designed to bypass said authorities. They would also argue that decentralized finance, allied with transparent and immutable decentralized ledger technology, is its own regulator.
Investors and speculators may well argue for a “caveat emptor” and point out that fraud and scams are already illegal. They also point out that some forms of market abuse, such as front running or other forms of insider trading, are not illegal in crypto markets, which are almost by definition unregulated and populated by unregulated businesses. Exactly, say the regulators.
Assuming that, in at least most democracies, the outcome of the debate is likely to be that of legalizing and regulating, there will be three key initial questions.
- First, what will be the overall objective of this regulation? Is it to preserve the stability of the existing financial system or to encourage innovation, a transition to a digital economy and a “move fast and break things” attitude? What priority should be given to investor protection?
- Second, what exactly should be regulated? In the immutable and borderless financial system inhabited by decentralized autonomous organizations, finding the place, even asserting sovereignty, to regulate participants, instruments and transactions is not a trivial task. How do you regulate application programming interface software produced by a non-financial institution? What new laws, regulations and regulatory approaches might be needed?
- Third, who should regulate and how? Should it be a split between existing sovereign and multilateral regulators or should it be brand new ones?
The Old West was eventually brought to heel, albeit in a long process involving shootings at OK Corral and Custer’s last stand. The regulation of the cryptoverse is expected to follow a similar path.
Philip Middleton is President of the OMFIF Digital Monetary Institute.