The right rules could provide a safe space for innovation
Crypto assets have been around for more than a decade, but only now are efforts to regulate them high on the political agenda. This is partly because only in the last few years have crypto assets evolved from niche products looking for a purpose to a mainstream presence as speculative investments, hedges against weak currencies, and potential payment tools.
The spectacular, albeit volatile, growth in crypto assets’ market capitalization and their intrusion into the regulated financial system has led to increased efforts to regulate them. So has the expansion of crypto’s many different products and offerings and the evolving innovations that have made issuance and transactions easier. The failure of crypto issuers, exchanges, and hedge funds — as well as a recent drop in crypto valuations — have given additional impetus to regulatory pressures.
Applying existing regulatory frameworks to crypto assets or developing new ones is challenging for several reasons. First of all, the crypto world is evolving rapidly. Regulators struggle to acquire the talent and learn the skills to keep up in the face of scarce resources and many other priorities. Monitoring the crypto markets is difficult as data is patchy and regulators find it difficult to keep tabs on thousands of players who may not be subject to typical disclosure or reporting requirements.
To make matters worse, the terminology used to describe the many different activities, products and stakeholders is not globally harmonized. The term “crypto asset” itself refers to a wide range of digital products that are privately issued using similar technologies (cryptography and often distributed ledgers) and that can be stored and traded primarily through digital wallets and exchanges.
Actual or proposed uses of crypto assets may simultaneously attract the attention of multiple domestic regulators – banking, commodities, securities, payments, among others – with fundamentally different frameworks and objectives. Some regulators may prioritize consumer protection, others safety and soundness, or financial integrity. And there are a number of crypto players — miners, validators, protocol developers — that are not easily covered by traditional financial regulation.
Companies that operate in the financial markets are usually authorized to carry out certain activities under certain conditions and to a defined extent. But the associated governance, prudential, and fiduciary responsibilities do not easily transfer to the participants, who may be difficult to identify due to the underlying technology, or sometimes play an incidental or voluntary role in the system. Regulation may also face the dissolution of conflicting roles that have centered on some centralized entities like crypto exchanges.
Finally, in addition to developing a framework that can regulate both actors and activities in the crypto ecosystem, national authorities may also need to take a position on how the underlying technology used to create crypto assets compares to other policy goals – as is also the case with the huge energy intensity of “mining” certain types of crypto assets.
Crypto assets are essentially just codes stored and accessed electronically. They may or may not be backed by physical or financial collateral. Their value may or may not be stabilized by being pegged to the value of fiat currency or any other price or asset. In particular, the electronic lifecycle of crypto assets amplifies the full range of technology-related risks that regulators are still working hard to incorporate into mainstream regulations. Chief among these are cyber and operational risks, which have already been brought to the fore by several high profile losses from hacking or accidental loss of control, access or records.
Some of these might have been less of a concern had the crypto-asset system remained closed. But that is no longer the case. Many functions in the financial system, such as B. providing leverage and liquidity, lending and storing value are now being imitated in the crypto world. Mainstream players compete for funding and clamor for a piece of the action. All of this leads to ever louder calls for the application of the “same activity, same risk, same rule” principle with the necessary changes to the crypto world – putting pressure on regulators to act. It also poses another public policy conundrum. How tightly can the two systems be integrated before there are calls for the same central banking facilities and safety nets in the crypto world?
Contrasting national approaches
It is not that national authorities or international regulators have been inactive – in fact much has been done. Some countries (like Japan and Switzerland) have changed or introduced new laws affecting crypto assets and their service providers, while others (including the European Union, United Arab Emirates, United Kingdom and United States) are in the drafting phase condition. Overall, however, national authorities have taken very different approaches in regulatory policy for crypto assets.
On the one hand, the authorities have the issuance or holding of crypto assets by residents or the ability to do business with them or use them for specific purposes, such as. B. Payments, prohibited. On the other hand, some countries were much more open and even tried to court companies to develop markets for these assets. The resulting fragmented global response neither guarantees a level playing field nor protects against a race to the bottom as crypto players migrate to the friendliest jurisdictions with the least regulatory stringency – while remaining accessible to anyone with internet access.
The international regulatory community has not been sitting idle either. In the early years, the primary concern was maintaining financial integrity by minimizing the use of crypto assets to facilitate money laundering and other illicit transactions. The Financial Action Task Force acted quickly to provide a global framework for all virtual asset service providers. The International Organization of Securities Commissions (IOSCO) has also issued regulatory guidance for crypto exchanges. But it was the announcement of Libra, touted as a “global stablecoin,” that caught the world’s attention and gave those efforts a bigger boost.
The Financial Stability Board began monitoring the crypto asset markets; published a set of principles to guide the regulatory treatment of global stablecoins; and is now developing guidance for the broader spectrum of crypto assets, including unsecured crypto assets. Other standard-setters are following suit, working on the application of financial market infrastructure principles to systemically important stablecoin arrangements (Committee on Payments and Market Infrastructures and IOSCO) and on the regulatory treatment of banking risks in crypto assets (Basel Committee on Banking Supervision).
The regulatory fabric is woven and a pattern is expected to emerge. But the concern is that the longer this takes, the more national authorities will become locked into different regulatory frameworks. For this reason, the IMF calls for a global response that is (1) coordinated to close the regulatory gaps that result from inherently cross-sector and cross-border issuance and to ensure a level playing field; (2) consistent, so that it aligns with established regulatory approaches across the spectrum of activity and risk; and (3) comprehensive, covering all actors and all aspects of the crypto ecosystem.
A global regulatory framework will bring order to markets, help build consumer confidence, set the limits of what is acceptable and provide a safe space for useful innovation to continue.
The opinions expressed in articles and other materials are those of the authors; they do not necessarily reflect IMF policy.