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Thomas Kalafatis

Richard Nesbitt

November 17th, 2022

Why cryptocurrencies need more regulation

0 comments | 11 shares

Estimated reading time: 3 minutes

Thomas Kalafatis

Richard Nesbitt

November 17th, 2022

Why cryptocurrencies need more regulation

0 comments | 11 shares

Estimated reading time: 3 minutes

Crypto assets represent high-risk, largely unregulated and non-transparent vehicles that leave individual investors on their own, making it impossible to know what is really happening with their investments. There are calls for regulation in several countries, and regulators must balance consumer protection with encouragement to innovation. Thomas Kalafatis and Richard Nesbitt hope that the recent significant market reaction to a price reduction of crypto assets is a wake-up call for all players in the market. 


 

In two of our recent papers, we proposed a framework for evaluating the fairness and social inclusiveness of crypto currencies, including stablecoins. Our framework for contrasting currency features helps us consider issues of inclusiveness and glean some possible answers. Here are some advantages of central bank digital currencies (CBDC) over private crypto providers:

  • Control: A central bank digital currency (CBDC) by definition is controlled by the central bank of the nation that creates it. This control is as legitimate as the government of the country itself. Sponsorship and accessibility therefore become key features of CBDCs.
  • Concentration: CBDCs are concentrated in one entity, the central bank, which has the power to choose policies that are fair and inclusive of all members of society. If fairness and inclusion is a priority, then much can be accomplished by the appropriate policies.
  • Taxation: CBDCs are an instrument of the central bank, whose power is granted by the country’s government. Taxation authorities would be directly connected into this process, and we assume would collect their desired tax revenue.
  • Regulation: Similar to taxation, regulators will be fully in the loop on CBDC development, and their needs will be a priority in many cases. This may or may not improve inclusiveness in our societies, depending on what purpose the central authorities wish to accomplish. For example, regulation can be easily effected electronically to track legitimate transactions of consumers as a source of revenue, or it can be used to eliminate the illegitimate transactions of criminals. Will anonymity become a feature or a software bug?
  • Negative externalities (such as energy use): While these will undoubtedly exist, using massive amounts of electrical power to “mine” crypto currencies is largely avoided by CBDCs.

Much has happened in the world of crypto finance. Most of it is not good. From 1 January to 1 July 2022, the price of bitcoin has declined from 46,311 to 19,977. The decline in prices has led to a reported staggering loss of US$2 trillion in value from all crypto assets globally. In addition, the knock-on effect has been the collapse of several large crypto organisations engaged in providing trading and other services to the industry.

Two notable examples are Terra Luna of South Korea and Celsius of the US. Terra Luna was launched in 2020 and reached a high-water stablecoin valuation of US$10 billion. The assets purporting to value their stablecoin at $1.00 went into a death spiral on 7 May 2022, leaving the currency nearly worthless as it became clear the assets backing it could not be realised upon. The crypto currency lender Celsius filed for Chapter 11 bankruptcy protection in July 2022. Their business model involved pooling together investor funds and then lending these to borrowers who would secure their loans with crypto currencies on an overcollateralised basis. When the value of the underlying collateral fell, it caused classic margin calls. This further pushed down asset prices. Two months prior to its collapse, Celsius said they had US$ 11.7 billion of assets under management and over 1.7 million users. “Court filings show that Celsius is around $1.2 billion in the red, with $5.5 billion in liabilities and $4.3 billion (in assets)”. (Forbes, 2022)

The impact of crypto currency asset losses is not spread proportionately through society. Nor are they limited to those who can most afford the losses. As per the FT (Rogers, 5 July 2022) , “a quarter of Black American investors owned cryptocurrencies at the start of the year, compared with only 15 per cent of white investors, according to a survey by Ariel Investments and Charles Schwab. Black Americans were more than twice as likely to purchase cryptocurrency as their first investment.” Some argue that minority investors have been attracted to crypto assets due to what they perceive as unfairness or exclusion from the benefits of traditional banking and finance instruments. Unfortunately, crypto assets represent high-risk, largely unregulated and nontransparent vehicles, which means individual investors are on their own and it is impossible to know what is really happening with their investments.

Where will the industry go from here? One necessary step underway is regulation in a manner that is the same as we would see for any other financial instrument. On 30 June 2022, the European Union announced the creation of Markets in Crypto Assets (MiCA), which will be a regulatory framework providing protection and financial stability for investors in unbacked crypto-assets and stablecoins. It will not apply to non fungible tokens. This framework will cover the usual areas focused on preventing fraud and providing recourse for unfairly treated investors. It will also require assets’ environmental and climate footprint disclosure—negative externalities. EU anti-money laundering regulatory provisions will now apply to these crypto assets, a major step forward for this market.

In the US, the Treasury has stated an urgent need for crypto regulation. While that is still not in place, the industry is moving to consider crypto exchanges under the same rules as brokers. This would significantly enhance the reporting and record keeping of these institutions in the US.

In the UK, crypto regulatory progress is still at an early stage of evolution. Crypto exchanges must register with the Financial Conduct Authority (FCA). While no specific provisions have been created for crypto, the FCA instructs exchanges to comply with money laundering and terrorist financing laws.

Canada, meanwhile, is requiring a $30,000 “buy limit” on “restricted” coins to protect general consumers (defined as “retail investors”). A new category of “eligible” investor allows for a $100,000 limit. Meanwhile, high net worth accredited investors have no limit. These categorisations are based on a questionnaire. The limit excludes Bitcoin. Bitcoin Cash. Litecoin and Ethereum. The Ethereum exclusion seems relevant given Canadian linkages to its creation and its promotion of innovation in the space.

Singapore, which has promoted itself as a safe destination for digital assets, also announced via its monetary authority that it further restricts retail access to cryptocurrencies and consider “further measures to reduce consumer harm”.

Regulators are in a difficult position as they seek to balance consumer protection with encouragement to innovation. Let’s hope that the recent significant market reaction to a price reduction of crypto assets is a wake-up call for all players in the market. Any financial market or financial asset is prone to abuse and over many decades it has been prudent to provide regulation to reduce the harm of these abuses. The innovations arising from new digital assets are important. All participants in these markets benefit from clear and fair rules which guide appropriate behaviour.

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Notes:

  • This blog post represents the views of its author(s), not the position of LSE Business Review or the London School of Economics.
  • Featured image by Kanchanara on Unsplash
  • When you leave a comment, you’re agreeing to our Comment Policy.

About the author

Thomas Kalafatis

Thomas Kalafatis is founder and CEO of Aegis Sports Labs.

Richard Nesbitt

Richard Nesbitt is chair of the Inclusion Initiative at LSE.

Posted In: Diversity and Inclusion | LSE Authors | Technology

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