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Cryptocurrency’s quick evolution from speculative investment to a bonafide asset class has created a strong sense of urgency among lawmakers and regulators to develop and deploy meaningful controls. To date, however, their efforts have done little to tame the new frontier — still often referred to as a “wild west,” even by regulators — and key voices within the industry refer to the regulatory landscape as a “muddled mess.”
One key challenge that has yet to be overcome is finding a workable balance that promotes both consumer protection and industry innovation. Without sufficient consumer protections, users don’t have the information they need to make informed investment decisions, while the wrong kind of protection threatens to slow the pace of innovation that has become integral to the crypto space.
“Even though in many areas we have regulations that are too expansive and too complicated, some degree of regulation is necessary in financial markets to protect investors and guarantee a fair market,” says Patrick Gruhn, the founder and CEO of Perpetuals.com. “For example, investors need to have minimum disclosures that empower them to make wise decisions. Problems occur when governments issue patronizing regulations that seek to limit their citizens’ investment activities.”
Gruhn started his journey in the digital asset space as a Partner at K&G Lawyers, a Swiss firm specializing in digital assets. Later he co-founded DigitalAssets.ag, which later became FTX Europe, to make tokenized stocks available with an approved security prospectus. His most recent company, Perpetuals.com, is a MiFID II market infrastructure startup for crypto derivatives trading that empowers perpetual futures trading without boundaries.
Lawmakers seem keenly aware of the need for protection that Gruhn points out, as shown by comments made to mark the recent passage of the Financial Innovation and Technology for the 21st Century Act by the US House of Representatives. US Representative Patrick McHenry applauded the bill for providing “regulatory clarity” and “robust consumer protections necessary for the digital asset ecosystem to thrive in the United States.”
Yet lawmakers seem reluctant to address the unique characteristics that set crypto apart as an asset class. Even the recently passed House bill, which still faces scrutiny in the Senate, is focused mainly on bringing crypto into the realm of already defined asset classes. One of its key provisions seeks to define certain digital assets as “digital commodities” subject to oversight by the US Commodity Futures Trading Commission.
“The most important thing is legal certainty and clear rules for different business models in the digital asset space,” Gruhn argues. “Any crypto project should be able to identify and understand what regulations they have to follow to avoid unexpected enforcement action.”
As the crypto regulatory landscape continues to evolve, lawmakers and regulators must pay close attention to cryptocurrency’s DNA. Controls that contribute to a thriving crypto ecosystem will seek to protect its unique features. The following are some key considerations for those seeking to create a healthy crypto ecosystem fit for mainstream adoption.
Lack of regulations is not an option
Definitions are a key component of regulations that clearly establish what they address, how they address it, and the implications for affected industries. In the crypto space, this includes determining what assets are or are not regulated and the obligations placed upon those who engage with them.
“The last thing a crypto company needs is legal uncertainty,” Gruhn says. “Every crypto company already has to deal with a complex and uncertain environment. Knowing what is permitted for a business and what is prohibited is essential for building a successful crypto industry.”
Effective regulations also play a key role in building consumer confidence, which is one of the key challenges keeping crypto from mainstream adoption. Regulations that protect users, such as those focused on minimum disclosures, are necessary to guarantee a fair market. The challenge is protecting without patronizing, as regulations seeking to limit citizens’ access to crypto would be an overreach.
Leveling the playing field should be a key goal
Crypto is not a traditional asset class. Although it shares some characteristics with traditional asset classes, it also introduces new possibilities. Healthy regulations will seek to empower the industry to fully leverage those possibilities rather than limit crypto to the functionality of other asset types.
“Regulators must try to provide a level playing field between traditional finance and crypto,” Gruhn says. “Technological differences must be taken into account, even where business models are very similar. In some cases, the risks that crypto regulations aim to address are already addressed by technology. Regulators must carefully assess and differentiate between risks that have already been addressed and those that could arise.”
Efforts to level the playing field for the emerging crypto market should also focus on addressing offshore competition. Crypto’s decentralized nature makes it a uniquely global asset class by design, but expecting regulated crypto businesses to compete with unregulated offshore companies puts them at a considerable economic disadvantage.
Digital controls may be the best controls
Cryptocurrency manifested a vision of assets that would not require centralized oversight. Essentially, it was designed to thrive without the need for regulations. While that does not mean that regulations focused on governing the industry are not warranted, it does indicate that certain controls needed for conventional assets could be superfluous at best and damaging at worst.
“Regulators and policymakers should be carefully analyzing how technology can be better than regulations at solving crypto industry issues,” Gruhn says. “The crypto derivatives exchange model that utilizes auto-liquidation rules instead of centralized and regulated clearing houses provides an example of this.”
The ongoing debate surrounding crypto regulations over a decade after the first Bitcoin was mined proves the complex challenge lawmakers and regulators face. To succeed, they must resist the temptation to limit crypto’s development by subjecting it to conventional controls. Creating regulations that consider and promote the unique characteristics of crypto will be essential to establishing an ecosystem that can thrive.
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