Crypto: a regulatory headache

The brutal ‘crypto winter’ has taken the shine off the cryptocurrency market. Bitcoin is down two thirds from its peak, stablecoins have come untethered from their dollar pegs, and last week, crypto lender Celsius Network filed for bankruptcy, having effectively faced a modern-day bank run, most likely resulting in the equivalent of customers losing billions of dollars.

Is crypto dead? In a speech last week, Sir Jon Cunliffe, the deputy governor of the Bank of England said “the lesson we should not take from this episode is that crypto is somehow over and we do not need to be concerned about it anymore”’. In fact, crypto might already be more mainstream than you think – Cunliffe compared it to the dotcom bubble, in that the early stages have come with very high risks but the overall shift will continue. 

According to the Financial Conduct Authority (FCA), around 2.3mn Brits currently hold cryptoassets, and PwC’s senior blockchain specialist, Haydn Jones, that we are nowhere near peak crypto yet. This might prove positive: the underlying blockchain technology has potential for use in retail and wholesale payments, and could make financial infrastructure more efficient and accessible. But crypto also has the potential to cause significant damage: think financial crime, mis-selling and even financial contagion. How can regulators manage this?

Cryptoassets are a broad bunch. There are stablecoins (whose values are tethered to the US dollar), more established cryptocurrencies like Bitcoin (see chart), and around 10,000 more speculative tokens. Crypto is a multidimensional product, creating multidimensional problems. And it needs an appropriate regulatory approach.

For stablecoins, the picture is starting to become clearer. According to the Bank of England, 75 per cent of all trades on crypto-asset trading platforms involve a stablecoin, and they are now integral to the functioning of crypto markets. But although they may be stable by name, they are not necessarily stable by nature – two of the three biggest stablecoins recently saw confidence in their ability to maintain their peg to the dollar eroded, leading to a run on the coin and a price collapse. 

PwC’s Jones explained that if customers rapidly withdraw stablecoins, they are effectively redeeming from a bank – although stablecoins are not yet big enough to trigger financial contagion, in theory, they could. This means that banks’ balance sheets will come under increasing scrutiny: internationally, the Basel Committee on Banking Supervision is issuing guidance on the treatment of cryptoassets held by banks. 

Domestically, “the UK authorities have made clear that they are prepared to see stablecoins operate in the UK, provided they are properly regulated and supervised”, the BoE’s Cunliffe said. The more secure regulatory environment could ultimately open the door to more widespread use of stablecoins. 

The direction of travel for more speculative tokens is unclear. The FCA already publishes a list of unregistered crypto exchanges, and there will soon be stronger rules around cryptoasset promotions, which often target new investors using celebrities on social media. But how much further should regulation go? There are other unregulated speculative activities – after all, investors can buy gold, commodities and obscure collectibles which also incur a chance of loss. Crypto is similarly risky – Cuncliffe stressed that technology alone did not make assets “with no intrinsic value a safe or one-way bet”. 

Then there is the argument that by regulating these investments, the FCA might end up giving them an unintended ‘halo’, encouraging false expectations of consumer protection. Over a tenth of crypto investors already think that they will be compensated by the FCA or the Financial Services Compensation Scheme if something goes wrong with their investment. They won’t. 

The FCA also stresses that regulation requires information. “We are not going to award FCA registration or authorisation to businesses which won’t explain basic issues, such as who is responsible for key functions or how they are organised,” it said. But crypto’s place outside of the banking industry is a draw for investors in some economies – especially if they fear a collapse of the banking industry or appropriation of money by the government. Speculative tokens are created in a decentralised way – will they be willing to submit themselves to regulatory oversight? 

These issues may prove transitory. Cunliffe argued that the “initial use cases for the technologies developed in the crypto world, such as speculative crypto assets, may have a limited future”. He pointed out the valuation and revenue generation from early online firms was highly speculative – and collapsed. But the technology did not go away; it re-emerged in the form of the platforms that now dominate commerce. Will the crypto winter see the decline of speculative tokens and the rise of smarter crypto technology-driven payment methods? 

Cunliffe made the case that good regulation was in everyone’s interests: after all, a succession of crashes will do little to help the wider adoption of crypto technologies. Yet we are still grappling with how to regulate the internet 20 years on: the balance between regulation and innovation is always a particularly difficult one to strike.