Regulated Cryptocurrency – An Oxymoron?

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Robert Kay

Last month HM Treasury announced that the UK Government would “set out ambitious plans to robustly regulate crypto asset activities – providing confidence and clarity to consumers and businesses alike.” To which the interested industry observer and the UK taxpayer might reasonably raise two questions. Firstly, are crypto asset activities actually capable of being regulated by purely national regulators? Secondly, even if regulation is possible, is it actually worth all the trouble, expense and risk?

In response to the first question, a recent note from the IMF highlights just some of the practical problems involved. As they recognize. “The crypto world is evolving rapidly. Regulators are struggling to acquire the talent and learn the skills to keep pace given stretched resources and many other priorities. Monitoring crypto markets is difficult because data is patchy, and regulators find it tricky to keep tabs on thousands of actors who may not be subject to typical disclosure or reporting requirements.” The IMF recommends, as one might expect, a globally coordinated approach. However, more practically they do note that, “entities operating in financial markets are typically authorized to undertake specified activities under specified conditions and defined scope. But the associated governance, prudence, and fiduciary responsibilities do not easily carry over to participants, who may be hard to identify because of the underlying technology or who may sometimes play a casual or voluntary role in the system.” That is a warning that prospective regulators and politicians who enjoy being associated with the glamour of the ‘next new thing’ should take very seriously.

Even in an apparently straightforward activity such as financial promotion, the industry could involve a social media influencer based in the US, creating a promotional video for an asset that is traded on an exchange in the Cayman Islands, which video is placed on a platform run by a Chinese company that is delivered on a server in Singapore or Ireland and is seen by a putative ‘investor’ in the UK. Identifying such videos – before or after the fact of investment – is arguably the least of the problems. If investors lose money, whether by fraud or incompetence, how can responsibility be determined among the different actors and can any of them be held accountable. Once a financial regulator says it is regulating an activity, the public expects certain protections to exist and to be compensated to some extent if those protections fail.

If compensation is made possible by charging all market participants, that will simply move the business to the environments that charge least, or indeed explicitly offer ‘investors’ no protection whatsoever. If the participants do not pay, in the event of a major problem, it is likely that tax payers will be asked to cover losses. Baling out individuals who fell for ‘get rich quick’ schemes promoted by ‘foreign celebrities’ may be a step too far for UK taxpayers, simply because the UK chose to establish some world-first regulatory regimes in, for example, crypto lending.

Given the complexity and risk involved, one might wonder why politicians and regulators are so keen to do anything. The following quote may provide part of the answer, at least in the case of the UK Government. Economic Secretary to the Treasury, Andrew Griffith, was quoted in the HM Treasury report as follows:

“We remain steadfast in our commitment to grow the economy and enable technological change and innovation – and this includes crypto asset technology. But we must also protect consumers who are embracing this new technology - ensuring robust, transparent, and fair standards.”

Under plans set out by the UK government, it states that it will seek to regulate a broad suite of crypto asset activities, consistent with its approach to traditional finance. This reflects concerns that the strong position enjoyed by the UK in so called FinTech activities is under threat post-Brexit and needs to be supported. Ironically despite being apparently about coins, tokens and other expressions of money and finance, crypto assets and technology are poorly suited to the high value, high volume, fast trading, data driven financial activity at which London excels. Quite simply transactions authenticated, proved and recorded by the new ledger technology are too slow and expensive to provide any benefit to those key strengths of the City of London market activities.

In addition, UK politicians might take note of the following comment from the IMF concerning other externalities associated with the crypto asset world. “In addition to developing a framework that can regulate both actors and activities in the crypto ecosystem, national authorities may also have to take a position on how the underlying technology used to create crypto assets stacks up against other public policy objectives—as is the case with the enormous energy intensity of ‘mining’ certain types of crypto assets.”

In summary there are reasonable differences of opinion as to whether, either in their current or some future form, crypto asset businesses and their underlying technology, will be sustained over the long run or seen as merely one of the many price bubbles that resulted from 15 years of ultra-low interest rates. Whatever the outcome, the desire to regulate by any single national authority appears fraught with especial difficulty and a range of known and as yet unknown risks. For the UK to seek to take on such a burden simply to protect its reputation for innovation in finance appears doubly strange as the main areas of commercial value of the technology identified to date, are authentication of supply chains, limited edition art works and copyright. There are many other real-world problems that would benefit from the best technology brains being applied to them. The UK also has a strong position in gaming and medical technology. Does the UK really want or need to encourage our best technologists to go into crypto assets?

April 2023