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  • Writer's pictureRichelle Khor

Beyond the crypto winter: A new regulatory direction


Cryptocurrency's spectacular collapse in 2022, marked by the failure of Terra's UST stablecoin, the bankruptcy of Celsius Network, and the FTX scandal, dealt a blow to public confidence. However, the rise of blockchain technology and asset tokenization, including NFTs and the Metaverse, has created an intricate crypto economy with venture capital firms, hedge funds, bitcoin "whales", and mainstream investors. This article investigates the involvement of governments and financial institutions in regulating cryptocurrency, arguing that a more robust regulatory framework is needed to restore public confidence in the technology.

The spectacular meltdown of the cryptocurrency industry was undoubtedly one of the major financial catastrophes in 2022. Starting from the failure of Terra’s algorithmic stablecoin UST that led many to question the sustainability of the Luna ecosystem, followed by the bankruptcy of Celsius Network, the eroding public confidence towards the fintech fairy tale took the final blow from the FTX scandal. Bankman-Fried had his cat out of the bag in November 2022, when it was reported that the value of his hedge fund, Alameda Research, was composed of a crypto token manufactured by FTX itself. Binance promptly dodged the bullet by calling off the takeover, and Voyager’s fate was left more uncertain than ever. Although the mastermind was arrested in the Bahamas, the large-scale breach of fiduciary duty sent a wave of disastrous repercussions across the industry. The average value of cryptocurrency transactions per day fell from $131 billion in May to $57 billion in December, and Bitcoin's value plummeted by 65%. It appeared that the crypto bubble had popped, and a desolate crypto winter had dawned upon the once flourishing market.

Explaining the genesis of cryptocurrency is no easy feat. The idea that monetary transactions could take place without involving financial institutions came about in 2008, when the Lehman Brothers bankruptcy contributed to public distrust of financial systems. Believing that money is a form of state monopoly, the first cryptocurrency, Bitcoin, functioned independently of banks and governments and facilitated public access to the distributed ledgers. Bitcoin was gaining favour in the ideological battle, and this was demonstrated by the steady growth in its prices in the early 2010s. Cointelegraph reported that Microsoft accepted Bitcoin for payments, and it subsequently made its phenomenal debut in The Economist. It was not until 2014 when the crypto universe was made more sophisticated as blockchain technology took over the central platform. Ethereum unlocked the next phase of development by employing blockchain as its central feature, which allows users to write applications and make money from their work; Etherium’s Initial Coin Offering (ICO) raised $18 million. In 2018, the price of Ethereum reached a record-breaking high (600 times higher than its initial launch price), and Bitcoin’s price surged more than 1000% before falling off by 80% in the same year. As asset tokenisation, in the form of NFT’s, and the Metaverse further expanded the domain of cryptocurrency, we see an intricate crypto economy with venture capital firms, hedge funds, mysterious bitcoin "whales'', and mainstream investors as the active players in the field.

Paradoxically, cryptocurrency has been subsumed into the system it was meant to overthrow. The crypto community today is no longer the original community of blockchain technology aficionados and true believers of Satoshi Nakamoto's ideology. Governments and financial institutions desire to tap into the lucrative prospects and rein the speculative investment that has materialised into a new class of assets. Even before the eruption of the FTX saga, governments around the world have been anxious about being blindsided by private companies. For instance, following the high-profile lawsuit against Ripple for allegedly raising more than $1.3 billion in unregistered securities transactions, the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) proposed a framework that suggests the creation of a U.S. central bank digital currency. This would effectively diffuse public authorities' scrutiny into digital exchanges. Other countries have pursued broadly similar but nuanced regulatory trajectories. The U.K. requires all crypto exchanges to register with the U.K. Financial Conduct Authority (FCA), and capital gains tax is imposed on crypto trading profits. On the other hand, while long-term capital gains are not taxed in Singapore, the country taxes companies that frequently make cryptocurrency transactions. The Monetary Authority of Singapore (MAS) also issued guidelines prohibiting Digital Payment Token (DPT) service providers from promoting their services to the public. Measures against anti-money laundering and terrorism financing are also incorporated, such as the EU's fifth Anti-Money Laundering Directive (5AMLD) that encapsulates exchange services providers within its regulatory parameter and confers Financial Intelligence Units (FIU) unfettered access to information.

What can be gleaned from the FTX fiasco? What can we learn from the unravelling of crypto assets? It appears that like financial institutions, crypto exchanges are not immune to market contamination, and users in fact have limited visibility of the exchanges taking place on the trading platforms. Bankman-Fried's fraudulent orchestration set off a destructive avalanche across the crypto industry, resulting in the capital of several companies being locked on FTX, namely Galois Capital, BlockFi, and Multicoin Capital. The incessant call for more robust regulatory oversight demonstrates that state authorities ultimately command higher confidence from the public, which should lead us to question: why bother retaining such a volatile currency when the system is haemorrhaging public trust? This article argues that the loopholes of financial misconducts could be remedied by more stringent regulatory measures, and it should not be conflated with the functioning of the digital currency. The original landscape of cryptocurrency is permanently modified, after years of incremental developments, it has become an indispensable part of the future of money. The intention of bypassing financial middlemen might have constituted its foundation, but what sustains its demand is the sense of self-custody given to the holders of the private key. Often described as a digital gold, its supply being capped by mathematical algorithms make it a reliable, inflation-proof store of value.

Getting through the crypto winter will entail restoring the public confidence with a more robust and innovative regulatory framework. At present, cryptocurrency exchange service providers must be answerable to the registration and licensing requirements, anti-money laundering and counter-terrorism financing programmes, and other forms of due diligence mandated by central authorities. The focus is then to identify what to make out of the FTX fiasco - should state authorities broaden the scope of regulation under the existing legal framework? Or is the scandal a striking indication of regulatory incompetence, and the pragmatic response would be to allow self-regulating organisations (SRO) to take over? The latter proposition is appealing in a sense that the financial industry collectively has greater domain expertise than regulators. In fact, it is not an entirely fresh concept. In 2018, Gemini put forward a proposal for the Virtual Community Association (VCA), which aimed to foster financially responsible practices in the virtual commodity markets through industry-approved standards. Later in the same year, ten blockchain and fintech firms launched the Association for Digital Assets Market (ADAM), which sought to establish a uniform code of conduct for the industry. The Global Digital Asset and Cryptocurrency Association marks the first organisation with an international orientation, headquartered in Chicago.

In the coming digital era, self-regulation is likely to have a stronger presence in the regulatory sphere. Anything more than the existing legal framework would burden the crypto industry with compliance costs and red tape that might be adversarial to innovation. As opposed to inadequately funded regulators, SROs are better positioned to spearhead the new regulatory direction as it tends to be more efficient in addressing industry-specific issues, given their expertise. Instead of a one size fits all approach, more focused scrutiny would ensure that regulation is fit for purpose and simultaneously adaptable to changing market conditions. Separate and specific regulations could be developed for different types of cryptocurrencies, such as privacy coins, smart contracts, and settlement networks. Free from political agendas, SROs possess more appetite for global collaboration in introducing regulations that balance public protection and the investors’ interests. SROs could serve as the connective tissue that lobby and interact with governments and regulators. Beyond the U.S., countries have begun to resonate with the idea. For instance, CryptoUK was established by seven British cryptocurrency companies to promote a higher standard of conduct and facilitate the swift maturing of the digital assets. The Korean Blockchain Association is committed to enhancing the competitiveness of the crypto industry while protecting customer profits. A revitalised crypto ecosystem would see SROs being the frontrunners of regulation.

What goes up will come down sometime, not to mention the tendency of cryptocurrency to fluctuate rapidly. Demand and supply mechanisms have drastic effects on the market, which make it susceptible to exuberant booms and panic-induced busts. The presence of the aforementioned crypto whales is also something to be wary of in the speculative market. In December 2021, the price of the Shiba Inu meme coin surged as an Ethereum crypto whale single-handedly scooped up 4 billion coins. Lou Kerner, the CEO of Blockchain Coinvestors Acquisition Corp., perceived the market crunch as a convulsion in the technology’s lurch towards the future. Certain institutional players remain bullish in their stride: Blackrock announced in early January that it is adding bitcoin as an eligible investment to its Global Allocation Fund worth $15 billion. The world’s largest asset manager had previously entered a partnership with Boston fintech startup Circle to explore capital market applications for its stablecoin. The regulatory crackdown in the FTX fiasco is likely to bring about a new regulatory direction that empowers the roles of SROs. Institutions grounded on fiduciary ethos would be able to uphold market integrity while navigating through the crypto winter.

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