Yet with so many people suffering big losses from the FTX collapse, the crypto dramas of 2022 will have a lasting impact because they confirmed once and for all that the asset class is just too big for regulators to recognize could ignore.
The Bank for International Settlements (BIS), a central bankers’ club skeptical about cryptos, explained this reality in a paper this month. The BIS fears that investors large and small who continue to trade cryptocurrencies will intertwine with other financial markets and create risk of contagion in the next collapse.
The other major reason crypto is regulated is to protect investors, some of whom may not fully appreciate the risks when investing their money, which is notoriously volatile and prone to fraud.
“Crypto asset markets have seen booms and busts before, and so far the crises have not resulted in a major contagion that threatens financial stability. However, the scale and significance of the recent outages heighten the urgency of addressing these risks before crypto markets become systemic,” it reads.
The other major reason crypto is regulated is to protect investors, some of whom may not fully appreciate the risks when investing their money, which is notoriously volatile and prone to fraud.
The Commonwealth Bank, which has delayed plans to offer crypto trading through its app, has told the Treasury it believes Australians will have invested $20 billion in crypto assets in 2021. She said losses from crypto scams — which Choice estimated at $129 million for 2021 — are likely to multiply.
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“Some investments in crypto assets may not fully understand the nature of the risks they face and can expect that doing business in this sector will be regulated to ensure minimum standards if this is not the case,” CBA said in a published note to the Treasury Department last month.
Therefore, financial stability and investor protection are probably the most compelling reasons for crypto regulation. But if these digital assets are so risky for investors and the financial system, why not go further and limit access or even ban cryptos like China has done?
The BIS is exploring these possibilities but says an outright ban would be extreme and difficult to enforce, as trade would simply shift to friendlier jurisdictions.
Banning cryptos would also increase the risk of missing out on useful innovations that have emerged from cryptocurrency — like more efficient cross-border payments, “smart contracts,” and the like.
The BIS says regulators may also seek to rein in crypto trading, making it a fringe activity separate from the rest of the financial system. It says this approach would avoid giving crypto a regulatory “stamp,” but it could also be difficult to implement, especially when there is strong demand for trading.
Another crypto meltdown is all but inevitable.Credit:`
So the most pragmatic option seems to be regulation: putting in place some basic standards and minimum protections for investors while allowing innovation.
This seems to be the path we are on. The Australian Securities and Investments Commission (ASIC) has strongly supported crypto regulation, taking action against a handful of crypto firms it says have broken existing rules.
Finance Services Secretary Stephen Jones has pledged to discuss the framework for a crypto-asset custody and licensing regime this year, including “mapping” the various crypto-assets it wants to regulate before introducing legislation.
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There has been some debate as to what form regulation should take: should the government create a new licensing regime just for crypto firms, or bring crypto firms into existing financial services regulation?
Powerful players like ASIC and banks have supported the regulation of cryptos as financial products and this seems the most likely outcome.
Of course, the regulation of privately issued digital currencies will lead to complications. For one, it goes against the libertarian philosophy of some in the crypto world, who have set out to create a form of money outside the control of banks and governments.
More practically, there is a risk that regulation of cryptos will implicitly support high-risk assets whose value could eventually drop to zero.
But the bottom line is that crypto’s popularity means it’s becoming increasingly intertwined with traditional finance. It makes sense to take precautions for the next time there is a major crypto bust.
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