Why regulators need to crack down on crypto

Yet with so many people nursing big losses from the FTX collapse, the crypto dramas of 2022 will have a lasting effect, because they confirmed once and for all that the asset class is simply too big for regulators to ignore.

The Bank for International Settlements (BIS), a central bankers’ club that is sceptical about cryptos, explained this reality in a paper this month. The BIS worries that as investors big and small continue to trade crytpo assets, they are becoming intertwined with other financial markets, creating the risk of contagion next time there’s a meltdown.

The other big reason for regulating crypto is to protect investors, some of whom may not fully appreciate the risks of putting their money asset that is notoriously volatile and prone to scams.

“Crypto asset markets have gone through booms and busts before, and so far, the busts have not led to wider contagion threatening financial stability. Yet the scale and prominence of recent failures heighten the urgency of addressing these risks before crypto markets become systemic,” it says.

The other big reason for regulating crypto is to protect investors, some of whom may not fully appreciate the risks of putting their money asset that is notoriously volatile and prone to scams.

The Commonwealth Bank, which has delayed its plans to offer crypto trading on its app, told Treasury it thought Australians had put $20 billion into crypto assets in 2021. It said crypto scam losses – which Choice estimated were $129 million in 2021 – were likely to multiply.

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“Some investing in crypto assets may not fully understand the nature of risks to which they are exposed, and may assume that regulation governs commercial activity in the sector to guarantee minimum standards in cases where it does not,” CBA told Treasury in a submission released last month.

So, financial stability and investor protection are probably the most compelling reasons for crypto regulation. But if these digital assets are so risky to investors and the financial system, why not go further, and restrict access or even ban cryptos, as China has done?

The BIS explores these possibilities, but it says an outright ban would be extreme and difficult to enforce, because the trading would simply move to more friendly jurisdictions.

Banning cryptos would also raise the risk of missing out on any useful innovation that emerged from cryptocurrency – such as more efficient overseas payments, “smart contracts” and the like.

The BIS says regulators could also try to contain crypto trading, so it is a fringe activity separate from the rest of the financial system. It says this approach would avoid giving crypto a regulatory “seal of approval”, but it might also be tricky to implement, especially if there was strong demand for trading.

So, the most pragmatic option seems to be regulation: introducing some basic standards and minimum protections for investors, while allowing innovation to occur.

This appears to be the path we are on. The Australian Securities and Investments Commission (ASIC) has strongly backed crypto regulation, and taken action against a handful of crypto firms it thinks breached existing rules.

Financial Services Minister Stephen Jones has committed to consulting on the framework for a custody and licensing regime for crypto assets this year, including “mapping” the various crypto assets it wants to regulate, before introducing legislation.

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There has been some debate over what form the 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 including ASIC and banks have backed regulating cryptos as financial products, and this looks the most likely outcome.

Of course, regulating privately issued digital currencies will throw up complications. For one, it goes against the libertarian philosophy of some in the crypto world, who set out to create a type of money outside the control of banks and governments.

More practically, there’s a risk that regulating cryptos will give an implicit endorsement to high-risk assets that may ultimately see their value fall to zero.

But the bottom line is that crypto’s popularity means it is becoming more closely intertwined with the traditional financial world. It makes sense to take precautions for the next time there’s a big crypto bust.

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