Beware the Dangers of Crypto Regulation | Tech News

Beware the Dangers of Crypto Regulation

With so many unknowns and the risks of contagion mostly contained, the best policy right now is caution.

| Updated on: Jan 04 2023, 10:29 IST
FTX has not created systemic financial risk, which should be the main concern of regulators. (Bloomberg)

The collapse of FTX and the charges against Sam Bankman-Fried have brought many renewed calls for crypto regulation, from both commentators and legislators. That is precisely why this is a time for caution. No matter how strong the temptation, we should not overregulate.

Begin with two central facts. First, there are numerous ways for small and large investors to lose their money, including by investing in risky equities. Regulating crypto won't end that danger. Second, despite being one of the largest financial frauds in history, FTX has not created systemic financial risk, which should be the main concern of regulators. And market forces already have made the risk from crypto much smaller: At the peak of crypto values in late 2021, crypto assets had a total value of about $2 trillion; as of this writing, that figure is about $845 billion.

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Still, that second factor — the possibility of crypto risk and the fear that it will become increasingly intertwined with the mainstream banking system — keeps regulators up at night. At this point, however, it is highly unlikely that many banks or commercial lenders are seeking more integration with potentially leveraged crypto exchanges.

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Crypto regulation is not easy to do well. If crypto institutions are treated like regular depository institutions, requiring heavy layers of capital and lots of legal staffing, crypto innovation is likely to dwindle. Such innovation has been more the province of eccentric geniuses than of mainstream regulated institutions. It is hard to imagine Satoshi Nakamoto or Vitalik Buterin at Goldman Sachs.

And what exactly should be the goal of crypto regulation? To make stablecoins truly stable in nominal value? Is that even possible? Or to encourage market participants to see those assets as inherently fluctuating in value?

Neither academic research nor market experience offers clear answers. With systemic risk currently low, perhaps it is better to wait and learn more before moving ahead with regulation. And on a purely practical level, very few members of Congressional (or their staff members) have a good working knowledge of crypto and all of its current wrinkles and innovations.

Hyun Song Shin, the head of research and the Bank of International Settlements, is sure that crypto innovations have not panned out and that it not necessary to worry about loss of value from stricter crypto regulation. Yet a primary use case for crypto is to get capital out of China, Russia, Venezuela and other financially repressive countries. That is one reason for the US to support rather than undercut the current crypto ecosystem.

More generally, it's hard to argue that crypto innovation is over. What about crypto as a means of owning and trading one's online data? Or as a means of affirming one's online identity? How about lower-cost remittances made using crypto? Who has the knowledge to conclude that current attempts to build out DAOs — Decentralized Autonomous Organizations — are going to fail? The point is that no regulators or commentators have the knowledge to understand which of these projects is going to succeed or fail.

Think of quantum mechanics in the early 20th century, when it seemed to have few real-world applications. It wasn't until the middle part of the century that it became an essential idea behind computers.

I am not arguing, by the way, for zero regulation of crypto. I am merely saying that a hurried bipartisan move against crypto, following a highly visible public event with an identifiable villain, would be a mistake.

I am reminded of the Enron debacle and the resulting Sarbanes-Oxley legislation, passed in 2002. Fraud had been committed, and emotions were high. The bill passed with widespread support from both parties, but it included too many regulatory burdens and higher compliance costs. The number of publicly traded companies declined, and it became harder for smaller investors to earn high returns from new ventures. And the law did not offer much protection from the 2008-2009 financial crisis.

It would be nice if there were a simple way to give more regulatory clarity to the crypto market, as many crypto participants themselves desire. But without further market evolution, there isn't. For now, the best option is to tie our hands to the mast and hang on.

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First Published Date: 04 Jan, 10:08 IST