The evolving regulation of crypto-currencies and crypto-assets

The news that footballer, Lionel Messi’s financial package at French soccer club Paris Saint-Germain includes crypto fan tokens has caused a stir in the business and banking world. Although Bitcoin has been circulating in the world’s monetary system for over a decade, when it comes to regulation, governments remain in the frontier days of digital cryptocurrency. However, news of Mr Messi’s part payment in crypto tokens demonstrates that the pressure is on for regulators to achieve oversight over cryptocurrencies.

Large banks such as Goldman Sachs and the Bank of England want to enter into this developing and ever more important financial opportunity. Central banks around the world are busily looking to implement their own crypto-currencies (referred to as Central Bank Digital Currency – CBDC), to create monetary and financial control and stability. It is likely that shortly there will be a significant increase in CBDCs. However, this will require overall market regulation so global financial market assimilation can be achieved. Furthermore, recent developments such as ‘stablecoins’ must be understood and regulated to ensure the long-term stability of financial markets. In this article, we examine the tasks faced by regulators in controlling cryptocurrency and how global regulation may be achieved.

Current cryptocurrency regulation

Cryptocurrencies have developed at the edge of the traditional monetary system; therefore, many regulatory controls that apply to the regular financial system, such as anti-money laundering regulations were not or could not be implemented. Blockchain, by its very nature, is designed to promote data integrity and provide a permanent, unchangeable history of financial transactions. However, the blockchain model and its global span also mean that central governments and regulatory bodies are unable to exert fundamental control over cryptocurrencies.

There is concern coming from the world’s central banks and treasuries that digital currencies being used to finance or engage in criminal activities. US Treasury Secretary Janet Yellen has said that cryptocurrencies are “mainly for illicit financing, and I think we really need to examine ways in which we can curtail their use”. The biggest threat comes from countries that do not have a stable government and regulated banking systems. Without these, it can be almost impossible to thwart financial crime and compensate victims.

Another key concern for central banks and governments is the wild instability of cryptocurrencies, especially given that in many cases, instances of volatility are not connected to any particular event.

The above challenges beg the question – how can cryptocurrencies be adequately regulated?

Regulating cryptocurrencies

Every country faces the challenge of being able to effectively regulate cryptocurrencies. The Basel Committee on Banking Supervision (BCBS), which describes itself as the “primary global standard-setter for the prudential regulation of banks”, began a consultation in Autumn 2021 on the ‘Prudential treatment of crypto-asset exposures”. The consultation paper states, “The Committee is of the view that the growth of crypto-assets and related services has the potential to raise financial stability concerns and increase risks faced by banks. Certain crypto-assets have exhibited a high degree of volatility and could present risks for banks as exposures increase, including liquidity risk; credit risk; market risk; operational risk (including fraud and cyber risks); money laundering / terrorist financing risk; and legal and reputation risks…. To that end, the Committee has taken steps to address these risks”. The BCBS has set out principles that it believes cryptocurrency regulation should be founded on. These include:

  • Consistency – if a crypto-asset has the same economic function and risks as a traditional asset, the same capital and liquidity requirements should apply.
  • Simplicity –regulatory models should be uncomplicated and flexible enough to evolve.
  • Minimum standards –allow countries to increase or decrease regulatory control as required, but implement by Convention that a minimum standard must be maintained.

Incorporating the regulation of cryptocurrencies and assets into an already highly regulated banking system will be a challenge. Some crypto exchanges have already applied for banking licences (e.g. Xapo and Kraken), which is both hastening the demand for regulatory change and illustrating the risks cryptocurrencies impose on the existing financial system. Governments may have to push crypto exchanges into the existing banking system, for example, using them as financial clearinghouses to exert regulatory control.

Final words

The Bank of England recently released a discussion paper on regulatory control over cryptocurrencies and assets. However, with so many stakeholders involved, regulations, especially those on a level that requires some form of international agreement, are unlikely to present themselves any time soon. As developments occur, I will ensure to update you.

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