Will regulated cryptocurrency become the new fiat currency?

With the collapse of FTX in November 2022 bringing to the forefront the need for regulation in the crypto industry, both policymakers and the financial sector are left asking how a virtual asset, existing only on a borderless blockchain ledger, can be truly regulated.

The digital assets industry should open its arms to sensible regulations

Likewise, if crypto is designed to be inherently decentralised, how can it be regulated by central agencies? As with all emerging technologies and new financial instruments, we remain trapped between enabling innovation and protecting the public. Cryptocurrency, stablecoins, and NFTs went swiftly from being a fringe novelty to becoming widely adopted and intertwined with mainstream financial markets, presenting lawmakers with a problem they don’t fully understand.

With the disintegration of FTX, as well as the unprecedented decline of the Terra stablecoin, 2022 saw a series of hyper-profile events within the cryptocurrency market that demonstrated the immediate need for significant regulatory oversight. Rival interests are seeking to answer questions about what we want the fundamental nature of digital assets to be. Are they securities or commodities? Should cryptocurrencies, which have no physical token, behave like the US dollar and other fiat currencies? Will regulations put an end to crypto’s potential for unprecedented financial inclusion?

The present situation: crypto regulations

One of the most comprehensive cryptocurrency regulations to date, known as Markets in Crypto Assets (MiCA), promulgated by the European Union, is likely to take effect in 2024 and puts the EU at the epicentre of crypto regulations.

In October 2022, the UK’s House of Commons voted to recognise all cryptocurrencies as regulated financial instruments, introduced via an amendment to the Financial Services and Markets Bill (FSMB) — which still must pass the House of Lords.

Meanwhile, the US has opted to incorporate digital assets into existing financial regulatory frameworks and allow the states to regulate themselves. Comprehensive federal legislation will take years of deliberations, as bipartisan proposals to set up crypto standards at the federal level have been exercises in futility. The White House did however release the inaugural Comprehensive Framework for Responsible Development of Digital Assets in 2022, which serves as part of a much-needed awareness campaign to educate US lawmakers about the opportunities and threats of digital assets.

What are the ramifications for the consumer?

With the collapse of FTX, one of the world’s largest crypto exchanges, we can see a major issue present itself within an unregulated market. Investors in the stock market are protected by intermediary actors like brokers and exchanges, whereas collapses in the largely unregulated crypto market can allow billions of dollars to disintegrate. A fully operational MiCA can prevent this from occurring, according to an official from the European Commission’s financial stability unit. A properly regulated crypto market would afford consumers protection. Crypto firms and exchanges would be required to have controls and accurate disclosures and reporting standards, and also separate the customer’s assets from the institution’s own assets, to prevent what happened with FTX from occurring ever again.

Unregulated crypto markets and the consequences for the economy

Crypto exchanges going bankrupt and individual consumers losing their money are not the only consequence of an unregulated crypto market. There has been rapid growth within the digital asset market, with an estimated 46 million Americans now owning crypto. Legacy investment banks such as JPMorgan Chase, payment apps like PayPal, and credit card titans like Mastercard have all incorporated cryptocurrency into their services. We now exist in an age where cryptocurrencies are normalised and intertwined with other facets of the financial sector. We saw in 2008 how a poorly regulated subprime mortgage market decimated the global economy – an unregulated digital asset market collapse could have similar, or even worse, effects someday.

A fragmented regulatory landscape

For crypto to continue to innovate while also having strong regulations that protect the consumer, industry leaders, politicians, and policymakers must work together, rather than apart. The global and US regulatory landscapes are fragmented with a lack of cohesion and collaboration, causing a nightmare for compliance teams and a waterbed effect where people move around from country to country depending on the regulations.

This is not to say that there are no pro-innovation stances, as some jurisdictions have imposed commercially attractive regulatory stances, but others have pursued a more critical approach. At least 37 US states currently have varying levels of crypto regulatory standards on the books. Federal regulators like the SEC and the Commodity Futures Trading Commission are executing their own oversight against crypto-market participants, based on assumptions that certain digital assets fall under their jurisdictions.

The future of cryptocurrency and compliance

All of these inscrutable regulatory deliberations spell enormous complexity for corporate counsels and compliance leaders working in exchanges or other virtual asset service providers (VASPs). It is seemingly inevitable that the once-lawless crypto market will be regulated, and so compliance with these regulations is a necessity, and must be covered within a company’s policies. VASPs must also find precise, real-time methods to manage and mitigate regulatory risk, which is a decidedly moving target.

Now more than ever, compliance officers should be prioritising using the strongest regtech available to establish processes for identifying new and changing regulations, communications to all impacted parties, assessing the new or changed regulation against business processes, risk rating, the appropriate documentation and reporting, and mapping to business, products, and processes. Compliance professionals relying on paper-based, manual processes will likely leave their companies susceptible to penalisation. In a sink-or-swim scenario, the crypto exchanges that survive will be the ones that work proactively with regulatory agencies to manufacture a framework for the future success of crypto.

Regulated cryptocurrency – the newest fiat currency?

The existence of a regulated industry would not place cryptocurrencies on the same stage as other fiat currencies – i.e., real money. Many applications of tokenised assets on the blockchain have emerged, from speculative investing, NFTs, play-to-earn gaming, overseas money transfers, gold trading, fully pegged stablecoins (which act more like fiat currencies than most crypto), and merchant payments, among other things. Cryptocurrencies have brought millions of previously unbanked or underbanked people into the financial and economic system, especially in Latin America. Furthermore, many believe crypto will be the common method of exchange in Web3 and the metaverse. In many ways, the question is not about if regulated crypto will become another fiat currency, but rather if regulating the industry will dilute the essence of a decentralised and democratic currency.

Putting aside the benefit that crypto provides for inclusivity, what differentiates it from traditional fiat currency is the way it facilitates and makes transactions instant, as well as the increased liquidity it offers for certain investors. The digital assets industry should open its arms to sensible regulations. The existence of regulation is only a further demonstration that cryptocurrency is a legitimate and mainstream avenue for the financial sector. Further, volatility and instability do not benefit the industry’s long-term viability, it benefits only the criminals and fraudsters.