• Mon. Jul 22nd, 2024

What Are the Effects of Self-Regulation on the Crypto Industry?

The drama on Capitol Hill, the SEC, and its many contradictory actions.

Then we have the 2024 U.S. presidential hopefuls.


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In the background institutions such as the Bank for International Settlements (BIS) and International Monetary Fund (IMF) are jostling for attention in the crypto arena.

These and more, are some of the issues the crypto regulatory landscape faces.

Self-regulation has become an “escape” route for the industry as everything descends into chaos and volatility.

What are the effects of self-regulation on the industry?


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How do these activities affect outcomes?

Are there any possible exits outside the regulatory quagmire?

Our team of experts has provided insights, thought leadership, and more.

C’est la vie…

Christopher Alexander, Chief Analytics Officer of Pioneer Development Group

“The SEC’s disastrous regime of regulation by enforcement has forced the blockchain industry to self-regulate in hopes of avoiding these ridiculous ex-post facto prosecutions where an action that was perfectly legal in 2019 is suddenly considered a violation.

This is problematic for a number of reasons. The first is the stifling of innovation. For our firm, instead of focusing entirely on our mission of developing blockchain technology to promote free and open societies in the future, we are spending time predicting what random SEC action could be taken against us or guessing what the SEC chairman actually means when he gives evasive or nonsensical answers when testifying under oath before Congress.

The second issue is consumer confidence. Some firms may be overly invasive in the collection of consumer data, or may refuse to provide services at the faintest trigger of a fraud detection algorithm out of a fear of ham-fisted SEC or other US government agencies actions. This perpetuates the myth that crypto is some sort of “scam.”

Lastly, the SEC and the other government agencies’ refusal to govern that forces self-regulation disproportionately hurts communities of color. These communities use crypto and blockchain services at a greater rate than white people, so self-regulation often closes down pathways that minority communities rely on, most notably the estimated 30 million or so unbanked.”

Related: What are the Best Compliance Practices for the Crypto Space? (Round Table Interview)

 

Mriganka Pattnaik, CEO at Merkle Science

“The cryptocurrency industry has long been plagued by spectacular corporate scandals. One recent example is the implosion of FTX, which collapsed due to various shenanigans, such as self-dealing between its executives and sister company Alamada Research, that would have been surely prevented by existing safeguards in traditional finance. These incidents of course create distrust in users of the wider cryptocurrency industry.

Self-regulation is helpful because it will help restore some of the trust that has been lost in scandals like FTX, signaling to customers, investors, and other stakeholders that the industry is serious about establishing clear policies for conduct. In addition to this positive messaging, a self-regulatory organization (SRO) could address the current regulatory gap for digital assets that are not securities, which falls beyond the current scope of both the SEC and the CFTC. As Howell Jackson and Timothy Massad have theorized, these two entities could set up an SRO that sets policies on “protection and custody of consumer assets, governance standards, conflicts of interest, financial resources, including capital and margin, risk management procedures, fraud prevention and more.”

In some cases, an SRO may be the most practical option, especially for use cases and applications on the cutting-edge. Take, for instance, the example of coin mixers. Lacking expertise in this technology, most governments would jump to outright banning them, which undermines even the legitimate uses of these tools. An industry-driven push to self-regulate coin mixers could more easily strike the middle ground between preventing criminal uses of the technology, while still allowing for privacy-centric use cases. Who can better understand technology, after all, than a technologist?

By taking this proactive approach through self-regulation, industry stakeholders can create a harbinger for formal governmental regulation. Self-regulation will provide government authorities with a benchmark, putting industry leaders in a position to shape the direction of official policies.
In some cases, self-regulation may even serve as an official bridge or transition to any newly created, official regime. Due to these many benefits of self-regulation, I don’t see it being anything other than a net positive for cryptocurrency adoption: When consumers and enterprises see that the industry is taking steps to professionalize the field with tighter regulations, more people will inevitably want to participate in a sandbox where their interests are finally protected.

The cryptocurrency industry has long been plagued by spectacular corporate scandals. One recent example is the implosion of FTX, which collapsed due to various shenanigans, such as self-dealing between its executives and sister company Alamada Research, that would have been surely prevented by existing safeguards in traditional finance. These incidents of course create distrust in users of the wider cryptocurrency industry.

Self-regulation is helpful because it will help restore some of the trust that has been lost in scandals like FTX, signaling to customers, investors, and other stakeholders that the industry is serious about establishing clear policies for conduct. In addition to this positive messaging, a self-regulatory organization (SRO) could address the current regulatory gap for digital assets that are not securities, which falls beyond the current scope of both the SEC and the CFTC. As Howell Jackson and Timothy Massad have theorized, these two entities could set up an SRO that sets policies on “protection and custody of consumer assets, governance standards, conflicts of interest, financial resources, including capital and margin, risk management procedures, fraud prevention and more.”

In some cases, an SRO may be the most practical option, especially for use cases and applications on the cutting-edge. Take, for instance, the example of coin mixers. Lacking expertise in this technology, most governments would jump to outright banning them, which undermines even the legitimate uses of these tools. An industry-driven push to self-regulate coin mixers could more easily strike the middle ground between preventing criminal uses of the technology, while still allowing for privacy-centric use cases. Who can better understand technology, after all, than a technologist?

By taking this proactive approach through self-regulation, industry stakeholders can create a harbinger for formal governmental regulation. Self-regulation will provide government authorities with a benchmark, putting industry leaders in a position to shape the direction of official policies.
In some cases, self-regulation may even serve as an official bridge or transition to any newly created, official regime. Due to these many benefits of self-regulation, I don’t see it being anything other than a net positive for cryptocurrency adoption: When consumers and enterprises see that the industry is taking steps to professionalize the field with tighter regulations, more people will inevitably want to participate in a sandbox where their interests are finally protected.

Pan Lorattawut, CEO at VUCA Digital, Chief Business Development Officer at T&B Media Global

“The intensity and friendliness of government regulatory efforts are different over time and among nations. The regulator seeks to monitor, or even control, or eliminate the financial stability risks posed by crypto. However, heavily regulating or banning crypto does not always mean customer protection.

Implementing self-regulatory efforts on crypto requires sufficient investor education and protection. To become a 100% self-regulation, it remains important to consider factors like an effective implementation of anti-money laundering or combating the financing of terrorism.

Some Web3 users prefer to stay anonymous; the KYC and AML procedures have made them feel like it’s no longer secure for them. They are pro-self-regulatory since they trust the systems rather than the government or other individuals. But when bad incidents on a material scale occur, and the nation’s macroeconomics is at risk, it would be hard for the self-regulatory framework to be fully implemented.

The right balance of government regulation and self-regulation should facilitate the development of the technology, encourage innovation, and support greater adoption of crypto businesses and digital assets.”

 

Natalia Zakharova, Head of Operations at FXOpen

“The cryptocurrency industry is currently undergoing a significant change, largely driven by the sudden professionalism of some of the larger companies that offer solely cryptocurrency trading or exchange services.

The newer generation of traders in traditional instruments is made up of a relatively substantial proportion of people who entered the world of trading via cryptocurrency and are used to very intuitive platforms from some of the larger firms. Because of this synergy, it is now clear to mainstream financial regulators, such as ESMA in Europe, that actual regulation by such financial markets regulatory authorities is necessary, so the MiCA regulation is almost ready to be rolled out.

Therefore, self-regulation is perhaps superfluous because very soon, cryptocurrency markets may well become regulated by other regulators globally, if they follow the lead set by ESMA. Self-regulation was trialled in the FX and CFD industry, but ultimately the vast majority of brokers are regulated by well-recognised regulatory authorities, and therefore the cryptocurrency business may well follow a similar path.”

About FXOpen:
FXOpen is a global forex and CFD broker, founded in 2005 by a group of traders determined to make trading easy, secure and accessible to all. Now a highly established ECN broker offering trading on over 600 markets, with spreads from 0.0 pips, the company has a network of worldwide offices with brokerages in London, Cyprus, and Australia regulated by the FCA, CySEC, and ASIC respectively.

 

Cuautemoc Weber, Co-Founder and CEO at Gateway.fm

“In response to the glacial pace of crypto regulatory framework implementation, self-regulatory initiatives have emerged as a proactive approach by the industry to address concerns and promote responsible practices. Self-regulatory bodies, such as the Crypto Council for Innovation (CCI) and the Blockchain Association, work to establish industry standards, best practices, and specific codes of conduct. These standards can help instill confidence in consumers, investors, and businesses, driving greater adoption.

I have long felt that blockchain has an inherent complexity problem, but by offering easily accessible information explaining how transactions work, security measures, and the benefits of decentralization, customers can get a better sense of the benefits that come with engaging with this technology.

By proactively addressing issues like security, fraud prevention, and consumer protection, self-regulation fosters trust within the community, and crypto firms should always aim to uphold the highest standards of security to build trust with prospective consumers. This involves implementing multi-factor authentication, cold storage for digital assets, and regular security audits. By communicating these measures clearly, crypto firms can reassure consumers about the safety of their investments.

By adopting these kinds of strategies, crypto firms can foster trust and confidence among industry participants while maintaining transparency and regulatory compliance. However, self-regulation shouldn’t be viewed as a potential substitute for proper and clear government oversight. Rather, it should complement robust regulatory frameworks, striking the right balance between self-regulation and government.”

 

Nikita Buzov, CEO & Founder of Solace

“Self-regulation is often very helpful to all parties involved. Users can benefit from a more standardized approach to product development and/or offering. The industry shares the experience and responsibility amongst each other on a particular matter, all while providing more guidance to the regulator. Furthermore, that regulatory body now has better clarity and support from the industry and may further improve some adopted standards. One example of self-regulation is the adoption of external open-source security audits by DeFi protocols that helps improve security of all of DeFi. This has allowed the users to feel more secure and comfortable, continuously driving adoption to new highs.”

 

Tim Zinin, the Founder of Botanica School

“The blockchain space is a whole different beast compared to traditional markets, so the players’ interests aren’t represented by some fancy associations or any other conglomerate of corporations. It’s like the Wild West, where every blockchain sets its own rules, and it’s all about the survival of the fittest and the smartest. It’s self-regulated by two things: the consensus built into the blockchain and the rep of an individual or a group. It’s the essence and the real genius of the technology where trust is scarce, and the code is the law.

Just like that, all it takes is a few slip-ups for a founder to lose a chunk of users. Any attempts at self-regulation in this industry are basically just shooting the breeze, especially by corporate lawyers. However, I disagree with the notion that lawyers are just slackers. They play a crucial role in bridging the crypto space with the realm of governments. Essentially, they’re programming and compiling the game rules set in natural language. So, lawyers would be better off focusing on interfacing with the world outside of blockchain projects.”

Peter Eberle, President at Castle Funds

“Government regulatory efforts in the cryptospace have been slow and unwieldy. This is an ever-changing process. I need expert quotes and thought leadership on self-regulatory efforts and what the impact is on adoption.

In the US, we see three major unresolved questions that regulators are working on:
Financial Crime, including sanctions, anti-money-laundering, counter-terrorist-financing, and general fraud;
Investor Protection, including financial disclosures, conflicts of interest, and manipulation of the digital asset markets; and
Taxation of digital asset transactions, including treatment of staking income and reporting of sales proceeds from digital asset transactions.

We see the financial crime compliance impact as the biggest barrier to institutional adoption, as the uncertainty over these obligations results in large shifts in the digital asset markets. We saw this earlier in 2023 with the US traditional banking system changing its attitudes towards digital asset intermediaries following the voluntary winding down of Silvergate Bank’s operations and the seizure of Signature Bank of New York by state regulators. The establishment of best practices in the financial crime area continues to be a barrier to institutional adoption, and the Blockchain Association, among others, is seeking to educate legislators and regulators on the industry’s preparedness to assist.

Investor protection mandates, on the other hand, are more likely to drive legislative action. The SEC has a clear investor protection mandate, which has led some advocacy groups to assume that the SEC will have primary responsibility for the regulation of the digital asset markets. However, we refer to the example of the CFTC’s responsibility for retail foreign exchange trading, which extended the CFTC’s regulatory mandate to retail investor protection as well. Ultimately, Congress will need to provide some legislative mandate (with associated supportive funding) to the regulators in order to clarify the situation.

Finally, we believe that the reporting of digital asset transactions to tax authorities, rather than the taxation decision itself, is the largest barrier to adoption for institutional investors. These requirements would include compliance with international data-sharing agreements in place with more than 150 countries under the OECD/G20 agreements. Compliance with these reporting standards requires the identification of natural persons owning or controlling a digital asset wallet, which is a substantial burden in the digital asset markets. These requirements, generically described as “KYC” or “Know Your Client,” are unclear, and market participants desiring anonymity in their holdings or transactions may see providers with looser KYC requirements as having a competitive advantage.”

 

Alex Rawitz, Co-Founder at DIMO

“Self-Regulatory Organizations (SROs) in the crypto industry serve dual functions. To the average consumer, the concept of an SRO might be nebulous, but these organizations are crucial in liaising with governmental bodies to develop more nuanced and appropriate regulations, particularly for emerging technologies that are still in regulatory limbo.

What makes SROs especially valuable in the crypto sector is their potential to legitimize the industry in the eyes of established financial institutions. For instance, earlier this week, Chase Bank in the UK announced they would be flagging, and potentially blocking, transactions from customer accounts to crypto exchanges and companies. This decision in particular underscores the caution most traditional banks exercise when dealing with an industry that lacks clear regulatory guidance.

The ultimate impact of SROs on adoption is less about individual consumers and more about the broader financial ecosystem. If credible SROs can emerge in the crypto space, they can significantly reduce the industry’s risk profile. In turn, this could pave the way for traditional financial institutions to more openly engage with crypto businesses. As these traditional institutions come on board, consumer confidence would likely increase, not because consumers are specifically looking for self-regulation, but because they trust traditional financial entities that are now willing to interact with the self-regulated crypto industry.”

 

Richard Gardner, CEO at Modulus

“Government regulators have had an uneven response to crypto. Some have embraced it, while others have banned it. Some have moved quickly, while others have adopted a wait-and-see approach. Some have reversed course and some have even reversed course time and again. The global regulatory community has not come up with a complete and universal approach to crypto. That has, in many cases, left the industry to self-regulate as it awaits further, comprehensive instructions. Self-regulation is something that helps build brands rather than build industries. Being known as the company that puts security first helps to make your brand synonymous with honesty and trustworthiness. It gives you exposure as a thought leader. And, perhaps most importantly, it keeps you out of regulators’ crosshairs. However, it still leaves a very new industry on its own. Sure, some companies will follow the leader’s approach to self-regulation in the spirit of competition. However, that allows bad actors to seek out the firms that are not operating on the up-and-up. For the industry to fully live up to its potential, the world’s major governmental powers need to come to the table and lead the rest. It requires a great deal of resources, not to mention political fortitude, to find the right balance to regulate digital assets competently. As we see more and more major players do just that, the industry will find itself getting safer and less volatile. I think that 2024 will bring just that kind of oversight – oversight for which the industry has yearned for quite some time.”

 

Related: What are the Implications of Capitol Hill’s Crypto Regulatory Efforts? (Roundtable Interview)

 

 


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Kevin Moore - E-Crypto News Editor

Kevin Moore - E-Crypto News Editor

Kevin Moore is the main author and editor for E-Crypto News.