Almost every day we hear of a new shiny set of crypto coins or protocol listed on your friendly crypto exchange and inevitably thrust into the ‘mainstream’. I suspect this is going to continue well into the future. The concepts the prop up these assets, are still novel and in their infancy (10 years on), and are developing at an incredible pace. The value of crypto assets, especially Bitcoin and Ether is increasing and gaining legitimacy, and this attracts people’s attention to this area. Somewhat of a self fulfilling process. But there is a sting in the ‘tale’, pun intended.
The rapid development of the crypto markets have created a real headache for regulators around the world. Even impacting the IMF see Paraguay. Regulators, it is clear, do not yet fully understand the utility and risks of the crypto ecosystem. Various geographies have started working together to understand the nature of crypto assets and address issues fully but they are too slow to respond to the rapid development taking place at this time. Most of the development is done in a decentralised way when the regulators are working using centralised principles.
In July 2021, the UK’s Financial Conduct Authority (FCA) completed its work on categorising crypto assets. Regulators in European jurisdictions continue to work with a similar approach. Some European jurisdictions have started investing in FinTech companies and adopted a “FinTech friendly” approach in their countries. The US is yet to catch on in real terms with its very archaic regulation and unfriendly approach to crypto innovation. The mainstream media is also not helping this cause either, publishing every crypto failure at the earliest opportunity.
What is cleat is that regulators must create opportunities for the industry to grow while trying to protect investors and consumers. Finding a balance between the two has many challenges. How to allow innovation in decentralised finance to take place but at the same time protect the consumer from themselves? In crypto transactions, there is no back button, once a deal is executed its done and in some cases its gone if you are wrong. The average consumer needs some protection but not at the expense of progress.
One of the biggest challenges for regulators is to classify existing cryptocurrencies correctly, think of tax classifications. Crypto assets have emerged as a direct result of recent digital technological advances, and their purpose is to provide new possibilities for barter, investment, and financial transactions. The source of the problem when arranging crypto-assets is the hybrid and transformative inherent in cryptos. This, market developments, and the rapid pace of innovation make regulators’ approaches difficult and make room for some gaps.
It is difficult for a comprehensive and standard classification to emerge in the market because some differ on crypto’s utility. i.e. store of value like gold or means of transactions, like cash? The approach used when considering these issues is to compare crypto assets with traditional currency. The European Parliament has done research on this issue and, as a result, has revealed that crypto assets are not yet accepted as a general payment instrument. Some crypto assets are fighting this with changes to their scalability and protocols that allow for rapid transfers of value just like VISA and MasterCard. We are talking more than 10,000 transactions per second if crypto is going to compete with cash and not to mention the user experience that comes with it. Did I mention we are only 10 years in? How long did it take VISA, certainly longer.
Crypto commentators think cryptocurrencies represent an entirely new asset class. This classification may be correct for tokens that function like securities, cash and a store of value. Generally, the research in this space suggests that crypto assets are defined as an investment as having other benefits apart from or in addition to their value. This is most certainly true when considering the cross boarder, censor-less nature of these assets.
Taxation can more clearly be defined once the regulators and legislators are able to agree on the correct classification of crypto assets, but until then we are sitting in a capital recognition and gains tax wasteland – more clarity is most certainly needed which can only come from the correct classification.
A real peril this market is facing is also over-regulation. The rapid rise in the value of assets like Ether has radically democratised the fundraising abilities of beginners. This demonstrates the need for a specially designed set of regulations to allow cash-strapped small companies to raise funds from a wide variety of funders in a decentralised way. This introduces a side step in the process of raising capital away from institutions and subsequently their exorbitant fees that charge for this service.
What’s next for Crypto Assets?
Despite intervention from governments and regulators, cryptocurrencies continue to rise which is a signal that they are gaining legitimacy and a real world use case. This uncontrolled rise from the ground-up poses a problem for some institutions and regulators around the world. Uncertainty from regulators limits the types of investors who seek cryptocurrencies as sophisticated investors understandibly need the diligence and comfort from a controlling body. The problem is that there is no one controlling body in the crypto markets with whom the regulators can interact. Way more creative and market driven solutions are needed to regulate the market appropriately. These solutions require playing good cop and developing effective self imposed regulations through coordination between government and industry to reduce fake crypto assets, ponzi schemes and the almost weekly rug pull events that take place through new exchanges and DeFi protocols.
Looking forward, I can only reiterate that crypto will be seen as an legitimate alternative investment asset class. As the assets’ value continue to rise, the investors and entrepreneurs who pursue them will continue their existence. Regulators have a very critical task here. This task is to ensure security and reduce uncertainty without disrupting the market system. How are they to do this if the tools they have do not match the paradigm upon which crypto was built?