(AF) From a regulatory standpoint, cryptocurrencies have come a long way from the wild wild West of the early 2010s.
A strong driving force has been the soaring demand for bitcoin. Its price – just under US$40,000 at the time of writing – has risen more than three times compared with a year ago, and more than 80 times compared with five years ago. Even after accounting for the correction in recent weeks, cryptocurrencies are an asset class worth over US$1 trillion today.
Pioneers of the bitcoin world have never worried much about regulation.
Invented in the aftermath of the Global Financial Crisis of 2008, cryptocurrencies were, indeed, designed to bypass central banks and governments, in part due to fears that the financial system as we knew it might one day collapse – not a far-fetched idea in the heart-stopping days of 2008.
Bitcoin is a decentralised currency by the people and for the people, one that will continue to exist as long as the Internet remains standing, the early adopters strongly believe.
But central banks were not going to simply allow themselves to be circumvented by a new global currency that might one day replace the fiat currencies they issue. They have a three-fold mission to safeguard the traditional financial system, to protect vulnerable investors and consumers, and to prevent financial crime, including money laundering. Bitcoin and other cryptocurrencies threaten to undermine each of these three goals.
How regulators are expanding oversight
Efforts to introduce rules and laws that govern the cryptocurrency market are therefore being ramped up in many countries, with the pace quickening as bitcoin prices rallied over the past year and more investors wanted a slice of the action.
Among the questions central banks have to grapple with as they deliberate over the appropriate level of regulatory oversight are: Is a crypto token a commodity or a property – or even a security? Can businesses accept bitcoin as payment for goods and services?
Can banks and other regulated financial institutions facilitate direct transactions in bitcoin? What about indirect transactions – say, in investment products that provide an exposure to cryptocurrencies? How should crypto exchanges be regulated to prevent money laundering or scams?
Last week, on May 20, the US Treasury Department announced that cryptocurrency transfers worth $10,000 or more will soon have to be reported to the US tax authority – another piece in the regulatory jigsaw that is becoming clearer and more complete over time.
As regulators mark out the boundaries of this emerging asset and how individuals and institutions should interact with it – a process that will take time, given the complexity of cryptocurrencies – some bitcoin investors have not extended a warm welcome to these regulations.
Analysts sometimes note the “regulatory risk” with investing in bitcoin – that is, the tendency of bitcoin prices to fall each time a new regulation is unveiled, to the chagrin of existing bitcoin holders.
Why investors should ultimately embrace regulated crypto investing
For most individual investors who are not experts in either cryptocurrencies or the blockchain technology that makes these digital assets possible, and who may not have time to research the many players competing for market share in the bitcoin space, increased regulation should be embraced like an old friend who appears in the midst of a treacherous and unfamiliar journey. Why?
Regulations bring cryptocurrencies into the mainstream of the financial system. They reduce the likelihood of bad behaviour and contribute to the confidence that banks and regulated financial institutions need to begin offering products to customers.
Citing rising demand among their wealth clients, Citi and JP Morgan are now looking to give their clients the chance to invest in cryptocurrency-related opportunities. JP Morgan wants to offer clients an actively-managed bitcoin fund. Citi is mulling over the possibility of cryptocurrency trading, custody and financing.
Non-bank financial institutions, such as security exchanges and brokerages, are also rolling out products, including bitcoin trackers, which are funds that track the performance of bitcoin.
For individual investors, adding bitcoin to their portfolios via a regulated financial institution can represent a safe shortcut to crypto investing.
These financial institutions face rigorous ongoing scrutiny from their respective central bank or national regulator on whether their systems are operationally sound and secure, whether their management team has a track record of financial probity, and whether they have done sufficient due diligence on the partners they work with, including their cryptocurrency partners.
Regulation forms a basis of trust, in the absence of which non-experienced and non-expert cryptocurrency investors have little to go on. They might otherwise have to rely on word of mouth and put their money with the cryptocurrency exchange that has the most customers or assets under management. That can be quite a risky strategy, as was demonstrated when the founder of Turkish cryptocurrency exchange Thodex reportedly went missing with as much as US$2 billion of his customers’ assets.
As monetary authorities worldwide start to bring various facets of the cryptocurrency market into their regulatory regimes, more investors will feel more comfortable introducing bitcoin to their wealth portfolios.
In the first phase of this transition, their investments might be done through regulated financial institutions that build partnerships with crypto players, after carrying out thorough checks on those partners. In the next phase, the crypto players might themselves be able to obtain regulatory approvals in some jurisdictions – which would be an obvious sign that the market is maturing.
Think of your investment portfolio as a box.
In this analogy, you grow your wealth by putting more precious stones into the box over time. But regulations are also needed because they ensure the box is made of sturdy, reliable material.
After all, if the bottom of the box falls out, the rubies, sapphires and emeralds you have painstakingly stored up may well roll down a byway and disappear into obscurity.
Investors who take on cryptocurrencies want to see fast growth. Regulations can ensure the growth happens with greater assurance as well.
# Oi Yee Choo, Chief Commercial Officer of digital securities exchange ADDX.