Three musketeers prompt regulatory reckoning for crypto assets
Cryptocurrencies need stricter regulation, but it needs to be done right.
US regulators are dethroning crypto CEOs these days, like Napoleon in full military campaign mode. First to go was Arthur Hayes, CEO of BitMex, in late 2020. At the time, BitMex was the place to be for any crypto trader, offering bitcoin derivatives with 100x leverage. “By wilfully failing to establish, implement, and maintain an adequate anti-money-laundering programme,” Mr Hayes found himself facing up to 10 years imprisonment, but got away with two years on probation.
Not bad, considering how vocal he had been on the matter. When asked how the financial regulators in the US compared to those in the Seychelles, where BitMex was registered, he proclaimed that “it just costs more to bribe them”, claiming to have paid only “a coconut” in bribes to the Seychelles’ regulator.
As fate caught up with Mr Hayes, it marked the end of an era for BitMex, which lost its market dominance as bitcoin exploded into a bull run. Traders sought sanctuary elsewhere. FTX, with a certain Sam Bankman-Fried at the rudder, sailed up as the new, tidier option.
With heavier regulations, the doors are now open for financial institutions to enter the market, bringing renewed trust and deep pockets
With the alternatives of investing on homeless exchanges thrown out of China, FTX seemed a safer bet. It obviously was not, and regulators could not turn a blind eye to a scam of this magnitude. Arguably the biggest meltdown in crypto history, a title contested only by Terra and Mt. Gox, FTX has entered a crowded graveyard.
And it’s getting even more crowded. Changpeng Zhao, CEO of Binance, is now looking for a plot for his mausoleum, after pleading guilty to violating money laundering and sanctions laws.
With Binance hosting the lion’s share of crypto trading volume, headlines claim the exchange’s downfall could prove the end for crypto. But the truth is rather the opposite. With heavier regulations, the doors are now open for financial institutions to enter the market, bringing renewed trust and deep pockets. Expect spot ETFs, custody services and cryptocurrencies supported in investment products across the financial landscape.
Crucial distinction
The long list of misdemeanours, scams, and wilful circumvention of regulations has led to a consensus that crypto immediately needs stricter regulation. No arguing with that.
Note however, that neither BitMex, FTX nor Binance are truly crypto enterprises. They do not run business logic as smart contracts on open blockchains, giving users self-custody. They just allow trading of instruments that do.
It is uncertain if crypto regulation (the EU’s MiCA and DCCPA in the US) will recognise this crucial distinction between centralised companies offering services dealing with crypto assets, and the protocols that have these as built-in features. If they fail to recognise this, the digital transformation of finance will be stuck under one broad ‘analogue’ regulation.
Resilient financial infrastructure
By running self-executing code on a decentralised blockchain, financial transactions are possible without reliance on intermediaries. People with bundles of legal contracts and software running on siloed servers are thereby replaced.
This creates a resilient financial infrastructure that ensures the users’ right to economic participation, while removing power concentration, risk of corruption and unwanted human interventions in times of turmoil and distress. Actors can freely access the system and can be held accountable, due to full transparency of transactions and real-time auditability.
Regulators now need to be careful not to throw the baby out with the bath water
In contrast, the current system relies on the intermediaries to enforce sanctions, consumer protection, and money laundering controls, or else end up in jail. Therefore, access to the system is granted only to qualifying users once personal data is controlled, and consumer patterns are monitored.
However cumbersome, regulating the intermediaries is the only sensible way to regulate an analogue system. But how to regulate a system without intermediaries?
Do we imprison the developer who wrote the code for swapping tokens, for failing to implement AML restrictions? He’s not acting as an intermediary, so cannot be held responsible. Should enforcement be on the website that makes swaps user friendly? They can be bypassed easily. Regulating the miners? That would be the end.
Digitisation and design
Regulators now need to be careful not to throw the baby out with the bath water. Human intervention or centralisation simply cannot be added to an autonomous, decentralised system. One cannot simply override an immutable ledger.
No intervention also means no compliance fail-safes, scary as it may seem. But the alternative, relying on people forever, is even scarier.
Terrorist financing, money laundering and consumer protection regulations will have to be digitised and redesigned. For the better. Blunt sanctions and excluding civilians from global finance are currently not considered human rights violations. Adding friction to the economy is not considered bad policy-making. We have a chance to change that. It is time to take a step back and assess which vices are compliant, and which virtues are criminal.
The blockchain can be the killer app for financial regulators, we just need to figure out how.
Oskar Åslund is head of business development at AKJ
