Can effective regulation make cryptoassets and stablecoins useful?
This was the question posed to a panel I was part of at a Bank of England research conference last month. The answer is in the question. Had the question been ‘can regulation, rather than ‘effective’ regulation make cryptoassets and stablecoins useful’? – then I think the answer would have been yes or no – depending on the detail. But as it was – can effective regulation make crypto assets and stablecoins useful? – then I think the answer has to be yes.
Not that this is an easy task. The government and regulators are faced with the challenge of balancing innovation and stability, while safeguarding consumers and the wider financial system.
The panel itself was delicately balanced with two ex-lawyers (myself and Julia Black, LSE and Bank of England) and two ex-investment bankers (Garrick Hileman, Visiting Fellow, LSE and Cambridge, Head of Research, previously of blockchain.com and Cecilia Skingsley, Head of Innovation at the Bank for International Settlements). Our respective approaches also offered a useful balance of perspectives.
We were all careful to distinguish between what was meant by ‘cryptoassets’ and ‘stablecoins’ – whether we meant the technology – DLT and potential use cases – asset backed stablecoins or speculative cryptoassets – which is undoubtably the high-risk area for consumers, governments, and regulators.
Julia pointed out that, from the regulators point of view, regulating this market could lead to what’s known as the halo effect and that comes with massive reputational risk. She suggested that the regulators always receive the downside risk and politicians always claim the upside risk.
Whilst I might not accept quite such a cynical view of politicians, I have to agree to the extent that this is exactly why I believe we need an independent, well-resourced, and effective regulator – and why I have tabled amendments to the Financial Services and Markets Bill in an effort to achieve just this.
Thinking beyond the risk to the approach we delved into first principles, asking what the regulatory goals and values are for these products, what our cognitive framework is for understanding them and what organisational structures, behaviours, regulatory tools and levels of trust or legitimacy we have when dealing with them.
The goals and values are largely the same as for traditional financial markets (AML, counter terror, fraud, consumer protection, financial stability, systemic issues) although we may be on less solid ground with the cognitive framework we have for understanding them. It was refreshing to hear Julia speak of the humility required by regulators – and I would say all of us – in thinking about this.
If an asset-backed stablecoin looks like a money market fund does this help or hinder our understanding and approach in terms of regulatory solutions? We have to interrogate our characterisations of these markets so that we can be aware of related biases or assumptions.
Just as we had pointed out the similarities in the regulatory goals and values, we see the same negative pathologies as any financial markets: pump and dump, market abuse, failures of governance, insider trading.
In trad fi, the line between gambling and investment has been established over time and precedence. We are at the early stages of regulating crypto and as the impact (on the economy and people) grows we will reach the end of our risk tolerance and require state intervention.
There are 20,000 crypto assets – a large number of which will be scams but a small number of which will be the next Bitcoin or Ethereum. Is caveat emptor sufficient for this scale of risk? In Belgium, the regulator is insisting that crypto ads carry the message ‘the only guarantee in crypto is risk.’ But what of the opportunity and potential for growth and innovation? This brings us right back to the need to balance innovation, stability, and consumer protection. Regulation can and should have a facilitation role as well.
The distinction between stablecoin and cryptoassets is important – it is worth remembering that the Financial Services and Markets Bill covers only asset backed stablecoins. Julia argued that ultimately “if you are going to make a claim about a stablecoin – that you are going to redeem this at part, that it’s going to be a store of value as well as a unit of account or a means of payment – then you need to be able to come good that on that claim. Here is a role for the regulator.”
Considering the ‘art of the possible’ – how will regulators manage this with distributed systems? Will we be able to use code as a regulatory tool, in terms of code as architecture?
We considered how other jurisdictions are approaching this puzzle and Garrick reminded us that Hong Kong has just announced they will be exploring formal authorisation of large digital asset trading by retail investors – what he described as turning Hong Kong into a “financial Petrie dish”.
London has been a successful financial centre for hundreds of years, to the envy of many other places, I believe we need to manage the risk but that the safest and best way of developing the right regulatory environment is by keeping crypto onshore. Cecilia emphasized the need for international coordination on stablecoin regulation, given their potential to operate across borders.
We also addressed potential use cases. We must always ask: Can we do something that we couldn’t do with what already had? Can we do something better with the new technology? There is a potential £15 trillion to be saved in cross border payments. It was good to hear from Cecilia at the BIS about their projects applying this technology to improve liquidity through automated market makers (AMMS) as well as experiments in green finance.
I’m on the record as being incredibly positive about the infinite nature of potential use cases and was pleased to – again – be the rational optimist in the room. To answer the question set for the panel, yes, taking a collaborative and flexible approach to regulation and establishing effective regulation can help to unlock the potential of these technologies while safeguarding consumers and the stability of the financial system.