Growing calls for bitcoin, other cryptos to be regulated

After the crypto crash, the industry wants governments to confer legitimacy on digital currencies whose enthusiasts originally boasted of being outside the system. For some operators, the alternative could be bleak.

Regulators largely ignored digital assets after bitcoin was introduced a decade ago, but last year’s 1 400% rally made them pay attention, with reactions in different jurisdictions ranging from courtship of a nascent industry to outright hostility. However, this year, some digital currencies have plunged as much as 90%.

A growing crowd of crypto entrepreneurs from San Francisco to Singapore say the market, estimated at US$200-billion, must shed its image as a lawless underworld and become a regulated asset class, like stocks and bonds, for professional investors. To become a staple for pension funds and asset managers, the industry will need to be regulated, a future that many in the market are lobbying for.

“The most powerful force to reverse such negative sentiment would be market regulation,” said Daniel Santos, a former Standard Chartered banker who’s starting a Singapore-based ratings company for digital assets. “If the crypto market is ever to establish itself as a credible alternative asset class, it will need a set of rules that will weed out fraudulent activity and encourage stable growth, which should attract the deep pockets of institutional investors.”

Santos’s company, Digital Asset Rating Agency, aims to assuage fund managers leery of investing in so-called utility and security tokens by grading issuers’ business models, management and compliance.

The idea of a version of S&P or Moody’s stamping their approval on digital assets shows how far crypto has come from the anarchic days of the original die-hards. But those ideological days are over, says Ryan Zagone of San Francisco-based Ripple Labs, who urges a focus on consumer protection, anti-money laundering and risk management. His firm, which holds about 60% of the currency XRP, is among those lobbying US lawmakers.

‘A betrayal’

“Regulation is in fact a betrayal of the origins of bitcoin, which was built around anonymity and skirting government oversight,” said Zagone, the digital money transfer company’s director of regulatory relations. “This philosophy is unrealistic and immature.”

An established crypto player who says regulation can’t come soon enough is Obi Nwosu, who plans to cut jobs at the London bitcoin exchange he runs — Coinfloor, which says it’s the UK’s oldest. He has been asking the Financial Conduct Authority to regulate Coinfloor and the broader industry since 2013.

“Institutional players bring large volumes as well as liquidity and credibility,” Nwosu said. That will “make other people that don’t necessarily have the resources to do due diligence on crypto, and have read some negative headlines, say ‘if its okay for these guys, maybe it’s okay for me’”.

While he has yet to persuade the FCA, Nwosu said he’s encouraged by UK policy makers’ recent statements. Chancellor of the Exchequer Philip Hammond said earlier this month that he wants Britain to lead global efforts to design a regulatory approach to crypto assets and distributed ledger technology. In the meantime, Coinfloor this month won approval to operate in the British overseas territory of Gibraltar, an offshore hub that has sought crypto firms. That could facilitate business with institutions that are prohibited from trading with unregulated entities.

The clamour for big government to step in shows just how immature the crash-chastened market still is, said Kyle Asman, co-founder of crypto advisory firm BX3 Capital.

“If you heard someone from a bank asking for more regulation, you would think you were reading a headline from The Onion,” said New York-based Asman, referring to the satirical news website. “But people don’t have confidence that crypto markets are not manipulated.”

New York’s attorney-general warned last month that the industry has largely failed to adopt serious measures to detect suspicious trading. US authorities have taken a hard line on market manipulation, with the justice department opening a probe into suspected illegal practices. One piece of good news for crypto bulls came from the Securities and Exchange Commission, which has said neither bitcoin nor ethereum are subject to federal securities rules.

More enthusiastic jurisdictions include Switzerland, which has encouraged the creation of “crypto valley” in the canton of Zug. The Swiss have extended regulatory recognition to former UBS Group banker Jan Brzezek and a unit of his crypto start-up, putting him on an equal standing as a fund manager to his counterparts in traditional assets. Brzezek, though, says crypto needs to spread quickly to the financial industry’s established players.

Counterparty risk

“If you come from institutional finance, there is no way you would ever trade with or store your cryptos or your clients’ with a small start-up, because of the counterparty risk,” said Brzezek, co-founder of Zug-based Crypto Finance.

In Asia, Hong Kong regulators recently said they’re considering experimenting with different approaches to crypto. Japan has welcomed digital currencies, but China has issued an outright ban on exchanges and initial coin offerings. In between is Singapore, where regulators said this month that they’re willing to help cryptocurrency firms set up local bank accounts, but don’t plan to loosen rules to lure more start-ups. Tony Mackay, the former chief of exchanges Chi-X Europe and Chi-X Global, is building a crypto exchange in the city-state.

A big name who is betting that crypto is ready for regulatory prime time is former hedge funder Michael Novogratz, who says big institutional money could turn the crypto price drop around, possibly in the first half of 2019. Most digital asset firms are already operating to standards equivalent to those in stock or currency markets, while waiting for greater clarity from regulators, he said last week on Bloomberg Television.

Some observers with experience of the compliance world are taking a jaded view of the rush to be regulated. Authorities should look first to see how existing rules protecting investors can apply, rather than creating an untested new framework from scratch as some crypto professionals might prefer, said Eoin O’Shea, a former compliance chief at Credit Suisse Group who now runs Temple Grange Partners, a consultancy.

“An industry that thrives on the idea that it’s selling something unique would be foolish not to look to commercially benefit from regulatory action,” he said.  — Reported by Alastair Marsh, (c) 2018 Bloomberg LP