From thriving systems of barter, to 11th century marauding monks cashing in IOUs, to the emergence of the Gold Standard, global systems of economic exchange have undergone many transformations. The crumbling of the Gold Standard in the 1970s marked a tumultuous transition onto the current fiat system. Regulation, or lack of, is connected to each of these stages in the evolution of finance – it’s an essential step on the journey to legitimacy and widespread adoption. 

Asset classes – including equities, securities, cash, and real estate – have been subject to waves of regulation. The US Securities Act of 1933, for example, was introduced following the 1929 stock market crash, and promised new transparency and fraud protection. As a brand-new asset class, crypto is set to follow this well-trodden trajectory.

This time it is different 

The crypto market is prone to cycles, but the most recent boom and bust has captured the attention of regulators like never before.

The digital asset boom of late 2021 saw an unprecedented number of investors getting involved — not only retail investors, but also many institutional investors. By the end of 2021, crypto investment managers had $62.5 billion in assets under management, with Bitcoin products attracting sizable investments. “It has become too large for regulators to ignore now,” says one director at a European digital asset investment firm.

The crash of early 2022 caught out investors who did not fully understand the market, the products or the risks. “I do not think sophisticated investors were the ones who were ultimately hurt,” says Adam Goldberg, co-founder of venture capital firm Standard Crypto, pointing to uninformed retail investors as the main victims. 

New research from Matrixport, and produced by FT Longitude, the specialist research and content marketing division of the Financial Times Group, into the attitudes of high-net-worth investors towards digital assets found that risk of fraud (20 per cent), cybersecurity risks (16 per cent) and market volatility (13 per cent) are the top three barriers to digital asset investment. Coupled with the recent implosion of stablecoin projects and the unscrupulous behaviour of some crypto companies in this cycle, there appears a renewed appetite for safety nets, i.e., regulation. 

What will regulation look like?

Countries around the world are taking steps to begin to regulate the cryptocurrency market. In key markets, there’s a strong appetite for new rules to shape the future of the industry.

At the top of regulators’ lists is likely to be consumer protection legislation, involving transparency disclosures from crypto companies. It will also aim to reduce liquidation risk, systemic risk and counterparty risk. “One of the biggest challenges in the last cycle was leverage that was completely opaque to users,” says Goldberg. Ultimately, the market downturn unwound that leverage and “resulted in a large loss of user funds”.

Another question for regulators is whether to regulate digital assets as commodities or securities. There are some calls to class coins as commodities and non-fungible tokens (NFTs) as securities, and discussion about whether crypto exchanges should be forced to register as securities exchanges is under way in the US. The outcome is likely to affect other jurisdictions. 

Regulation creates a virtuous circle

In the long term, regulation is vital to ensure that crypto keeps growing. The Private Wealth in Digital Assets Study 2022 research indicates:

• 44 per cent said that global regulatory change is increasing their appetite to invest, and this rises to 60 per cent of the most experienced investors. 
• 39 per cent of the least experienced digital asset investors say that internationally coordinated regulation would encourage them to start investing more. 

Institutional investors, meanwhile, are keen to invest more, but they want a more stable market and reassurance from regulators. The current market, “prolongs the view among many investors that crypto is just too volatile — that it is still an immature asset class,” says Manpreet Gill, Chief Investment Officer, AMEE, Standard Chartered Wealth Management at Standard Chartered Bank.

Regulation could help trigger a virtuous circle whereby more institutional investment leads to greater stability in markets, which in turn attracts more retail investors and helps to preserve the long-term stability and value of the market. For example, Hong Kong’s Financial Services and Treasury Bureau issued a policy statement on virtual assets at Hong Kong FinTech Week in October, saying that Hong Kong reconsiders its stance on virtual asset ETFs, tokenized securities, and retail investors. 

As major financial hubs continue to explore stablecoin regulations to infuse better guardrails and mitigate future shocks following the Terra Luna crash, business confidence will follow, says Pavel Matveev, CEO of Wirex. “Once we have rules, we will see more adoption coming from banks and other enterprises.”