Chartbook #116: The end of crypto's "Wild West"? The battle to shape the future of digital assets in US-UK-EU.
Bitcoin has no reason to exist. It delivers no meaningful benefit for society. It is a form of gambling, propelled by naked greed and generating vast quantities of CO2 emissions.
This was the uncompromising and hostile position towards crypto taken on behalf of the ECB by Executive Board member Fabio Panetta in December 2021, a campaign which Panetta continues today.
I am looking forward very much to being in conversation with Panetta and my colleague Jan Svejnar tomorrow. Join us at the link below:
Panetta’s stance is the hard edge of what amounts to a global push to regulate the crypto currency business, a push which has gathered significant pace in recent months.
China has taken the lead by going a long way towards banning both the use of crypto as a means of payment and bitcoin mining. Egypt, Morocco, Algeria, Bolivia, Bangladesh and Nepal have followed China’s lead.
Countries that have restricted the ability of banks to deal with crypto-assets or prohibited their use for payment transactions include Nigeria, Namibia, Colombia, Ecuador, Saudi Arabia, Jordan, Turkey, Iran, Indonesia, Vietnam and Russia.
In the financial centers of the West, in EU, UK and US, regulators, politicians and lobbyists are jostling to decide what will be the rules of the game.
It seems that we have reached a turning point in the development of the industry. For many this is the end of the “Wild West” phase of crypto’s development. This may mean some restriction of commercial and technical freedom. Will that mean the beginning of the end? The withering away of a speculative bubble? Or will it have the effect of establishing crypto as a recognized part of the financial ecosystem?
What is forcing the debate is the scale of crypto’s growth.
As recently as 2019 the global Financial Stability Board took a look at the crypto industry and judged that it posed no serious risk. Weeks later Facebook launched its bid to establish a global currency - libra. That got regulators’ attention. It turned out it was important and the regulators did not like what they saw. Faced with a wall of official hostility, at the start of 2022 Facebook finally abandoned the project.
Libra failed, but today, whether for better or for worse there is a growing sense that the crypto industry as a whole - tokens like bitcoin and tether and the exchanges that service them - is too big and dynamic to ignore. Accounting for the size of the business is tricky. But according to the White House the market capitalization of cryptocurrencies was in the order of $3tn in November 2021, up from $14bn five years ago. 16 per cent of American adults have bought, used or traded cryptocurrencies.
This gives the industry significant commercial and political weight, enabling its lobbyists to claim that the crypto industry will be an important source of competitiveness and growth.
If China is shutting down, what kind of regime will emerge in the historic hub of North Atlantic finance between Wall Street the City of London and Europe?
In the US, SEC Chair Gary Gensler is, like Panetta, a critic of bitcoin. As WSJ reports. He has let it be known that he
doesn’t see much long-term viability for cryptocurrencies… Mr. Gensler likened the thousands of cryptocurrencies in existence to the so-called wildcat banking era that took hold in the U.S. from 1837 until 1863 in the absence of federal bank regulation. “I don’t think there’s long-term viability for five or six thousand private forms of money,” Mr. Gensler said … So in the meantime I think it’s worthwhile to have an investor-protection regime placed around this.”
Gensler has demanded that crypto trading and lending platforms should register with the SEC since otherwise they risk being found responsible for offering unregistered securities in violation of federal law.
Last September, the SEC put Coinbase - a cryptocurrency exchange with a market capitalisation of $41bn - on notice that it would be sued if Coinbase went ahead with plans to launch a new digital asset lending product. Coinbase soon abandoned hte idea.
In other measures, the SEC posted a new guideline recommending that crypto exchanges record the digital assets of customers on their balance sheets as assets and liabilities. Crypto companies must also disclose the “nature and amount of crypto assets” they are holding for customers.
Gensler is amongst the most important voices warning of the false promise of stability offered by so-called stablecoins like Tether. The two largest stablecoins, Tether and USD Coin, are now worth a combined $133bn. They have attracted increased scrutiny from regulators because it is unclear whether they can really offer the backing in dollars and Treasuries that they promise to their clientele. Were that clientele to lose confidence it would not simply inflict losses, as would be the case with bitcoin. In the case of stable coins it would unleash a chain reaction akin to a bank run. Unlike bitcoin, which has no “backing” other than its scarcity and is close to being a pure speculative asset, the promise of asset-backing makes stable coins into an extension of the shadow banking system.
Gensler is not alone in expressing concerns.
“Tether is a financial Chernobyl waiting to happen,” says one former US financial regulator. “It should never have been allowed to grow so big unchecked.”
As reported by the WSJ:
Acting Comptroller of the Currency Michael Hsu said … the crypto industry is on a path that resembles that of credit derivatives ahead of the 2008 financial crisis. He expressed doubt that cryptocurrency is achieving its goal of promoting financial inclusion and criticized crypto instruments that promise steady yields to investors for failing to explain how those returns are generated. “I have seen one fool’s gold rush from up close in the lead-up to the 2008 financial crisis,” Mr. Hsu said in remarks to the Blockchain Association, a crypto lobbying group. “It feels like we may be on the cusp of another with cryptocurrencies and decentralized finance.”
To attempt to claw back some measure of regulatory power, the SEC is expanding the meaning of “securities dealer” as it tries to set stricter accounting standards for crypto exchanges.
But in making this regulatory push, Gensler and his colleagues face an increasingly vociferous and bipartisan lobby.
So far this has been most effective at the state level. El Salvador gets all the headlines for its adoption of bitcoin as legal tender, but Colorado is set to become the first US state where you can pay taxes in bitcoin, which is tantamount to the same thing. Florida is bidding to become America’s crypto capital.
And in Congress as well, as this important FT report spells out, the “crypto caucus” has increasing influence.
A bipartisan mix of libertarians, business champions and tech utopians is uniting on legislation to help the sector grow.
They want to define clear boundaries to what a security is and what a broker is so as to ensure that regulators like Gensler cannot engage in “rulemaking by enforcement”.
as regulators such as Gensler try to apply existing investment rules to an entirely new type of asset, there is a growing sense in Congress that elected representatives must step in to clarify what is legal and what is not. The defenders of the industry are now coalescing around several pieces of crypto legislation that would help define what kind of an asset digital coins are, and what responsibilities their issuers and traders have to consumers and within the market.
The battle over the future status of crypto in the US was opened in earnest by the Executive Order issued on March 9 2022, by the White House on the “Responsible Development of Digital Assets”.
On the face of it this was “incremental”, containing instructions for government agencies to examine the industry and report back. The issues to be assessed include the familiar issues of “crypto concern” - financial stability, consumer protection, money laundering, sanctions-busting, equitable access, climate risks etc.. Indeed, the Executive Order could be taken as carte blanche for a major regulatory push.
But, in fact, it delighted crypto lobbyists. And with good reasons. What matters above all are the opening lines of the executive order:
Digital assets, including cryptocurrencies, have seen explosive growth in recent years, …. Surveys suggest that around 16 percent of adult Americans – approximately 40 million people – have invested in, traded, or used cryptocurrencies … The rise in digital assets creates an opportunity to reinforce American leadership in the global financial system and at the technological frontier, but also has substantial implications for consumer protection, financial stability, national security, and climate risk. The United States must maintain technological leadership in this rapidly growing space, supporting innovation while mitigating the risks for consumers, businesses, the broader financial system, and the climate. And, it must play a leading role in international engagement and global governance of digital assets consistent with democratic values and U.S. global competitiveness.
The vital point is that the Executive Order takes the scale and growth of the crypto industry as a given. Rather than putting the future of the business in question it asserts that America must maintain leadership in this space. This is the language that the crypto caucus is desperate to hear.
“The EO was incredibly important in that it talked about US leadership in this area,” says Ari Redbord, head of government affairs at TRM Labs, which uses blockchain to investigate crypto fraud. “We may be moving away from this position of saying we have to ban cryptocurrency, thinking maybe we need to lead in this space.”
The immediate impact of the Executive Order was to unleash a relief rally in bitcoin in the days that followed.
In the rhetoric of their advocates, digital assets are being aligned with the history of the internet itself. We are at a moment, we are told, analogous to that legendary moment in the 1990s when the Clinton administration set the parameters that defined the world wide web and America’s dominance in the platform business. Whether this makes sense or not, and it surely a gross exaggeration, such analogies serve to generate political momentum. As the FT reports in gushing tones:
If members can find agreement, this could prove to be as seminal a moment as the mid-1990s, when members of Congress passed legislation that was to set the rules of the road for the internet. Legislation such as the 1996 Communications Decency Act, for example, provided the legal framework, which allowed the likes of Google, Amazon and Facebook to conquer the world. Supporters of cryptocurrencies believe US companies could similarly come to dominate the world of digital assets, but only if they have clear rules under which to grow. “We are in a similar moment with cryptocurrencies to the one we were in 30 years ago in the early days of the internet,” says Wyden (Senator for Oregon).
Not coincidentally, at the same time as the Clinton administration was defining the legal parameters of the internet boom, it was also unleashing a wave of financial deregulation, which contributed to the growth of market-based finance and the crash of 2008. The congruence between neoliberal tech and financial deregulation in the 1990s is far too rarely noted. To highlight it, is one of the important contributions of Gary Gerstle’s new history of neoliberalism.
This has about it the hallmarks of an all-American story. But one of the motivations for action is foreign competition which supposedly threatens American’s leadership.
Likewise, in the 1990s one of the driving forces behind the deregulation of Wall Street was competition between New York and the City of London. It was the sprawling trans-Atlantic operations of American and European banks that defined the direction of financial modernization to which national regulation needed to bow.
Unsurprisingly, in 2022, on the other side of the Atlantic the debate about crypto in the UK is following a similar trajectory to that in the US.
The United Kingdom is far and away the leading driver of crypto activity in European finance. And stable coins are far more dominant in Europe than in the US.
As in the United states, in the UK there is a divergence between on the one hand officials within the Bank of England and regulators who regularly express concern about crypto risks and, on the other hand, a political lobby that adopts a more growth-centered approach.
The Bank of England has roundly declared that bitcoin could become worthless.
The Bank of England’s Prudential Regulation Authority is increasing its staff and its budget to deal with crypto risks. Its funding comes from a levy raised on the financial industry itself.
As in the US, the Financial Conduct Authority wants companies offering crypto products and services to apply for registration. So far over 100 firms have applied but only a minority have been granted licenses conditional on strict anti money laundering rules.
As in the United States, in the UK the main focus of attention is on stable coins.
The UK Treasury also released long-awaited plans to regulate issuers of stablecoins — crypto tokens intended to mirror the value of other assets such as US dollars. One of the Treasury’s proposals is to adapt existing laws that govern electronic money, such as funds stored on mobile phone apps, to cover stablecoins, bringing them under the purview of the Financial Conduct Authority. This would require stablecoin issuers to hold equal reserves of pounds sterling for the tokens issued, which could not be used for purposes such as lending. The moves on crypto policy follow clashes between the industry and the FCA around its licensing regime for money laundering controls, which some industry participants have said was pushing firms to move overseas.
On the other hand, under pressure from heavy lobbying, the UK government has loudly declares that it wants to see London develop into a crypto hub.
The UK Treasury recently made headlines when it asked the Royal Mint, the agency responsible for creating British currency, to mint an NFT.
“We want this country to be a global hub — the very best place in the world to start and scale crypto companies,” City Minister John Glen said. “If there is one message I want you to leave here today with, it is that the UK is open for business, open for crypto businesses.”
As the FT reported:
We see enormous potential in crypto,” Glen said. “We aren’t going to lower our standards, but we are going to sustain our technological neutral approach.” The minister added that the government would study the possibility of issuing government debt using distributed ledger technology.
Compared to the US, the crypto business is far less developed in the EU, but the regulatory debate actually began earlier and in a more systematic way. As this useful ING report summarizes the state of play as of the end of March 2022:
The European Commission launched its proposal for a Markets in Crypto Assets Regulation (MiCAR) back in September 2020. The European Parliament’s Economic and Monetary Affairs Committee adopted MiCAR with amendments on 14 March, and the regulation will now move to discussions among the European Commission, Parliament and Ministers of Finance (the so-called “trilogue”). Once they converge, MiCAR can be established. Of course at that point supervisors will need time to prepare the new regulatory regime and draft technical standards, explaining how they will interpret and apply concepts in MiCARs. Based on the European Council’s MiCAR draft, provisions on stablecoins would start to apply in early 2024, while other provisions would apply in early 2025.
The regulatory system started with a preoccupation with money laundering. It has now expanded to address issues of consumer protection and financial market stability. Once more stable coins are at the center of the discussion since it is the promises of stable value that they make to their users that pose the stability risks.
It is not certain how far the European regulations will actually apply to bitcoin, for the basic reason that regulations apply to the legal entity responsible for issuing digital assets and in the case of bitcoin and other decentralized financial networks there is no entity that meets that definition.
The entire logic of crypto assets is that ownership is verified not by a single institution but by algorithmic consensus. Not only is that legally vague. It is also computationally expensive. And on both scores bitcoin ran into difficulty in Europe.
In fact, in March of 2022 the main concern of the crypto lobby was that the European parliament would issue a de facto ban of bitcoin by outlawing the immensely energy intensive practice of bitcoin mining.
On March 14 2022, a crucial European Parliament committed debated a motion put by the Greens and Social Democrats to phase out “proof of work” protocols in the EU. But they did not find the votes to pass the ban. Led by Stefan Berger the conservative MEP serving as rapporteur a more permissive wording carried day. Rather than banning energy intensive algorithms, the parliament resolved to reward more energy efficient systems, like Ethereum by including them in the notorious EU taxonomy of “green” business practices. MEPs ask the Commission to present MEPs with a legislative proposal to include in the EU taxonomy (a classification system) for sustainable activities.
Berger insists that by shunting crypto regulation into the dog-fight that is the EU’s green taxonomy the issue stays alive. That was not the view taken by other members of the comittee.
“We are disappointed that the rapporteur did not keep his word, breached previous broadly accepted agreements and gave up, given external pressures, to defend the interests of a part of the crypto industry,” Green MEP Ernest Urtasun said in an emailed statement.
In any case, in light of energy costs in the EU it is hard to imagine that it will become the base for large-scale mining activity.
Rather than regulating energy use, what the EU’s new regulations require for crypto exchanges is a disclosure of those buying and selling digital assets. Crypto firms such as exchanges would have to obtain, hold, and submit information on those involved in transfers.
The industry has protested that this will stifle the industry. “This regulation harms crypto innovation without a commensurate anti-money laundering benefit,” Cameron Winklevoss, co-founder and president of Gemini, said in a statement emailed to Protocol. Coinbase CEO Brian Armstrong blasted the proposal as “anti-innovation, anti-privacy, and anti-law enforcement.” Coinbase Chief Policy Officer Faryar Shirzad warned it could mean recording and reporting transactions through self-hosted wallets “even if there is no reason to suspect wrongdoing.”
Stefan Berger (EPP, DE), the lead MEP and by no means an enemy of fintech, robustly defended the compromise:
"By adopting the MiCA report, the European Parliament has paved the way for an innovation-friendly crypto-regulation that can set standards worldwide. The regulation being created is pioneering in terms of innovation, consumer protection, legal certainty and the establishment of reliable supervisory structures in the field of crypto-assets. Many countries around the world will now take a close look at MiCA."
The vote by the parliament is just the first step in a protracted process of European negotiation over new legislation. The fight with the crypto lobby has only begun. Aa one industry representative remarked. "There hasn't been strong enough or coordinated efforts across our industry in Europe." That is likely to change.
And this means that the next stage in the European regulatory push is crucial. As Panetta has noted from the ECB side,
“Europe is leading the way in bringing crypto-assets into the regulatory purview. The finalisation of the Regulation of Markets in Crypto-Assets (MiCA) will harmonise the regulatory approach across the European Union (EU). In a similar way, the European Commission’s legislative proposals to create an EU AML/CFT single rulebook will bring all crypto-asset service providers within the scope of the relevant EU framework, which will also provide the basis for a harmonised European approach to supervising them. Most importantly, the proposed Regulation on information accompanying transfers of funds and certain crypto-assets (FCTR) will ensure that crypto asset transfers that include at least one cryptoasset service provider can be traced just like traditional funds transfers and that suspicious transactions can be blocked.”
But what is crucial is that swift negotiations between the European Commission, European Parliament and the Council of the European Union, build the regulatory momentum. And Europe's regulatory measures need to ensure that they are not hamstrung by conventional legal categories and extend to crypto-asset activities that are undertaken without service providers and on a peer-to-peer basis.
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If this is a moment of regulatory sea change for the crypto industry there are striking parallels in timing between the US, UK and Europe. That is not a matter of coincidence. Their financial systems are closely knit together and their regulators exist in a close communication and rivalry.
Figures like Panetta and Gensler agree on the need to bring an end to the Wild West epoch of crypto. To do that, it is clearly essential to adopt a coordinated approach through bodies like the Financial Action Task Force, which lays out global guidelines on issues like money laundering.
But in the push for a common approach, they will also have to contend with the fact that they are operating within political and institutional settings with strikingly different colorations.
The Executive Order by the Biden Presidency frankly declares its national goal of maintaining American national leadership, understood as a matter of national advantage and in line with Washington’s power to impose financial sanctions.
The UK is bidding to attract global business to the City of London as a financial hub.
The EU parliament starts from the premise that its job is to create a defensible regulatory structure and hopes that the effect will be to set a global standard. It is counting, in short, on what Anu Bradford has dubbed “Brussels effect”, through which the EU’s regulatory power gains leverage on a global scale.
If there is one issue that spans all three major financial hubs as a matter of common concerns it is financial stability. The coming period will be a revealing test of whether that is sufficient to achieve anything like a unified approach. In any case, the struggle to define the place of crypto in the global financial system - whether as a speculative aberration or a permanent feature - has well and truly begun.
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