Luis Maldonado: «It’s Time For Regulation to Catch Up»
The winds of regulation moving around digital assets are strong and in the last few years, more and more countries have chosen to issue regulation. Yet, still, the debate is far from closed, Luis Maldonado writes in his opinion piece for finews.first.
finews.first is a forum for authors to comment on economic and financial topics.
Digital assets markets – which include cryptocurrencies, stablecoins, and other assets – have undergone a rapid expansion in the post-2020 landscape, marking a valuation trajectory from under $17 billion in 2017 to an astonishing $3 trillion by 2021.
This spectacular growth, however, was followed by a sharp decline of more than $1 trillion by the middle of 2022, a phenomenon known as crypto winter, and from which markets have only partially recovered their value.
In terms of the adoption of digital assets, the user and investor base has expanded significantly from only 0.5 percent of the global population back in 2017 to 3.4 percent by 2022, and, according to some market estimates, it is projected to incorporate more than 300 million new users in the next two years to reach over 4 percent of the global population by 2025.
«There is definitely a growing consensus to regulate the digital assets ecosystem»
The number and variety of digital assets have also multiplied in less than a decade. There were no more than one hundred in 2013 and the number now exceeds 16,000. Furthermore, despite the high attrition rate of these assets, new ones continue to enter the market, with around ten new assets each day according to the European Central Bank.
Against this backdrop, there is growing consensus about the need to regulate the digital assets ecosystem. While necessary, such regulation is also challenging, due to the use of decentralized technologies.
Additionally, the use of open-source platforms, combined with the borderless nature of their application and the fast and constantly evolving landscape, further compounds the complexity of regulatory efforts. One of the first challenges that any global approach to regulating digital assets faces is the lack of homogeneous definitions and classifications.
«Another challenge stems from the borderless nature of digital assets»
A second challenge to regulation is the absence of complete and coherent data. As the International Monetary Fund has raised on several occasions, the lack of homogeneous data disclosure standards by the different digital asset exchange platforms makes it extremely difficult to analyze aggregate data, which could give a comprehensive perspective and guide the direction of regulation.
A related challenge to the lack of comprehensive data is the difficulty of analyzing the systemic impact of digital assets and the contagion across different asset classes. Early analyses point out that the increase in digital assets adoption, especially since 2020, and the growing participation of institutional investors has led to instances of consistent positive correlations with stock indexes.
A fourth challenge stems from the borderless nature of digital assets, which allows for regulatory arbitrage and significantly reduces the individual oversight capacity of countries, thus making the case for a global regulatory approach.
«The approaches taken to reach these regulatory objectives differ across jurisdictions»
However, the fact that monitoring, supervision, and enforcement are mostly fragmented across jurisdictions means that a coordinated global approach is particularly complex. When embarking on the regulation of digital assets, national authorities aim to achieve key regulatory objectives such as maintaining financial stability, ensuring investors protection – especially retail investors – and preventing money laundering and financial crime.
Despite these commonalities, the approaches taken to reach these regulatory objectives differ across jurisdictions. In some cases, regulators and policymakers have opted for principle-based regulation, concentrating on the results, and expected outcomes, rather than prescribing detailed rules.
Another followed by many regulators is the risk-based approach, which establishes a level of intervention following the level of risk. In other cases, when the regulator would like to encourage innovation, an agile approach is the most appropriate, and this often includes the issuance of guidelines, the acceptance of no-objection letters, or the establishment of regulatory sandboxes.
«Regulations about decentralized finance are still in the consultation phases»
Various jurisdictions typically regulate the following: the establishment of licensing and registration regimes for exchanges, custodians and other intermediaries; the extension of AML/CFT requirements for crypto activities; the development of regulation or guidance for marketing and promotion of digital assets; the issuance of regulation for stablecoins; the inclusion of particular provisions to ensure consumer and investor protection; and clarifications to the tax treatment of digital assets.
Generally, regulations about decentralized finance (DeFi) are still in the consultation phases and have not yet been regulated.
International financial institutions such as the IMF have clearly justified the need for a global and coordinated approach to the regulation of digital assets. The growing size and adoption of digital assets, coupled with their increased interconnection with traditional financial systems, has pushed global regulatory standard-setters to expedite the release of guidelines and recommendations.
«Regulators and policymakers need to keep moving forward in this regard»
The winds of regulation moving around digital assets are strong and in the last few years, more and more countries have chosen to issue regulation. Yet, still, the debate is far from closed. Regulators and policymakers need to keep moving forward in this regard, and quickly, because the technology continues to evolve and the use cases to multiply. It’s time for regulation to catch up.
Luis Maldonado is a Professor of Economics and Finance at IE University in Madrid and academic Director of the Impact Xcelerator Financial Systems Lab.
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