One of cryptocurrency’s spiritual forebears, Timothy C. May, predicted in the 1990s that untraceable digital cash would allow online casinos, bank secrecy and money laundering to flourish. Although laws would be dodged, he said, the individual anonymity and freedom would be worth it — at least, until the inevitable government backlash.
This cycle is playing out almost three decades later, as regulators take a fresh crack at the $2.4 trillion crypto sector that’s ballooned largely out of their reach. Crypto executives were grilled by US lawmakers on Wednesday after a series of probes and fines into trading platforms amid a post-Covid digital gold rush. The bosses acknowledged the need for more oversight but warned that draconian rules would chase firms overseas.
The march toward more regulation is underway, and for good reason. While the execs defended their work policing bad actors, for the most part, anti-money laundering standards and client identification controls still look patchy. One survey of 16 platforms in March found that only four were subject to “significant” rules related to trading. Exchange activity primarily takes place in offshore jurisdictions. Binance, with no formal head office, is described as being “everywhere and nowhere.” Theft, fraud and hacks are rife.
Yet what’s more unnerving is the pace at which sophisticated investors — not just cyber-punters eager to make a buck — have thrown cash at trading venues regardless. Venture capitalists have invested more than $27 billion in crypto startups this year, according to PitchBook, including a $1 billion funding round for Bahamas-based FTX. In May, a firm backed by billionaires Peter Thiel and Alan Howard injected $10 billion of digital assets and cash into Gibraltar-licensed firm Bullish Global. Binance narrowly failed to raise $100 million earlier this year; it’s trying again.
VCs obviously have experience with risky bets on firms that disrupt the rules. It’s a tried-and-tested template: Move fast, break things and then ask for forgiveness. Regulation is always catching up. Europe’s gig-economy rules targeting the likes of Deliveroo and Uber have only come after years of the firms’ empire-building, for example. Still, it seems rather brave for VCs to be diving head-first into a crypto market with opaque actors and enough financial risk that the Bank of England compares it to the 2008 financial crisis (itself a product of “innovation” in mortgage finance).
And the “cypher-punk”-meets-Silicon-Valley enthusiasm has reached institutional investors who are not VCs. Many seem to be tossing aside the kind of counterparty risk management they would rigorously apply in traditional markets just to get a slice of crypto’s potentially vertiginous gains. Last year, crypto exchange Binance — which this summer was hit with regulatory warnings around the world — reported a 70% increase in institutional clients onboarded. Some hedge funds only decided to leave Binance “a bit” after the warnings.
It’s time for investors to question whether they’ve allowed the Fear Of Missing Out to take over. “The legal risk of posting funds within much of this ecosystem cannot be understated,” warns Martin Finnegan, partner at Punter Southall Law. While a regulated venue like the Chicago Mercantile Exchange is designed to guarantee terms of trade and eliminate counterparty, settlement and default risk, unregulated crypto venues have more conflicted roles combining brokerage, safekeeping and lending. Trade association FIA has said that a “significant” amount of activity on unregulated platforms could be wash trading and that basic market data can’t be trusted.
Regulation is already prompting market shifts. New exchanges see playing by the rules as a competitive advantage. Archax, a London-based exchange that it says is regulated by the UK FCA as a multilateral trading facility, plans to launch in January. Swarm describes itself as the first DeFi platform supervised by Germany’s BaFin. Binance and FTX are investing in regulated platforms; they’ve both shelved some products.
These shifts won’t answer all questions for investors trading crypto. Bitcoin will still have a questionable environmental footprint in an ESG-conscious world; its price tag will still inspire almost scholastic debates over whether it’s digital gold, a proxy for equities, or something else entirely. And central-bank digital currency experiments such as those of France and Switzerland will keep advancing, with potentially very disruptive results.
But as regulators try to keep a leash on cyber-speculation, investors should realize that they also have to adjust to a less hospitable world for freewheeling platforms — perhaps sooner than they think.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Lionel Laurent is a Bloomberg Opinion columnist covering the European Union and France. He worked previously at Reuters and Forbes.
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