In the wake of the collapse of FTX and other fairly big players in the crypto sector such as BlockFi and Celsius, many are wondering whether widespread regulation is coming in 2023. The impacts of the major collapses seen in 2022 are far reaching, and have certainly created cause for regulation to come sooner than later.
There are certainly aspects of regulation which will be a boon for crypto adoption, but it seems likely that new issues will arise as well. Before diving into both sides of the regulatory fence, let’s first take a look at current regulations around the world, and the potential changes already in the works.
Current Regulations Around the Globe
The majority of cryptocurrency regulations throughout the world tend to be more reactionary than proactive. Not only that, but there is very little consensus across both regulatory and governmental bodies as to how to approach crypto regulations. Some places want outright bans, some just want proper registration of users and assets, and some have already made certain crypto assets legal tender.
It seems nations’ approach to crypto tends to change depending on their current national economic standing. Let’s take a look at how regulations are going in two of the major areas: the US and Europe.
The SEC’s Crypto Crackdown
It took until November 2021 for the US to mention cryptocurrencies in national legislation with the Infrastructure Investment and Jobs Act, but the SEC has long been battling against crypto. Most recently they’ve begun targeting proof of stake digital assets such as Ethereum (ETH), Cardano (ADA), and Solana (SOL). They imposed a fine of $30 million dollars against Kraken for their staking services while also forcing them to stop offering them, and they are going to try and force stake pool operators and such blockchains to register as securities in the future.
The SEC has been in a legal battle with Ripple Labs since 2020. Ripple Labs, the company behind Ripple (XRP) is accused of selling unregistered securities. There is expected to be a decision sometime in the first half of 2023, which means in the next few months. Whatever the result, there will be a definite impact on the crypto sector.
The SEC has already sued Kim Kardashian and others for their promotion of certain crypto assets. More recently they placed sanctions on Tornado Cash, while arresting the person who created the code (but who has no control over the software). Much like many of the legal battles within crypto, it’s apparent that many within the courts and legal system actually have very little understanding of how blockchain protocols work, or smart contracts for that matter.
Another example of this lack of understanding occurred with a recently introduced bill to the Illinois Senate. The bill calls for the ability to force blockchain validators and miners to reverse a transaction if ordered to do so, or order a smart contract transaction to be altered or reversed. As most in crypto understand, that isn’t going to work, and is against the ethos of cryptocurrencies in general. But as we’re about to see with Europe, the Illinois Senate isn’t alone in trying to get a bill through that doesn’t make much sense.
European Commission and Markets in Crypto Assets (MiCA)
While Europe may be ahead of the curve with their MiCA proposal, which we’ll get to in a moment, the European Parliament just approved a data act that’s not all that different from the one that is trying to go through in Illinois. Passed on March 14, 2023, the Data Act does a few things, but one of the main articles is one that requires smart contracts to have a kill switch built in. Perhaps more concerning is the fact that there is no specification as to who will be allowed to use said switch. There isn’t much point to decentralized finance (DeFi) if it has a kill switch that can be used by governments at their whim, and it certainly isn’t possible for already existing protocols such as Uniswap.
The Markets in Crypto Assets proposal was made by the European Commission in 2020, more than a year before the US introduced their Infrastructure Investment and Jobs Act. It focuses on creating a legal framework for crypto-asset service providers (such as exchanges) and consumer protection. If and when it is finalized, which may not be until 2024 according to BNP Paribas, the MiCA proposal will require stablecoin issuers (such as Paxos and Circle) to hold enough reserves to prevent a Terra-like collapse. It would also require crypto miners to disclose their energy consumption, amongst other things.
Why Increased Regulation Might Not Be Bad (And Why It Might Be)
As you may have already ascertained from the preceding sections of this article, regulation is certainly coming, but whether it will be a good or bad thing overall isn’t yet clear. While it is certain that some sort of regulatory framework needs to be put in place, it’s just as important for that framework to make sense from a blockchain and code perspective.
Regulation might not be a bad thing from a perspective of progress, in order for adoption to become more widespread, consumers and institutions alike want some sort of protection around their investments in digital assets. Without a first regulatory step, we’ll be unlikely to truly create a thriving blockchain ecosystem where anyone can participate. However, it’s possible that some regulations will be more restrictive than anything.
As seen with both the Data Act already passed by the European Parliament, and the bills being introduced in the US, some aspects of regulation may simply create another centralized service controlled by a single entity, whether a person or company. This would potentially have a serious negative effect on the DeFi sector, where self-executing smart contracts are deployed on cryptocurrency blockchains to deliver financial instruments when specified conditions are met.
For example, you can lock X amount of collateral into a smart contract on a protocol such as AAVE and receive a crypto loan without a credit check. The only prerequisite is that you have the collateral, you don’t need any central authority’s permission to borrow.
Though crypto exchanges and services collapsing in 2022 has certainly led to more calls for regulation within the sector, early 2023 is proving that banks can be just as vulnerable to a run on their holdings. Silicon Valley Bank was one of the 20 largest banks in the US before its recent collapse, which is comparable to where Terra was in the top 20 crypto assets by market cap when it collapsed.
The reality of the banking system is that banks very rarely actually hold the majority of funds they receive from customers. Some analysts are worried what might happen if a run is made on regional banks in the US, as data shows that small banks had $6.8 trillion in assets and just $680 billion in equity as of February 2023. If a run were to occur on these banks, it would likely create a domino effect. Maybe regular banks need a proof of reserves audit to show they can cover a bank run, like crypto exchanges now do.
The potential risks of banks are now being felt in Switzerland with Credit Suisse facing serious problems. This is despite them being part of the $65 million funding raised by Tauros, a Swiss digital asset service provider, just one month ago. It seems clear that while crypto needs regulation, the current regulations surrounding the traditional financial system aren’t exactly proving to be safe. It will be interesting to see what happens if/when a larger banking player shows weakness like Credit Suisse has.
Closing Thoughts: Regulation is Inevitable
Widespread regulation is coming, though it may not be this year. Regardless of when it happens, it will certainly affect the entirety of the crypto market, though to what effect is hard to say.
While it’s necessary for regulation to happen, it may end up being more restrictive than crypto enthusiasts would like. However, with the issues facing the traditional financial system coming to the forefront, perhaps a shift towards the transparency of blockchain is on the horizon.