Regulatory harmonization to drive crypto adoption
Governments and industry must work together to maximize security and trust. By Leon Foong
Representations of Bitcoin, Ethereum, DogeCoin, Ripple and Litecoin are shown on a PC motherboard in this illustration dated June 29, 2021. As of May 2023, the total crypto market cap is estimated at $1.25 trillion. REUTERS
The events of 2022 have reminded us how important regulatory compliance is when it comes to protecting users and maximizing security and trust in the cryptocurrency industry.
As we usher in a new growth chapter for the crypto industry, regulatory harmonization will play a fundamental role in driving adoption, protecting users, and facilitating innovation.
Regulatory harmonization seeks convergence of regulatory frameworks by placing greater emphasis on global harmonization of policies and laws, thereby reducing opportunities for regulatory arbitrage.
As it stands, the differences in virtual asset regulations across jurisdictions shed light on the importance of harmonizing policies. A disparity in the classification of virtual assets has led to different regulators taking on the role of prescribing guidelines for this new asset class, which is not tied to traditional market and trading hours.
As the crypto industry continues to evolve at an unprecedented rate, the need for international standardization of crypto policies is becoming increasingly important. At a time when central banks are struggling to deliver on their policy goals, managing growth while meeting inflation targets, a resilient global source of liquidity is crucial to contain market volatility. Virtual assets can play a crucial role in rebalancing global liquidity across asset classes.
To date, the total crypto market cap is just $1.25 trillion, which is less than half of Apple Inc.’s $2.6 trillion market cap. If we had a way to measure the ratio of regulatory scrutiny to market cap, crypto would rank first among all asset classes given the impact blockchain technology can have on how consumers and businesses interact and exchange money.
To protect users from systemic risk and fraud, there should be a common goal to reduce regulatory complexity and discrepancies in the crypto and blockchain industries. The lack of clear global definitions and constitutions for different classes of digital assets makes enforcement of sanctions and policies difficult.
To encourage adoption and innovation, regulations should focus on three key components: fiat-to-crypto, custody, and crypto-to-crypto transactions. First, traditional financial market regulations and Financial Action Task Force (FATF) guidance are key to ensuring transaction reporting and anti-money laundering/countering the financing of terrorism requirements are met.
In the area of custody, the recent collapse of certain centralized exchanges highlighted the need for key proof of reserve/solvency and transparency requirements to ensure user funds are protected. Best practices related to security, private key encryption and wallet segregation should also be shared to ensure exchanges exhibit operational agility and efficiency while maintaining the security of user funds.
In crypto-to-crypto transactions, regulators must first understand how price discovery and fulfillment works in the virtual asset space, where both centralized (CEX) and decentralized (DEX) exchanges coexist. There are differences in the settlement and clearing processes between the two, and smart contracts and liquidity pools can actually replace traditional exchange order books. On-chain vs. off-chain and on-exchange vs. off-exchange settlement also need to be considered.
These differences create uncertainty and confusion within the industry, leading to more opportunities for malicious actors to undermine financial integrity. At the same time, they blur the guidelines for Web3 organizations and make it more difficult to establish preventive anti-money laundering measures.
Enforcement of cross-sector global standards will help fill in existing gaps in local policies, which will facilitate the creation of a safer, more transparent, and more trusted global crypto ecosystem in the future. Knowledge sharing and open dialogue between industry stakeholders and policy makers will be key to ensure this.
With the crypto industry still in its infancy, this is an opportune time to seek regulatory governance harmonization in anticipation of Web3’s growth. Clearly, Web3 is the way forward – with irrefutable economic potential and potential applications as the industry continues to grow.
ASIA PACIFIC POTENTIAL
It is notable that Web3 startup companies raised an estimated $16 billion in Asia Pacific alone in August 2022, even in the midst of “crypto winter.” While North America remains the largest Web3 market, Asia Pacific takes the crown for the world’s fastest growing region. This only serves to reiterate the huge untapped potential for Web3 growth in Asia Pacific.
Currently, the regulatory environment for digital assets in Asia Pacific is very different from other regions such as Europe and North America. Some countries have imposed bans on digital assets and want to tighten restrictions related to crypto-related activities. Other countries like Japan express their commitment to the development of Web3 and the digital asset economy.
Governments and regulators that are laying the groundwork for Web3 investors and entrepreneurs to establish themselves in their countries will undoubtedly see their Web3 ecosystems grow more significantly than countries that are taking a more conservative approach.
Regulatory harmonization and the establishment of consistent market regulations create a level playing field by preventing policies from impeding growth.
Regulatory harmonization goes a step further than coordinating regulatory developments. It also includes an uncompromising commitment from key industry players to conform and comply with regulatory guidelines.
On this front, global blockchain trade associations are playing a crucial role in bridging the structural gaps and enhancing communications within the blockchain and crypto space.
By engaging industry players in the Web3 space, global blockchain trade associations can enable a more inclusive and engaged ecosystem. Ultimately, this also builds more trust between Web3 organizations and regulators, which can only open more doors for crypto adoption.