The effects of regulations on cryptocurrency and digital assets
Cryptocurrency regulation is one of the hottest topics in the cryptocurrency industry.
When it comes to trading stocks, investors know what to expect. Regulations in this industry are clear, protecting investors from fraud and other risks. However, when it comes to cryptocurrency, the regulations are yet to be put in place. Furthermore, stakeholders in the market have divided opinions regarding regulating the crypto market.
For some investors, this condition of the market is beneficial. Early cryptocurrency adopters spent the previous decade profiting from the space, sometimes because of its unregulated nature. Some of these investors found a lack of regulations a compelling reason to join the digital asset space. This notion stems from the decentralized nature of crypto. The underpinning idea of cryptocurrency is doing away with centralization. Therefore, government intervention is seen as standing in the way of this industry realizing its primary goal.
However, the lack of government regulations means that the crypto market has less certainty and more significant risks than the stock market.
The cryptocurrency market recorded an all-time high, reaching a $2.9 trillion total market cap. This market size is significantly smaller than the $48 trillion stock market. However, crypto has been here just for slightly over a decade; hence the growth is commendable.
Since the 2021 peak, the market has entered a downturn. Bitcoin and Ethereum, the two largest cryptos in the market cap, have lost more than 65% of their total values. The entire crypto market is as of writing below $1 trillion. Not to mention, government regulations could be coming soon.
In March 2022, President Joe Biden signed an executive order to ensure “responsible development of digital assets”. The order provides the government's approach to addressing risks and exploiting the potential benefits of digital assets and their underlying technologies.
Additionally, about ten countries have already launched their digital currency. China may add to the number soon as they intend to launch its digital asset as early as 2023. Further, more countries are exploring launching their cryptocurrencies.
Some crypto investors are panicking out of uncertainties about a regulated future. However, other investors are looking forward to what the regulations would bring. Here are what regulations might mean for the crypto market.
A more stable market
Regulations could be a positive aspect of the crypto industry. Well-targeted regulatory guidance could help reduce speculation among digital assets, leading to higher investor confidence. Stability could entice long-term investors who have feared the highly speculative and volatile crypto market.
Additionally, changes in regulations will change people’s current behavior. Crypto has many benefits in its use cases, such as staking and yield farming. However, the lack of an appropriate regulatory framework keeps many users out of such use cases.
It is difficult to predict how the price-sensitive crypto asset class will react to regulation in the long term, as it depends on whether the regulations are more lenient or stringent. New regulations could inspire a sudden investor reaction to the markets on a short-term basis, suppressing the trading values of crypto assets. For example, in March 2017, the United States Security and Exchange Commission (SEC) turned down the proposal to alter stock exchange rules to accommodate the creation of an ETF for bitcoin. About five minutes after the announcement, the price of bitcoin dropped by 16%. In June 2018, the Japanese Financial Services Agency (FSA) ordered six cryptocurrency exchanges to prove their money laundering procedures. Again, prices dropped, although several hours after the announcement. In another example, China banning of cryptocurrency transactions in September 2021 caused a sudden significant market drop. However, over the long term, such regulations may stabilize the market, reducing some risks for crypto investors.
Increase investor protection and confidence
The lack of a regulatory framework for protecting assets exposes crypto investors to various risks.
Some exchanges such as Coinbase and Gemini remain compliant with evolving federal and state regulators in the United States. However, such brokers are not regulated similarly to public stock exchanges or other trading systems. That could be problematic since investor protection remains weaker in the crypto market than in securities or banking industries.
Therefore, regulations will make the market safer and less vulnerable to outside manipulation. Safer markets could increase investor confidence, which translates to greater value over time.
Regulations create a framework with disclosures, which makes the overall investment class transparent. Transparency is a significant factor for institutional investments. The risk management nature of such institutions calls for a risk profile for each investment. Such risks profile are practical only for transparent assets, which digital assets are not yet.
For example, the lack of transparency for the algorithmic stablecoin TerraUSD is one of the factors that caused the massive fall for UST in May 2022. The effect of the collapse of UST stretched to other assets and products in the market. It leads to the collapse of LUNA in a more direct manner. It had a ripple effect on the price of BTC as well. A few weeks into the fall, a Chicago investor brought a securities fraud class-section suit against six crypto venture capital firms that backed Terra tokens.
Additionally, a lack of transparency with Tether’s USDT caused problems with the stablecoins recently. For instance, the Commodity Futures Trading Commission slapped the USDT’s issuers with a $42 million fine for violating the Commodity Exchange Act and other CFTC regulations. In February 2021, the token issuer paid $18.5 million to the office of the New York Attorney General for settlements. Much of the fines were due to audit problems for USDT’s existing treasury.
These are classic examples of problems that cryptocurrency regulations could solve. For large firms, such kind of uncertainties are unbearable. Therefore, firms will remain on the sidelines, as speculating on such assets may lead to massive losses of future regulatory problems. The crypto market could attain transparency with the help of regulations and welcome large institutional investors. The actions of such investors could stabilize crypto prices overall on a long-term basis.
Safer Crypto Ecosystem
The U.S. Securities and Exchange Commission (SEC) chair Gary Gensler has described cryptocurrency as the "Wild West" due to the lack of regulations in the industry. This market's absence of laws and policies has created room for scams, fraud, rug pulls, and market manipulations.
Cryptocurrency scam has grown rapidly over the last couple of years. The money the crypto market lost to fraud doubled between 2020 and 2021. Scammers stole about $14 billion worth of crypto in 2021 compared to $7.8 billion in 2020. Furthermore, the market currently has more than 17,000 altcoins which are more volatile and speculative than Bitcoin. Such assets have higher risks of crypto scams, and frauds, including Rug Pulls.
A proper regulatory framework could help protect the users from such fraudulent activities.
Regulatory authorities in the U.S and across the world are introducing new regulations targeting the crypto market almost every month. These regulations will undoubtedly affect the crypto market, even though it may be difficult to predict precisely how. However, regulations could be the answer to stabilizing the volatile crypto prices and creating a healthy and competitive market that invites more investors and activities.