Should Cryptos Be Regulated?

With all the breaking news that we have been hearing recently about a collapse or a scam in the $3 trillion crypto world with the most recent FTX collapse, “Should Cryptos be regulated?”. This question has resurfaced in everyone's minds and rose the imperativeness of the matter. Despite the vast array of financial benefits of cryptocurrencies, their nature dictates a suspicious environment for regulators as it is highly vulnerable to money laundering, terrorist financing, and cyber hacking.

The old frameworks that define who is currently deemed a "person," what is "value," and how this "value" can be exchanged are challenged by new applications and concepts like tokenization, decentralized finance, NFTs (non-fungible tokens), and decentralized autonomous organizations. Existing laws governing international data transfers, intellectual property rights, and capital controls could be directly impacted. In addition to raising a number of other policy issues, a recent report by the International Monetary Fund (IMF) has shown a stronger correlation between Bitcoin and the stock market during the pandemic raising the probability of spillovers of sentiments, prices, and volatility between digitals assets and the global equity markets, as shown in figure 1 below.

About 1/10 of the variation in S&P 500 returns and 1/6 of the S&P 500 volatility during the pandemic can be attributed to Bitcoin volatility. As a result, a sudden drop in Bitcoin could make investors more risk-averse and decrease investment in stock markets. The average size of spillovers from the S&P 500 to Bitcoin, is comparable, indicating that there is a significant transmission of spillovers and “shocks” from one market to the other.

Figure 1 Correlation between Bitcoin Returns and S&P5OO Index. Source: CryptoCompare, Yahoo Finance, and IMF.

NB: The bottom panel shows a rolling 60-day correlation coefficient.

Bair, formerly head of the Federal Deposit Insurance Corporation, believes that the FTX collapse; however, could adversely impact the broader financial market, but she believes oversight is crucial. Regulating might prevent fraudulent activity within the ecosystem, increase investors’ protection and confidence and ensure a safe and stable investing experience. Others; however, believe that crypto regulation and oversight might be a double-edged sword as it might give “undeserved” credibility, while total opponents believe that it would mean a headwind to innovation that is against the core nature of cryptos.

Bair told the Financial Times:
               “I don’t want to throw the baby out with the bathwater. I’m hoping what this will actually do is reallocate capital away from speculative stuff to companies that are really trying to meaningfully use this technology for something of value. ”..                   “A regulatory imprimatur for them would absolutely help with that. Shut these other guys down.”

Few countries around the world issued digital assets regulations and policies, one of which is the US setting the pace for other governments to replicate such a move. Given that more than 40 million American dealing with cryptocurrencies, President Joe Biden approved the Executive order on ensuring the responsible development of digital assets last March. The Order outlines the national policy for digital assets in six main elements: consumer and investor protection; financial stability; illicit finance; U.S. leadership in the global financial system and economic competitiveness; financial inclusion; and responsible innovation. India, China, the EU, and UAE among others have also proposed to amend existing policies and set up new laws to protect their people. A consortium of more than 80organization from 33 different countries has been developed to discuss and develop international frameworks for digital assets governance.  Figure (2) below shows crypto regulations around the world.

Figure 2: Crypto Regulations across the world| Source: Comply Advantage

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