Benefits of self-regulation in the cryptocurrency industry

November 27, 2018
Darya Karatkevich

Restrictive and exclusionary banking and financial regulations no doubt played a role in the drive to create cryptocurrency to begin with, so there’s no surprise that the industry is resistant to regulations as a whole. However, one of the main challenges for mainstream acceptance of the new technology is apprehension due to the lack of regulations. Some people still wonder, ‘is bitcoin legal?’

Several high-profile thefts and hacks of cryptocurrency exchanges, coupled with the risk of deception among startups and ICOs make the risk level higher than most traditional investors are comfortable with. As the ecosystem grows and market cap soars, even those dedicated to the decentralized, peer-to-peer, and open-source nature of digital currency are realizing regulation is going to be necessary.

An option that may be just the right fit for the cryptocurrency market is self-regulation. There are many benefits to such regulatory model, which we believe outweigh the drawbacks. In the end, the creators and leaders of the crypto universe are best positioned to create regulations to protect and preserve their work.

Government is paying attention

governance

One thing that’s for sure is that governments and regulatory agencies around the world are paying close attention to the crypto market. The boom that we’ve seen over the last few years in investment has drawn lots of attention and with each high-profile scamthefthack, or system failure, chances of intervention from these agencies increases.

If these agencies do step in to create regulations for the cryptocurrency industry, they are unlikely to be beneficial to the companies already operating in the space. First of all, most governments do not have a good understanding of how blockchain or cryptocurrency works. Many are performing studies to improve that understanding, but ultimately the assumptions they make will not be as insightful as those of industry veterans.

The window is closing for the industry to self-regulate, created by the time it’s taking agencies to research the marketplace. Rest assured, the eyes of the world are on us due to the massive amount of capital, interest, and potential in decentralized systems. It is the perfect time for the industry to take it upon ourselves to organize and regulate.

Barriers to self-regulation

barriers

Probably the biggest barrier to effective self-regulation is a lack of consensus. There are many different opinions on how best to go about it, and lots of strong personalities leading successful companies. Depending on the firm, what’s best for one might not be best for another. Organizing will be key for the industry to create its own regulations.

That leads us to barrier number two, and that’s time. Most of the industry leaders are hard at work growing their companies, developing their product, and fighting for a slice of the market among an ever-increasing crowd of competitors. The rate of development in the industry is lightning-fast, and pausing to look at regulation is the last thing on minds of many CEOs.

It’s going to be important for these leaders to realize that without regulation, the waters will continue to be too muddy for some to join the market, and ultimately the lack of regulation will stunt the growth of the industry.

Finally, the idea of the ‘fox watching the henhouse’ may mean that even if the industry moves forward with a well-intentioned plan for self regulation, it may not be enough to inspire confidence among outsiders. The solutions have to be real, meaningful, and transparent to ensure maximum trust from those looking to join the market.

Proof of concept

proof of concept

There is a recent example to follow for those trying to better understand how the industry can achieve the goal of self-regulation. Sixteen domestic cryptocurrency exchanges in Japan recently convened a council called the Japan Virtual Currency Exchange Association (JVCEA), and Japan’s financial regulatory authority approved it as an official regulatory body.

The group has already published a 100-page set of stringent guidelines for the industry, including a ban on insider-trading, and a 4-1 limit on margin trading to ensure traders don’t over-leverage their initial deposits. Many more formalized rules are proposed for things like dispute resolution, anti-money laundering, and data privacy.

With the aim of the group being to gain and retain public trust in the industry, it can only serve to benefit future growth. And by being proactive, the members can control their own destiny as to how regulations are imposed. Working with government agencies instead of against them will allow the industry to help shape how they are regulated in the future.

Global reach needed

global reach

While the Japanese example is a great start, the true benefits of self-regulation will be when the global industry can work together to create standards. One of the key features of decentralized public blockchains is a borderless way to transfer assets. If each country has their own set of regulations, it burdens the industry to tailor their offering by jurisdiction, or narrows the limits where a solution can be applied.

This potential for standardized global guidelines is another key benefit of self-regulation, especially in preserving core concepts that underpin the benefits of digital currency. Thankfully, firms are beginning to step up and form alliances to start the process of creating SROs, or ‘Self Regulatory Organizations.’

The Virtual Commodity Association

virtual commodity association

Proposals by the famous Winklevoss twins, who are also creators of the Gemini digital currency exchange, have created a working group called the VCA that held their first meeting in September. In addition to Gemini, another U.S.-based company Bittrex has joined the group, as well as Japanese firm bitFlyer and the Belgian-based Bitstamp.

The aim of the group is to follow the model of traditional finance SROs like FINRA, which moderates the securities industry, and NFA which serves the derivatives market. According to their website, their mission is to establish sound practices in four areas: custody, customer communication, transparency, and regulation-based markets.

As recently as in July, the SEC (Securities and Exchange Commision) in the USA rejected a bid by the Winklevoss brothers to grant ETF status to the Winklevoss Bitcoin Trust, which was to be traded on the BZX exchange. The SEC cited numerous letters that led the agency to conclude that Bitcoin exchanges lack the ability to “prevent fraudulent and manipulative acts and practices and to protect investors and the public interest” in accordance with Exchange Act Section 6(b)(5).”

The decision by the government agency no doubt led the brothers to look at establishing a long-overdue SRO in the cryptocurrency and digital currency space.

CFTF commissioner weighs in

Not only are there clear benefits to self-regulation, but government bodies are essentially encouraging the industry to do so. As far back as March, the US Commodity Futures Trading Commission (CFTC) commissioner Brian Quintenz had strong words of encouragement at a blockchain conference in Washington DC.

He told the crowd,

“I believe that a private cryptocurrency oversight body could bridge the gap between the status quo and future government regulatory action,” adding that “if the community takes advantage of that time and that ambiguity, there’s the potential for a global framework to apply to everyone if there’s enough buy-in from the community…”

At the same time as making these remarks, he confirmed his belief that digital currencies like Bitcoin were absolutely a ‘commodity’ and not a security, going on to say that he wanted to avoid setting policy through enforcement, but would go that route if warranted. He pledged continuing to work with the SEC on punishment for ensuring that IPO laws are adhered to for ICOs, and that architects of failed offerings are held accountable.

Smart contracts and self-regulation

smart contracts

Blockchain technology actually presents a unique opportunity for regulatory policies to be built right into the digital platform itself. While Bitcoin lacks the mechanism to allow for such rules to be built into the blockchain, subsequent solutions like Ethereum allow for rules to be built into a system and carried forward by the blockchain.

This means that as SROs and governments collaborate on regulation, enforcement of those regulations can be completely automated. The appeal for government regulatory bodies is that enforcement of regulations would be much more efficient and require far less resources. This is another way the industry can leverage one of its key strengths to court the cooperation of government agencies.

It’s not a matter of if, but when

The ultimate success of the distributed ledger digital currency model is almost certain. Large corporations, financial institutions, and end users everywhere are taking notice. There are simply too many benefits of the blockchain architecture for it not to be a significant part of all digital systems in the future.

One of the many promises that cryptocurrency looked to deliver was an evening of the playing field. Tightly restricted financial markets, controlled by the wealthy few were out of reach for young, tech savvy entrepreneurs who designed a better model. As the industry is slowly but steadily co-opted by powerful, traditional finance companies, there’s a narrow window for the industry pioneers to stand up and create a set of regulations that help to stake a claim to what they designed.

Over the next year, one of the most important things to watch in the cryptocurrency trading ecosystem is the emergence and success of these SROs and how well they are able to work with global government agencies to create borderless policies that secure the industry and make it palatable to the everyday consumer.

Post written by Darya Karatkevich
Darya is a blockchain market observer with 5+ years of experience as an author and editor for major tech blogging platforms. Her fortes are blockchain technologies and solutions, cryptocurrencies and crypto-related regulations.

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2 comments

Mary Thibodeau February 3, 2019, 05:58

Great article. I will be citing it in an upcoming post about the current status of self-regulation. Thank you.

OpenLedger DEX February 4, 2019, 14:19

Thanks, Mary!

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