• 2022 a year to forget for crypto investors
• Regulation is likely to come even more into focus in 2023
• Greater transparency could help regain trust
2022 was a challenging year for the crypto market. The collapse of digital tokens Terra/LUNA, crypto lenders Celsius and Voyager Digital, and the demise of multibillion-dollar crypto hedge fund Three Arrows Capital sent shockwaves, sweeping other companies out of the industry with them. At the end of 2022, the next bad news followed with the bankruptcy of the former star of the scene, the crypto exchange FTX.
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The debacle on the crypto market should have shown the dangers that centralized crypto companies pose for consumers and so it is hardly surprising that calls for stronger regulation were heard from many quarters. Andrew Keys, venture capitalist and managing partner of DARMA Capital, therefore expects consumer protection to be the top priority for policymakers this year. In addition to stricter regulation, transparency is also an issue that concerns the crypto community and with which companies from the industry want to regain the trust of investors.
Calls for more regulation are getting louder
After the collapse of the FTX crypto exchange, ECB Director Fabio Panetta saw his doubts confirmed. In a speech to the London Business School, according to Dow Jones, he said, “It turns out crypto assets aren’t money,” instead many are “just a new kind of gambling.” He called for global regulation to protect consumers from the risks of crypto assets, stating that there should be minimum risk management and corporate governance requirements for crypto companies. In addition, the contagion risks of stablecoins must be reduced. Jon Cunliffe, deputy head of the Bank of England, also said that the FTX case makes it clear that supervisors must quickly ensure stricter controls.
According to Reuters, Gary Gensler, head of the US Securities and Exchange Commission, criticized crypto lenders, which he described as “crypto casinos”, and their business model after the debacle on the crypto market. This currently consists of offering the public an interest yield in crypto and then potentially trading against the customers, he said in an interview with Yahoo Finance. According to Gensler, entrepreneurs in this area would try to circumvent the law. As such, he warned that the air was getting thinner for windy players in the US and oversight was becoming more active.
In addition, US Senator and crypto skeptic Elizabeth Warren has again expressed criticism. In a post for The Wall Street Journal, she called the crypto exchange’s bankruptcy a “wake-up call” showing the need to enforce the law and for Congress to fill the loopholes in the regulatory structure. In December, she introduced the Digital Asset Anti-Money Laundering Act. The bill would impose sweeping monitoring and registration requirements on nearly all participants in blockchain networks, including software developers, miners and wallet makers.
Possible regulations for crypto exchanges
There are also advocates of more regulation among centralized crypto exchanges – Coinbase being one of them. In the December publication “Regulating Crypto: How we move forward as an industry from here,” Coinbase CEO Brian Armstrong outlines a “realistic blueprint to ensure we have regulatory clarity for centralized players and a level playing field for all exchanges while preserving the decentralized crypto innovations that will bring tremendous benefits to the world.”
In his opinion, it is best “to first create regulatory clarity regarding centralized crypto players (stablecoin issuers, exchanges and custodians)” as this is where the greatest damage to consumers has occurred so far. According to Armstrong, “a set of rules for centralized exchanges and custodians could help deter bad activity while preserving innovation.” Many ideas could be adopted from traditional financial companies. Some possible regulations for centralized exchanges and custodians, according to Armstrong, include implementing robust know-your-customer and anti-money laundering policies and procedures, establishing a federal licensing and registration system, requiring strong consumer protection regulations, creating of effective minimum standards for the protection of client assets and the ban on market manipulation, wash trading & Co.
After creating regulatory clarity regarding centralized crypto players, a level playing field would also need to be enforced.
However, Armstrong believes that the role of financial regulators should be limited to centralized crypto players where additional transparency and disclosure is required, and recommends: “Let innovation in decentralized crypto happen.”
Regain trust through more transparency
In addition to stricter regulation, more transparency could also help crypto exchanges regain investor confidence. After the collapse of FTX, some exchanges released the Merkle tree and addresses of their reserve proofs.
Proof-of-reserves was the topic on the crypto market after the FTX bankruptcy. It is an independent audit, conducted by a third party, designed to determine whether a crypto company actually has sufficient funds to secure the digital assets it holds on behalf of its customers. According to cryptocurrency exchange Kraken, the verifier “creates an anonymized snapshot of all balances held and aggregates them into a Merkle tree.” From there, the examiner receives a Merkle root – a kind of “cryptographic fingerprint that uniquely identifies the combination of these balances at the time the snapshot was created”. According to Binance, the Merkle tree provides “an easily accessible record of transactions in a block”. This makes it very easy to check whether the data in a block has been changed or manipulated.
As CoinEX reported in a press release published by Cointelegraph, shortly after the collapse of FTX, leading trading platforms such as Binance, OKX, Crypto.com, Huobi, and CoinEx, among others, themselves disclosed their proof-of-reserves. According to the published data, these exchanges managed to cover 100 percent of user assets. Some exchanges even have reserve funds that far exceed user assets. For example, Binance and CoinEx USDC reserve rates are both above 400 percent.
Although some market participants argue that reserves are not definitive proof of a platform’s security, according to CoinEx, proof-of-reserves appear to be more popular with users compared to strict regulation.
After the bankruptcy of the crypto exchange FTX and the dubious transactions and interdependencies that came to light in the course of the insolvency proceedings, both stricter regulation by the authorities and more transparency on the part of the crypto exchanges are likely to be necessary in order to gain the trust of the crypto exchanges Winning back investors and making 2023 a more successful crypto year than the last.
Editorial office finanzen.net
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