The writer is a member of the executive board of the European Central Bank
Last year marked the unravelling of the crypto market as investors moved from the fear of missing out to the fear of not getting out.
TerraUSD — a stablecoin that was stable in name only — was among the first to fall in a chain of collapses that brought down several lending platforms, a hedge fund, a leading crypto asset exchange and most recently a large US-listed crypto mining company. Other crypto companies are likely to be added to this list in the coming months.
These failures occurred in rapid succession, reflecting crypto players’ incredibly high leverage, their interconnectedness across the crypto ecosystem and their inadequate governance structures.
Yet remarkably, the crypto market rout has left the financial system largely unscathed. Many therefore think it preferable to let crypto burn rather than regulate at the risk of legitimising cryptos. Let me voice two important reservations about this view.
First, despite their fundamental flaws, it is not certain that crypto assets will ultimately self-combust.
Take unbacked crypto assets, for instance. They do not perform any socially or economically useful function: they are rarely used for payments and do not fund consumption or investment. As a form of investment, unbacked cryptos lack any intrinsic value, too. They are speculative assets. Investors buy them with the sole objective of selling them on at a higher price. In fact, they are a gamble disguised as an investment asset.
But it is precisely for this reason that we cannot expect them to disappear. People have always gambled in many different ways. And in the digital era, unbacked cryptos are likely to continue to be a vehicle for gambling.
Second, the cost to society of an unregulated crypto industry is too high to ignore. For one, this year’s crypto market meltdown caught millions of investors off guard. Uninformed investors were left with significant losses. It is not just cryptos that are being burnt.
In addition, unregulated crypto assets can be used for tax evasion, money laundering, terrorist financing and the circumvention of sanctions. They also have high environmental costs.
That is why we cannot afford to leave cryptos unregulated. We need to build guardrails that address regulatory gaps and arbitrage and tackle the significant social costs of cryptos head-on.
This is easier said than done. Regulators must walk a tightrope. Like Ulysses, they must resist the beguiling crypto sirens to avoid falling prey to the industry’s intense lobbying. And on their journey, they must steer clear of the Scylla of poor regulation and the Charybdis of legitimising unsound crypto models.
The EU’s Regulation on Markets in Crypto-Assets is an important step. It is crucial that it is implemented as soon as possible. However, further work needs to be done to ensure that all segments of the industry are regulated, including decentralised finance activities such as crypto asset lending or non-custodial wallet services.
In addition, regulation should acknowledge the speculative nature of unbacked cryptos and treat them as gambling activities. Vulnerable consumers should be protected through principles similar to those recommended by the European Commission for online gambling. They should be taxed in accordance with the costs they impose on society.
To avoid the risk of regulation lagging behind because of the time needed for legislative processes, regulators and supervisors need to be empowered to keep pace with crypto developments.
And to be effective and prevent regulatory arbitrage, regulation must have a global reach. The recommendations of the Financial Stability Board for the regulation and oversight of crypto asset activities and markets should be finalised and applied urgently, as should the rules recently published by the Basel Committee for the treatment of banks’ exposures to cryptos.
However, regulation and taxation alone will not be sufficient to address the shortcomings of cryptos. To build solid foundations for the digital finance ecosystem, we need a risk-free and dependable digital settlement asset, which can only be provided by central bank money. That is why the ECB and central banks around the world are working on both retail and wholesale central bank digital currencies. By preserving the role of central bank money as the anchor of the payment system, central banks will safeguard the trust on which private forms of money ultimately depend.
