“Crypto-winter” is the term used by experts to describe the recent volatility in the crypto markets, marked in particular by the 70 percent drop in value since November of the most famous digital asset, Bitcoin. This collapse in valuation has also led to the failure of a number of crypto-related firms, most notably one of the major Singaporean players Three Arrows Capital.
Cunliffe draws the following conclusions from these developments, which he believes will be relevant to both regulators and those involved in the crypto market over the next few years:
- Technology does not change the underlying risks in economics and finance.
- Regulators must continue and accelerate their work to effectively regulate the use of crypto technologies in finance.
- This regulation should be based on the iron principle of “same risk, same regulatory result”; to be effective, regulatory frameworks must take a common approach internationally and be implemented at national level.
- Crypto technologies offer the prospect of substantial innovation and improvement in finance. Innovation needs a framework in which risks are managed to thrive.
Technology does not change the underlying risks in economics and finance
Cunliffe believes that new technologies are unable to eliminate the risks that are effectively inherent in finance. Crypto technologies could indeed change the management and allocation of risks – including those related to assets with no intrinsic value, the stability of the settlement asset and the use of leverage – but it will not eliminate them. A large number of coins that have no intrinsic value pose a risk of total loss. Crypto trading platforms face well-known risks arising from the use of leverage. They have already led to various crises that should not be ignored.
As for fixed stablecoins, Cunliffe emphasizes the importance of backing stablecoins with assets in the real economy so that they can function as a currency even in the face of declining trust. The recent collapse of Terra – an algorithmically backed stablecoin backed by a Bitcoin reserve – illustrates what can happen when there is a loss of confidence in a “currency” that is not backed by any assets in the real economy.
Regulators must continue and accelerate their work to effectively regulate the use of crypto technologies in finance
The recent crypto crashes are a clear sign that regulators need to continue their work and move forward with the regulation of crypto technologies. According to Cunliffe, it cannot be concluded that “crypto is over” and that there is nothing to worry about anymore. Even if cryptocurrency has not posed a systemic risk so far, it may in the near future.
He draws a parallel to the so-called “dotcom bubble,” in which the valuation of young tech companies was also highly speculative and eventually collapsed. In the long run, however, these technologies led to the current market-leading platforms in Internet commerce, and a similar outcome is possible for crypto technologies.
“Same risk, same regulatory outcome” and the need for international standards
This is an oft-repeated regulatory mantra. Regulators should apply regulation to the risks inherent in the provision of a financial service, regardless of how it is provided, focusing on the desired regulatory outcome. Cunliffe argues that this is true in the context of crypto. If existing regulation may not work in this context or be ineffective in managing the risks, the same level of risk mitigation must be achieved through alternative means to achieve the ‘same regulatory outcome’. If it is not possible to mitigate and manage risk for certain cryptocurrency-related activities to the extent required by regulation, that is, to the extent that risk is managed in other parts of the financial system, Cunliffe advocates not allowing activities to continue. Such a globally adopted approach has so far prevented, for example, any launch of a globally systemic stablecoin.
For a “same risk, same regulatory outcome” approach to be effective for stablecoins and the overall crypto-environment, international standards are needed that are incorporated into national frameworks. In the UK, the government will pass legislation in the current session of Parliament to update the powers of the Bank of England and the Financial Conduct Authority to regulate and oversee stablecoins. A consultation on the regulatory framework is due to follow later this year. It remains to be seen what impact this in-house approach will have on the broader regulation and operation of stablecoins.
Innovation and regulation are ultimately friends, not enemies
Cunliffe ends on a positive note regarding the future of crypto and its regulation. According to him, if developed correctly, crypto-based technologies can have huge benefits for finance and create lower costs for end investors, as well as higher speed and better transparency. However, to achieve this, more “crypto-winters” must be avoided to support the adoption and adaptation of new technologies, as well as to build the much-needed trust of the general public.
Regulators as well as innovators should have an interest in developing appropriate regulation and risk management. Only in such a framework can they truly flourish and the benefits of technological change can be secured. People in the crypto industry will be hoping that regulators pay attention and engage so that the potential of these new technologies can be realized.
Some Lessons from Crypto Winter – Speech by Sir John Cunliffe