Improve, Eliminate, Delegate
Summary: Reflections on advancing digital asset regulation in 2023. How can we eliminate roadblocks and engender robust and transparent markets?
Like so many of us who have busy lives and demanding careers, we preciously guard our time for private life and relaxation. For me, having an overabundance of free time between jobs was daunting in its own way. I am sure that many of you, in a period of calm, also tend to want to take stock of your life, read books, clean out your closets, listen to podcasts, and do all the “things” there normally isn’t time for, while paradoxically filling the time we wish to have more of.
Eventually I found a balance where I enjoyed the calm and time for positive self-reflection through lots of running and reading. Like many of you, I could not escape thinking about my profession, which frankly, I love. I contemplated how we can build on the solid work already undertaken this year in the nascent regulation of digital assets, through further collaboration and analysis, while eliminating barriers and roadblocks that aren’t helping to engender robust, fair, liquid, open and transparent markets.
Improve
“To improve is to change; to be perfect is to change often.” -Winston Churchill
In discussing digital assets and the events of the past year, the saying, “don’t throw out the baby with the bath water”, is often used to emphasise the importance of not discarding the positives that DLT has delivered in seeking to improve financial markets through removal of bad practices such as fraud and market manipulation (to name just a couple) and increase participation in the financial system.
This can also be applied to regulation. There is a tendency to think that because there is new technology, the governing policies and regulations must also be completely new, yet this is not always the case.
The Great Financial Crisis of 2007/2008 led to many useful reforms and strong global principles and standards in the (global) financial services sector. These provide a solid foundation that can be modified, improved, and built upon for the regulation of new technologies within financial markets.
Many global standard setting bodies (GSSBs) have already begun to consult on and modify their principles and recommendations to provide guidance for emerging regional frameworks. There are a few foundational pieces of work by the GSSBs that have been set out over the past few years such as FATF policies[1], FSB recommendations[2], and IOSCO principles[3] aiming to improve their existing guidance and requirements and mitigate any unintended gaps.
At a regional level, financial regulators around the world seek to implement the improvements made by the GSSBs while also enhancing and modifying local frameworks. In Europe, work on digital assets frameworks has been predominately grounded in MiFID II. The EU’s MiCA Regulation aims to complement MiFID II, and the UK’s recent consultations have also indicated that they will seek to improve upon these frameworks, and others that are already implemented in the region.
North America has taken approaches that vary widely by country. The US and Canada have drawn predominately on both existing securities and commodities frameworks. Some, such as Bermuda have been amending existing regulation for specific topics such as issuance or custody.
The Asia-Pacific region has also drawn on securities regulation, as well as payments regulation. The UAE is racing ahead with a bold new approach for virtual assets while balancing these with strong securities laws and a common law framework. South America, by contrast has seen some countries jumping straight to using digital assets as legal tender and/or as a permissible mode of payment.
From these few examples of recent policy developments, it is clear there are frameworks that should be built upon. Regulation does not need to start from a blank sheet of paper, and market participants must continuously improve and implement best practices from the responsible innovation of the previous decade.
Eliminate
“Their knowledge of their tools is purely empirical; and they have a firm belief in the mummery that surrounds them.” – Isaac Asimov, Foundation
The dangers of trust without a comprehensive understanding of digital assets and regulation are hazardous, and this is arguably evident in the rhetoric from all sides. It often appears that many are blind in their beliefs and will trust without question the technology or the current regulation from those who have taught it to them. While much of this works and appears to have a high degree of social utility, many do not have a true grasp on why it works, or how to closely interrogate any individual component to ensure it works in the future with a higher degree of social utility.
Danger may present itself in overzealous faith in DLT, especially when compounded by new regulations that are not proportional and are ill-fitting to new digital technologies. If those who work in technology regulation allow ‘mummery’ to induce a haze of belief in the infallibility of innovation, bad actors will continue to undermine the ecosystem. Blind belief must be eliminated, and replaced with verifiable transparency, compliance, and technical understanding from both regulators and market participants.
Despite much work in 2023 to advance legal definitions, there remains a lack of clarity for many market practitioners. Unclear or undecided legal status for digital assets is a clear barrier for the market. There are other missing pieces as well such as a lack of a global taxonomy for digital assets that prevent clear dialogue and comprehensive development of global frameworks.
The persistent use of the term “crypto” when referring to any kind of digital asset muddies the waters and puts Shiba Inu coin into the same bucket as a fully reserved fiat stablecoin or a bank issued digital bond. That is not a particularly helpful association, and a comprehensive global taxonomy could serve to eliminate some of this conflation and confusion.
While it is important not to blindly believe in technology, it is also important not to vilify it. In a truly technologically neutral approach DLT is not a cult, to be either worshiped or rallied against. DLT-specific risk should be assessed based on its implementation model, lifecycle activity, and network archetype and then the risk management and controls configured accordingly, with regulatory treatment to match.
So, what isn’t working? Ideologically, blind belief, while either favourable or punitive towards digital assets and DLT can be harmful to the market as a whole. From a legal and regulatory lens, lack of clarity both in the terms used, and the legalities that apply must also eventually be replaced by specificity and global consensus.
Delegate
“In dealing with the future… it is more important to be imaginative and insightful than to be one hundred percent ‘right.’” – Alvin Toffler
Beyond the foundational aspects of existing regulation and the problems still to be eliminated, what are aspects of the digital assets market that are not ‘solvable’ so to speak, by immediate regulation?[4]
DeFi is one such still evolving area where it may be prudent for regulators to delegate further analysis and research before imposing requirements. Recently, IOSCO published their consultation on DeFi[5], and the BiS also published a report on the future of DeFi[6]. Yet it is still evolving rapidly and difficult even to define. Even if the right definition is agreed upon, an enterprise that is truly decentralised in nature would present regulatory challenges and a unique and imaginative approach may be necessary.
Another item that can, and perhaps should be delegated, is RegTech. The ability for regulators to access, analyse and interpret the digital assets market is imperative. There are many RegTech solutions being created by the private sector, and regulators who leverage those innovations to implement outsourced technology, will have a fresh capability for digital supervision and this is pivotal to complete the ecosystem.
These are only two areas where perhaps creativity is needed to solve the problem. As progress is made, neither the public nor private sector may always have the ‘right’ answer, however with insight, and imagination, these answers can evolve to contribute to the broader framework in innovative ways.
My reading, running, and at times, at times self-absorbed reflections left me a singular conclusion – it is clear there is much to be improved upon, but not in the sense that what already exists is not beneficial or useful.
There is a wealth of knowledge and existing regulation that can be drawn from to build a comprehensive global digital assets framework. Dogma towards both technological developments and unclear policies should be eliminated to better support the further digital development of the global financial services ecosystem and mitigate risks.
While there are areas where regulation may not provide the (optimal) solution for society, further discovery through cross-sector, multi-jurisdictional, and public private sector cooperation remains pivotal to the success of a robust, transparent, viable, and innovative digital assets market for everyone.
Improve, Eliminate, Delegate.
By: Elise Soucie – Director of Policy & Regulation GBBC Digital Finance
