Cryptocurrencies are facing an ‘existential moment’ – and time is running out to align on standards

International crypto regulation is suffering from coordination problems. FTX’s collapse signalled greater urgency is needed to harmonise standards
The deepening ‘cryptocurrency winter’ has wiped out more than US$2 trillion from digital currency markets globally over the past 12 months

Liam Gibson

Published: 9:00am, 20 Nov, 2022

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The sudden implosion of FTX earlier this month – the world’s second largest cryptocurrency exchange – has delivered a body blow to the crypto world. As the contagion spreads throughout the ecosystem, with cryptocurrency lender BlockFi edging towards bankruptcy and exchanges Crypto.com and Binance assuring investors they won’t be next to fall, many fear cryptocurrency’s “ Lehman Brothers’ moment” has arrived.

Precipitated by earlier tremors, like the collapse of stablecoin Terra Luna and cryptocurrency bank Celsius Network, this crisis has taken 2022’s crypto winter into an even deeper freeze. All told, the meltdown has wiped out more than US$2 trillion from global cryptocurrency markets over the past twelve months.

At this week’s V20 Summit in Bali, an official G20 event and the cryptocurrency industry’s peak regulatory industry dialogue, delegates have grappled with the fallout.

“This is an existential moment,” summit chair Mark Pesce told the conference in his opening remarks.

“The industry that emerges, post-FTX, will not look very much like that which existed pre-FTX. That simply won’t be allowed – both for political reasons, and for financial ones … we’re in for a very rough ride.”

The urgency to enhance oversight of cryptocurrency is building. Yet, despite policy proposals from industry bodies and efforts by international standard setters to guide governments, effective regulation has been hampered where it really counts – in nation states. Though there are several notable leaders such as Singapore and Switzerland, many countries have not yet introduced a complete legal framework for digital assets.

The absence of clear laws has permitted opaque, overleveraged platforms like FTX to morph into pillars of the supposedly-decentralised industry. Now, as their shoddy foundations begin to crumble, they pose a systemic risk to the entire ecosystem.

Adoption of international standards among nations has not only been slow, but highly fragmented.

The intergovernmental Financial Action Task Force’s (FATF) “travel rule” is a case in point. Designed to counter money laundering and terrorist financing in traditional banking, the rule mandates the collection of personal details from the sender and receiver of transactions.

FATF extended the regulation to cover virtual asset service providers in 2019. Yet, as of June this year, the watchdog found only about one-quarter of 53 countries to be fully compliant in enforcing the order on virtual asset platforms.

This situation is of “extreme concern”, FATF officials told delegates at the V20 conference, urging national governments and the industry to do more to uphold standards.

Yet service providers are in a bind. For them, compliance is less a technical challenge and more a question of which rules to follow. Many governments have not implemented FATF guidelines, and even among those that have, divergences remain.

For instance, FATF’s recommended threshold for reporting on the travel rule is any transaction valued at US$1,000 or more. Yet it is US$3,000 in the US, while in Switzerland it is effectively zero dollars, and other jurisdictions, like Canada, set an aggregate sum of C$10,000 (US$7,500) within 24 hours.

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This then gives rise to the “sunrise problem” – if cryptocurrency providers should interact with other providers in different jurisdictions operating under different standards.

There is also a mismatch in terminology between countries, even on foundational concepts, such as distinguishing virtual assets from digital assets.

“We need to have clarification and legal alignment on definitions,” said Loretta Joseph, who has advised several countries on regulating virtual assets as deputy chair of the ADC Global Advisory Group. “With a global standard terminology, we’d have a much better idea of how to proceed.”

Clarifying these terms must be a priority, especially now that other international standards setters, like the Financial Stability Board (FSB), are entering the fray.

FSB officials told the V20 that the FTX crisis has so far not threatened stability in the broader financial system, but cryptocurrency’s growing role means that similar events in the near future could cause a systemic risk.

The FSB put out a consultative document last month, outlining nine recommendations based on the principle “same activity, same risk same regulation”, signalling its intention to apply the same standards used in traditional finance to cryptocurrency. It is currently canvassing feedback and aims to finalise these standards at next year’s G20 summit in New Delhi and begin reviewing implementation worldwide in 2025.

Meanwhile, the International Organisation of Securities Commissions, the global body for securities regulators, also formed a task force for cryptocurrency markets this year, with policy recommendations due at the end of 2023. Its mandate covers protecting investors from loss of assets in events such as the FTX collapse, which has now affected an estimated one million creditors.

Yet if these organisations encounter the same hurdles as FATF, it could be years before guidelines on stability and investor protections are broadly adopted. It’s doubtful the ecosystem will survive that long without proper safeguards.

“Recent events have really reinforced the need for speedier implementation of standards,” Rick McDonell, co-founder of McDonell-Nadeau advisory firm, and former executive secretary of FATF, told This Week in Asia.

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Time is running out to fix this coordination problem. The longer it is left unresolved, the larger the regulatory gulfs between jurisdictions may become, which will not only hamper the development of the asset class, but leave loopholes for criminals to exploit.

If more drastic action is not taken to change course, the cryptocurrency ecosystem risks becoming a permanent pariah of the financial system and the domain of bad actors, rather than a vehicle for financial inclusion and an engine for economic growth. International regulators, national governments and industry players must work harder to converge the rules for cryptocurrency and salvage this technological revolution while they still can.

Liam Gibson is a freelance journalist and opinion columnist who regularly writes on geopolitics and technology for leading Asian publications.