What is the future regulation of crypto?

In November 2022, due to mounting turmoil, crypto asset exchange FTX collapsed in just five days, causing many investors to lose enormous assets.

The impact of the collapse of the world’s second largest exchange was so significant that major crypto assets such as Bitcoin and Ethereum collapsed across the board and projects that had relied on FTX collapsed in a chain reaction. Including indirect damage, it can be assumed that more than ten billion dollars will be needed to cover the damage.

This collapse was also inevitable when Enron’s FTX defrauded investors with massive accounting fraud (window dressing), engaged in insider trading and faking the failure of many investments. The two companies also share the same cunning of donating money to the Republican and Democratic parties and suppressing the political side. The fact that the headquarters of both companies collapsed shortly after entering the Japanese market is also strangely synchronous.

This type of incident is not unique to crypto assets. Still, it is based on traditional fraud techniques: accounting manipulation, undue inflating of company value, embezzlement of customer funds, etc., a combination of fraudulent activities prior to crypto assets.

How to prevent a recurrence

However, there are also circumstances specific to the crypto asset industry that led to the collapse of FTX. The regulation of crypto assets has yet to mature. Therefore, unlike the highly regulated financial sector, there is room for various evasions and fraud.

Also Read: Light at the End of the Crypto Tunnel? How to emerge stronger from it

For example, only a few countries have fully regulated insider trading in crypto assets. Combined with the high level of anonymity due to its technical nature, fraud is straightforward. While this cannot be proven, insider trading has likely occurred on a significant number (or almost all) crypto asset exchanges.

Insider trading does not harm the assets of the exchange but rather increases them, except when it is an appropriation of client assets; A major cause of the FTX collapse was the dramatic drain on capital through the misappropriation of client funds and the subsequent run on them. The key to avoiding repetition is regulation to protect customer assets.

Notable Japanese Regulations

In this regard, Japanese regulation is progressive. Japan has learned from the typical failures in the crypto asset industry, like the Mt.

First, as with securities and forex, clients’ crypto assets are to be segregated and managed separately. CPAs regularly review the separation to ensure it is being performed correctly. They also check whether cold wallets and multisig are used sensibly. The segregated crypto assets will be used to reimburse investors in the event of an exchange failure (i.e. 100 percent of deposited funds are guaranteed to be returned).

In addition, Japan is also trying to lead the world in systematic regulation of stablecoins. Although there is a general criticism in Japan that “Japan is too tightly regulated, making it difficult to start a crypto-asset-related business”, there is an opinion that this strict regulation and monitoring system is a lesson learned from the past and it also prevented significant incidents from occurring after FTX went bankrupt.

The need for global regulation

But even in Japan, the crypto assets of FTX JP clients remain frozen. Since the assets of FTX JP (as well as those of bankrupt FTX and its affiliates) will be used to repay FTX Group’s creditors (including its clients), it is not clear if they will be returned to investors after bankruptcy, although they will separately and separately managed.

Also Read: The Future of Blockchain Technology Goes Beyond Cryptocurrency and NFTs

The reason for this is said to be that FTX JP’s customers cannot be given priority in repayment. In other words, if the parent company is based outside of Japan, the assets of the Japanese subsidiary’s customers would not necessarily be protected in the event of the parent company’s insolvency.

Therefore, there is a limit to considering only one country when it comes to regulation. FTX broke through by operating in the Bahamas with virtually no regulations. In the Bahamas, taxes are low and there is no need to file accounting records with the authorities.

This scheme of establishing headquarters in a tax haven and incorporating a company in the US or Japan as a subsidiary is often used in the crypto-asset industry (as in other sectors). In this case, the subsidiary is subject to strict regulations, but the parent company is not.

Therefore, the risk of the parent company failing due to the misuse of client funds, as with FTX, cannot be ruled out, no matter how many regulations are enforced in the country where the subsidiary is located.

In order to fundamentally solve this problem, it is imperative to create a global standard for regulation. Although many experts have pointed out, the road to realization is exceptionally long, as it takes work to reach a global consensus.

However, without international emphasis and the establishment of appropriate and consistent international rules, clients’ assets cannot be protected and the crypto-asset industry cannot be further developed.

It’s not that the blockchain side isn’t responding to anything; there are already blockchains like Concordium, which performs full KYC and can identify individuals in case of illegal activity, while usually remaining anonymous; Concordium has stated that it will be improved in response to regulations.

The idea is to change the blockchain according to international regulatory trends (many are ready for hard fork and many nodes understand this).

Editor’s note: e27 aims to promote thought leadership by publishing opinions from the community. Share your thoughts by submitting an article, video, podcast, or infographic

Join our e27 Telegram group, FB community or like the e27 Facebook page

Image credit: Canva Pro

The post What is the Future Regulation of Crypto? first appeared on e27.