Bridging the Gap between the Mainstream Financial Market and the Crypto Industry

Michael Ou, CEO of CoolBitX, a blockchain security company and creator of the first hardware wallet that enables bluetooth-to-smartphone pairings, shares his thoughts on what needs to be done to bridge the gap between the mainstream market and cryptocurrency industry.

Crypto’s kryptonite?

 In guidance released in June 2019, the Financial Action Task Force (FATF) revealed its latest standards for mitigating money laundering and terrorist financing. The 200 global jurisdictions committed to FATF recommendations are required to comply with Recommendation 16 aka the “travel rule”. What this means for Virtual Asset Service Providers (VASPs) registered or licensed within FATF member countries is that they will be required to exchange and hold personally identifiable information (PII) to each other when transferring crypto assets. Many in the cryptocurrency industry have baulked at this and other instances of increasing regulatory oversight, but could this actually be the push the crypto industry needs towards mainstream adoption in the financial market?

The majority of blockchains do not have a built-in protocol to automatically capture the real-world identities of its users, and digital assets are either pseudonymous like Bitcoin, or anonymous like privacy coins. For the more libertarian-minded, this is the big draw towards cryptocurrencies in the first place, though some now view it as a weakness that is impeding the adoption of digital assets among the masses. Over 50% of Americans own stocks, but only 2% own Bitcoin, as estimated in a 2018 Wells Fargo/Gallup poll. About 1 in 4 investors in the US are intrigued by crypto assets but are reluctant to buy it in the near future considering its price volatility and uncertain legal status. There is a need for stability and security in the crypto industry, and regulations could be the key to establishing a safer and more mature environment that can benefit the industry and its stakeholders in the short and long-term.

Setting the rules in black and white

At the moment, crypto-friendly financial institutions and banks are few and far between. Established institutions are put off by the legal uncertainty surrounding virtual assets, a lack of technical knowledge,  as well as the costly systems for AML/KYC that are required of them when complying with ambiguous and divergent regulations. On this point, putting in place a clearer and coordinated regulatory framework can help financial institutions categorise and understand the functions of various cryptocurrencies, effectively giving them the green light to invest in virtual assets. We can see that regulation is already affecting the industry in the slew of privacy coin delistings that show how VASPs are taking tougher measures in the move toward compliance.

It seems like any small sign of cryptocurrency’s wider adoption can trigger a substantial price jump.

Eventually, regulations like the “travel rule” will lead to a divide in crypto assets between the regulated and unregulated sides of the coin. By tying identifiable information of users to virtual assets, crypto exchanges and regulators will be better able to identify and validate legal transactions while recognising those tied to illicit activities such as money laundering or terrorism funding. Criminals and bad actors will be driven underground where their digital assets can only exist through legal ambiguity or in clear violation of the law. Unregulated assets will in time become less fungible and their value will be weakened, whereas robust regulation will allow compliant virtual assets to become increasingly stable and fungible, thereby improving their appeal to institutional and individual investors as a legitimate long-term investment rather than a short-term speculative opportunity.

Getting the price right

It seems like any small sign of cryptocurrency’s wider adoption can trigger a substantial price jump. But whether it’s Facebook’s Libra launch or China’s newly announced pro-blockchain stance, the excitement inevitably peters out, and the value of cryptocurrency drops again. A high cryptocurrency price should not be the end goal — Bitcoin’s rapid price rise in 2017 ended in a crash and massive losses for investors because of market manipulation, over-valuation, and financial scams. What cryptocurrencies need instead is a level playing field where real identities can be tied to illegal transactions, and market manipulators can be stopped and held accountable. In a regulated marketplace, individual virtual assets can be better-judged on their merits and the economic forces of supply and demand, thereby attracting a larger pool of investors who will provide liquidity and allow for a more accurate valuation of cryptocurrency’s worth.

Regulation will also make virtual asset ownership more secure, and set the stage for virtual asset custodians and owners to be more accountable in their transactions. VASPs will have the ability to reject suspicious transaction requests, stop irregular dealings in progress, or reverse transmittals after the fact if law enforcement can establish that they are tied to unlawful conduct. Lawbreakers and con artists will know that they leave a virtual trail behind them even whether their crimes are successful or not. In the long-run, increased cooperation between VASPs and financial institutions means that more sophisticated and technologically advanced security solutions can be developed for the protection of legitimate crypto users. For instance, traditional finance is more advanced in AML-compliance, and VASPs with access to this professional expertise will be better equipped to identify bad actors on their platforms.

In a regulated marketplace, individual virtual assets can be better-judged on their merits and the economic forces of supply and demand, thereby attracting a larger pool of investors who will provide liquidity and allow for a more accurate valuation of cryptocurrency’s worth.

Going the distance

It is surely only a matter of time until we have a solid regulatory framework with which crypto exchanges can operate in different markets. If there is enough coordination between regulators, VASP users will be allowed to send virtual asset transmittals to any regulatory-compliant destination in the world without needing to undergo time-consuming KYC registrations each time they open an account. A universal digital profile linked to their personal identities can instead be created and used for more efficient trading of virtual assets. With improved regulation, traders and institutional investors may be more willing to invest a larger portion of their portfolios exclusively in cryptocurrency if it offers them the same protection as physical currencies.

All in all, it is short-sighted, and ultimately futile, to rail against impending regulation of the crypto industry around the world. Increasing regulatory oversight is merely a step towards mainstream acceptance for cryptocurrencies, and there are far more benefits to outweigh the negatives in the long-run. The writing is on the wall and for crypto to keep growing as a sector, we need more than the experts and enthusiasts to get on board — we need the general public to have trust in and access to the technology. Some VASPs may be afraid that implementing strict KYC processes will hurt their businesses, driving their customers to exchanges with laxer rules. However, to go the distance and have viable businesses in the long run, it would behove VASPs to get ahead of the game and implement solutions that will allow them to be compliant with minimal disruption to their businesses.

Regulation isn’t the end of the line for the crypto industry, it’s actually the starter pistol going off. So now it is up to the industry players, big and small, to work together with regulators in addresses their biggest concerns and have a say in the direction of the industry’s future.

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