Many in the cryptocurrency world stay awake at night worrying about what regulators will do next. The industry lacks firmly established standards, which means that the jurisdiction you are operating in could close its doors without warning, and a grey zone will turn pitch black.
This was not the case on Wall Street, where I spent the majority of my career as as an equity and derivatives trader. The rules were clear, and people were acutely aware of the lines that must not be crossed. When people made mistakes, both intentionally and unintentionally, they faced the consequences. I saw traders execute illegal short sales of stocks, massively driving down a stock for a quick profit. When the market noticed, regulators stepped in and suspended the firm’s business for a month, costing millions of dollars in lost revenue. The head of the desk and the trader responsible were passed on a promotion and both left the firm shortly after.
This healthy tension between bankers and regulators was supposed to keep people in check. And still, it wasn’t enough. The 2008 global financial crisis was caused by overconfidence in the idea that financial markets would take care of themselves. Insufficient oversight resulted in the massive growth of sophisticated structured products and derivatives, or “financial weapons of destruction,” and the rest is history.
The global financial crisis has left a deep and permanent scar. Regulation became extremely strict. Compliance, not business, became bankers’ priority. New legislation to prevent banks from acting recklessly and to protect consumers went into place globally, most notably the Dodd-Frank Act in the United States. Dodd-Frank included the Volcker Rule that restricts US banks from undertaking certain speculative businesses that are not in the benefit of their customers. This included proprietary trading, which was a very lucrative business until the crisis.
The Markets in Financial Instruments Directive (MIFIDD II) in Europe also aimed to increase consumer protection and transparency in investment services. To comply, brokers must provide much more data about their transactions, and asset managers who are managing customer money have stricter obligations to ensure that they are paying the most competitive prices. This is a huge cost burden to the industry. Bankers clearly needed to be reeled in. But one could argue that they are now in a strait jacket.
So what can cryptocurrency regulators learn from Wall Street’s experience? The main lesson is that we shouldn’t fear regulation, we should fear bad regulation.
Regulation is necessary, and good, for cryptocurrencies. The current lack of regulatory oversight leaves the space wide open for businesses to operate without accountability, leading to a flood of fraudulent initial coin offerings, or ICOs. The trick is finding a regulatory framework that sets clear guidelines without stifling innovation.
Japan in particular could learn from Wall Street’s experience. Japan has famously been one of the most progressive countries on cryptocurrency, but now risks clamping down too hard. Japanese regulators were quick to adopt Bitcoin. The amended Payments Services Act legalized virtual currencies as a form of payment and also implemented a regulated crypto exchange licensing system. These stamps of government approval, along with increased demand from China and Korea, catapulted Japan to the world’s center of cryptocurrency trade.
Even in Japan, however, regulations are far from perfect. There is a common misperception that Japan is a crypto heaven, or a free for all for ICOs. This is not the case, especially now. The legislation that was passed last year was intended for the adoption of digital currency payments, and has yet to adapt to the rise of ICOs. The FSA thus began requiring crypto exchange license for any crypto-fiat swap including ICOs as well as Bitcoin ATMs. This one-size-fits-all approach has essentially put a halt to ICOs in Japan as well as startups trying to develop digital payment services.
Making matters worse was the hack of the Japanese cryptocurrency exchange Coincheck earlier this year, which resulted in the loss of $500 million. This hack demonstrated that some exchanges’ security standards were lacking, and the Japanese Financial Services Agency naturally became hesitant to sanction new businesses. Now, with hundreds of licenses waiting to be approved and ICOs anxiously still waiting for the nod of approval, the Japanese crypto and blockchain community feel a strong sense of crisis. Ill-implemented regulation is already hindering industry growth, and could potentially kill the entire market. Dialogue between regulators, businesses and consumers is crucial for shaping the ideal regulatory framework.
France’s Finance Minister Bruno LeMaire has highlighted the need for regulation without suppressing innovation. He said that France intends to become the first major financial center to propose an ad-hoc legislative framework for companies making an ICO. “We should not miss out on the blockchain revolution,” LeMaire said.
We must not let Wall Street’s bitter experience spill over into the cryptocurrency space. It’s not a coincidence that so many people are leaving investment banks to work on blockchain startups. Banking is just no longer the innovative, exciting and glamorous workplace that it once was. The blockchain industry, by contrast, is populated with ambitious entrepreneurs with a different vision of the future. Regulation must help these entrepreneurs thrive, not wither.
Ken Yagami, the Japan country manager at SwissBorg, formerly worked at Bank of America Merrill Lynch, Deutsche Bank and Morgan Stanley.