Regulation has been a hot-button issue in the world of cryptocurrency, with a greater emphasis on security, consumer protections and integrating digital assets into the rest of the economy than at any other point in crypto’s relatively short history.
The most recent news on this front was a proposal by the United States Consumer Financial Protection Bureau to make whole consumers who lose funds due to highs, unauthorised transactions and other instances of fraud.
This would mean that people with digital assets in a crypto wallet app would receive protections and service providers would need to ensure they have suitable reserves to pay back consumers and make them whole, extending the protections seen in the Electronic Fund Transfer Act to other digital assets.
In many respects, this would be positive for people getting into crypto for the first time, as they would sidestep the issues that have faced the decentralised finance space during its history.
At the same time, however, it would lead to some fundamental changes to the nature of blockchain finance which might cause it to lose certain aspects of its appeal.
The regulation debate is the biggest and most passionate in the crypto space, particularly given the wider geopolitical implications, and for developers and investors, it is about the trade-off between flexibility and the ability to move fast against ensuring the market is moving in an ethical direction
Parallel No More
The biggest criticism of the potential for greater regulation is less about practicalities and more about philosophies.
Historically, the reason for the creation of Bitcoin was to avoid the regulatory issues that had surrounded previous digital currencies such as E-Gold, Liberty Reserve and, to a lesser degree, Flooz and Beanz in the early 2000s.
All four of them, as well as the initial wave of physical crypto coins that doubled as wallets fell foul of money-transmitting business licensing regulations and, in the case of Liberty Reserve, it did not matter that the company was not based in the country that shut them down.
The decentralised nature of the blockchain allowed for a parallel economy that avoided many of the global barriers that came with stock trading, options or forex.
At the same time, however, there was from an early stage an understanding that because the cryptocurrency in your wallet is not representative but is the actual unit of exchange, any issue with trades, transactions or linking a wallet to a service would basically be impossible to fix.
The only way to reverse transactions on the blockchain is a hard fork, as happened following the collapse of The DAO after an exploit was found in the prototypical decentralised autonomous organisation that an attacker used to steal millions of dollars worth of Ether.
The DAO Attack was a huge moment when it came to the blockchain, not because of the money that was lost but because it was the first example of a blockchain-based organisation that was deemed “too big to fail” and was, effectively, bailed out.
This violation of the mantra of “code is law” highlights that there have always been elements of regulation and higher-level control when it comes to the blockchain, and with that comes the potential for a much firmer invisible hand to guide the market.
As more people enter the cryptocurrency space, it is not really good enough to simply claim “caveat emptor” given that people should be able to trade cryptocurrency without a degree in cryptology, computer science or finance.
The greater the protections, the greater the trust of cryptocurrency itself, and the more opportunities there will be for good-faith traders to make money through trading, buying and selling tokens.
The recent history of cryptocurrency bears this truth out. In 2022, Bitcoin plummeted to below $20,000 following the collapse of FTX and the criminal prosecution of Sam Bankman-Fried.
It took two years before former customers were made whole again, and this was aided in no small part by improvements in regulation catalysed by the collapse in the crypto market and bankruptcies such as FTX.
The culmination of this, and the reason why crypto has ballooned in value in 2024, was regulatory approval. In this case, it took the form of exchange-traded funds which allowed pension funds and traditional financiers to trade in crypto without wallets and without exposing themself to the market.
Further regulation would likely bolster the opportunities to interlink crypto and traditional finance, particularly given the perception of Bitcoin as a type of digital gold, and that would in turn not only help current wallet holders but potentially inspire new ones.