The conversation around crypto regulations and compliance is often centered on the crypto industry, but we must not forget the crypto user. The purpose of financial regulation is to maximize consumer protection, prevent fraud and abuse, and ensure well-ordered markets. This mission is the same in any jurisdiction and for any financial regulator. As long as we focus too much on whether specific exchanges must follow new or existing regulations, we miss the chance to consider how consumers can best benefit.
Timothy Cradle, the director of regulatory affairs at Blockchain Intelligence Group and compliance advisor to Biokript, believes that crypto regulation and compliance must be viewed from a dispassionate perspective. The question to ask is, “What needs to be done to ensure compliance?” Too restrictive regulations negatively affect a business model, while too permissive regulations set them up for long-term failure. Compliance professionals take personal liability for the compliance programs they recommend, so getting it wrong is a career-existential concern.
When looking at the two counterposed operating models in crypto, decentralized and centralized services, the potential failures of each can only be addressed if each extreme borrows from the other. The ultimate goal of crypto is to provide individuals with a better financial system. In fact, the U.S. Department of Treasury highlighted many of the noteworthy financial crime risks decentralized finance (DeFi) poses – including money laundering, theft, scams, and sanctions evasion. The agency noted that “DeFi services often have a controlling organization that provides a measure of centralized administration and governance.”
In this context, imposing the same sort of regulatory controls expected of a centralized institution on DeFi is neither impossible nor unreasonable. The Digital Assets Anti-Money Laundering bill introduced to the U.S. Senate in December 2022 seems to come to the same conclusion as it seeks to bring any service that “facilitates digital asset transactions” into the scope of the Bank Secrecy Act (the U.S. anti-money laundering law). A simple search of crypto theft, rug pulls, hacks, and scams will point to a litany of DeFi failures. The centralized players obviously have their own problems.
In just the past month, we’ve seen scathing revelations about Binance and its avoidance of the most basic forms of compliance, namely know-your-customer (KYC) and regulatory registration rules. Binance is being sued in the U.S., likely to withdraw from Canada and the U.K., and may lose its license in Australia (whose regulator included a full list of Binance’s regulatory failings in the license announcement). We’ve also seen multiple players in the U.S. incur fines for not registering their securities products with the Securities and Exchange Commission, which of course means little to no consumer protection was in place for the users of these products. This was all following the year of shame which was 2022 when billions of dollars worth of crypto were lost to outright fraud, market manipulation, embezzlement, and bankruptcy – losses largely preventable had these players not also had direct control of their user’s assets.
To make both centralized and decentralized entities work well, we need transparency and accountability from centralized entities. These firms must be required to ensure they are acting in the best interest of users, disclose the risks in an honest way, and can be forced to provide the necessary disclosures to that effect. They must also implement cybersecurity, fraud, and money laundering controls. From decentralized entities, transaction settlement must lie with the service, while asset custody always remains with the user. We must remember that the ultimate goal of crypto is to provide individuals with a better financial system than what they’ve gotten from legacy systems. The ultimate goal of regulation is to ensure consumers are protected.
The right rules to oversee crypto are already in place to protect consumers. What the industry needs now is to embrace the right aspects of centralization without losing the tenets of decentralization. The best result can be achieved by mixing the philosophies of centralized finance and decentralized finance to achieve a system that’s fair and useful for all participants.