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The taming of the Wild West — Part III

The taming of the Wild West of the United States from the middle of the 19th century was not a quick or simple process. Ultimately, the US Government was able to impose the rule of law and to ensure adequate protection of property rights. What do regulators need to remember if they really are to tame the Crypto World?

Like the Wild West, the Crypto World is not likely to realise its enormous potential until it is characterized by the rule of law and adequate protection of property rights. [See Sidebar — How the West was won] Over the last two years or so, the Crypto World has developed so rapidly that regulators around the world have struggled to keep up with the changes. In fact, the pace of change is one of the main differences between the Crypto World and the original Wild West.

The other key difference is that Crypto World — unlike the Wild West — is not confined to one country. Crypto-exchanges may be found in many places. So too are the Crypto-VC entrepreneurs who are developing new crypto-coins that are made available to the public through Initial Coin Offerings (ICOs). The public, of course, includes crypto buyers and traders in all corners of the globe.

As of mid-2018, it is very clear that many regulators rightly realise that the Crypto World needs to be tamed. It is also becoming clearer what are the principles that any government or regulator needs to follow if it is to have a lasting impact on the Crypto World:

AML/CFT or what? The globality and (pseudo-) anonymity of the Crypto World means that it is well suited for money laundering, circumventing rules governing foreign exchange transactions and funding of illegal transactions. However, there are many other issues that need to be considered. How are crypto buyers/traders protected against theft by hackers? What mechanisms are in place to prevent insider trading and other market abuses? The effective regulator makes it clear what is the issue or problem that it is addressing, and knows that it may have to deal with several challenges at once.

Eco-system or what? In conventional financial systems, there is an eco-system with many different stakeholders. Stock exchanges usually work effectively with traders/crypto buyers, issuers, the issuers’ advisers, payments systems and other service providers even if each of these stakeholders is overseen by a different regulator. The Crypto World is evolving so quickly that is still not entirely clear how the eco-system will work in six-to-twelve months’ time. The regulatory environment is especially opaque. A regulator that attempts to think of the entire eco-system may produce inadequate laws and rules. A regulator that ignores the eco-system in its entirety will produce inadequate laws and rules.

Crypto-currency or what? There are many reasons why official bans on trading of virtual currencies are flawed. Most crypto-coins are not conceived as money. They may be used to incentivise communities, assist the funding of new ventures, make it easier for individuals to buy into illiquid assets (such as commercial real estate) or a lot of other things. Further, people who are physically in country X can often trade crypto-coins through crypto-exchanges that are based in country Y. The effective regulator develops rules that are sufficiently flexible to recognise this.

Securities or what? A security provides ongoing evidence of an obligation from the issuer to the holder. It is true that some crypto-coins do this. However, a lot of crypto-coins (including Bitcoin, for instance) do not. Existing securities regulations will work well for crypto-coins that have the characteristics of securities. They will also work well with crypto-exchanges that solely handle securities. In all other situations, new regulations will need to be developed. The effective regulator is an innovative one.

National collaboration or what? In many countries, it makes sense to have more than one financial regulator. If country Z is to have a regulatory regime for the Crypto World that works, all regulators in that country will need to have, and to communicate, consistent policies.

International collaboration or what? Virtually all governments globally are co-operating in relation to anti-money laundering and countering the financing of terrorism (AML/CFT) issues. However, the financial systems of different countries differ from each other, and for valid reasons. This means that there is no ‘one size fits all’ regulatory regime that will automatically work in every country. The Crypto World, on the other hand, is a single — if complex, rapidly changing and often misunderstood — place. The regulator that develops the best overall regime for the Crypto World may well find that its ideas are emulated by regulators in other countries. Being seen as a leading crypto-regulator should bring other advantages (such as the arrival of crypto-exchange operators and crypto-VC entrepreneurs).

Sandbox or what? A regulatory sandbox is a conceptual (and sometimes a physical) place where new and innovative companies can develop freed from most of the regulatory constraints that would normally apply. In a number of countries, the regulators provide a sandbox in order to promote start-ups. A constraint on a sandbox is that much of the finance that is available typically comes from conventional venture capital (VC) community. VC financiers are usually very bright and effective people. However, most of their work involves companies that have actually been established (and survived) for some time. The Crypto World is different from a sandbox in that it connects the retail public with enterprises that are genuinely start-ups. The truly successful regulator is one that understands this.

Co-regulation or what? The novelty and the pace of change of the Crypto World means that the work of the regulator will likely be much easier if it collaborates closely with operators of crypto-exchanges and crypto-VC entrepreneurs in the development of new rules and laws. It could well be that the geographic centres that have the greatest impact on the growth of the Crypto World over the next two years are those where the stakeholders do the most to regulate themselves.

Sidebar: How the West was won

The first railroad across the United States was completed in May 1869, at Promontory Summit, Utah. That did not of itself cause the Wild West to be tamed. For example, Colonel George Armstrong Custer died in the Battle of Little Bighorn in June 1876. The Gunfight at the O.K. Corral took place in October 1881. The famous outlaws Butch Cassidy and the Sundance Kid did not meet their end (in Bolivia) until November 1908.

Nevertheless, the railroad dramatically reduced the costs and risks of moving people, animals and things from the Eastern states to the West Coast. Other opportunities came from improved communications (with the transcontinental telegraph being completed in October 1861), industrialization and large scale immigration to the United States. North America was changed forever.

What really mattered, though, was that the US Government had the will, the money and the understanding of the issues to impose the rule of law and to ensure adequate (if not always just) protection of property rights. The West became a lot less wild, and it flourished.

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