Can self-regulatory organizations (SROs) provide a solution to the regulation problem in cryptocurrency markets?
Tyler and Cameron Winklevoss, who own crypto-trading exchange Gemini, think they might and recently unveiled a proposal for a Virtual Commodity Association, a self-regulatory organization for cryptocurrency markets that promotes “price discovery, efficiency, and transparency” through adoption of industry standards. (See also: All about Gemini, the Winklevoss Bitcoin Exchange.)
Among other things, it aims to introduce information sharing, rules-based markets, and surveillance systems to an industry whose workings are largely hidden from public and government scrutiny. (See also: Should Cryptocurrency Exchanges Self-Regulate?)
Their proposal has received a cautious welcome from members of crypto markets.
“The (cryptocurrency) industry suffers from a lack of transparency, sometimes ethics, and, to a large extent, clearly-defined rules that participants can follow,” says Rob Viglione, founder of Zen Cash, a cryptocurrency.
The combination of an opaque technology and a free-for-all ecosystem has drawn harsh reactions and extreme statements from economists and government regulators. According to Viglione, there is a danger that government regulatory scales might “tip too far as a reaction to egregious behavior” by cryptocurrency exchanges.
The introduction of rules could result in a couple of tangible benefits for SROs. For example, minimum capital requirements and audits could help prevent bankruptcy and build trust. Most cryptocurrencies exchange with fiat currencies and Tether, a coin that trades at parity with the U.S. dollar and claims to have equivalent amounts of the fiat currency in it bank account as backing. This could be a problem.
“Exchanges that interface with fiat (currency) have the additional risk of liquidity crises or complete insolvency,” explains Rachel Lam, vice president of regulatory strategy at Polymath, a startup that provides services for issuing security tokens to organizations. (See also: Tether and Bitfinex Crypto Companies Subpoenaed By U.S. Regulators.)
A self-regulatory organization could also help preserve an ecosystem of innovation within cryptocurrency markets. Much of the investment in cryptocurrencies is based on expectations of future growth of underlying protocols. Recent problems, whether they relate to a slowdown in transaction speeds or spiraling transactions fees, have only highlighted the need for further research on protocols. (See also: Bitcoin's Lightning Network: What Is It and Can It Solve Bitcoin's Scaling Problem?)
Government regulation could bottleneck innovation by saddling it with compliance rules. SROs are a middling path. “For regulators, this hopefully means ensuring consumer safety without stifling innovation,” says Chris Housser, co-founder of Polymath.
To be sure, this is not the first time that self-regulatory organizations have been proposed to monitor financial markets. Back in the 1970s, an explosive growth in futures contracts and options trading led to an increase in futures fraud and unscrupulous actors within its ecosystem.
The Commodities and Futures Trading Commission (CFTC), which was a newly-formed agency then, struggled to maintain order but failed and was even described by some as “one of the most screwed up (agencies) in the whole Federal Government.” The end result was the establishment of the National Futures Association (NFA), an SRO for futures markets which works in coordination with CFTC to implement order in the industry. The NFA’s introduction brought order and consensus among futures.
Not a Magic Bullet
There have already been similar, concerted efforts to bring order to the cryptocurrency ecosystem. For example, Japan’s cryptocurrency exchanges came together to form an SRO after the recent Coincheck hack. South Korea’s crypto exchanges formed one in November 2017. (See also: Coincheck.)
In spite of their popularity, however, SROs might not prove to be a magic bullet to an industry’s problems.
For example, the NFA has been accused of falsifying facts and manipulating data to suit its ends. A similar situation in cryptocurrency markets could lead to a collapse of multiple markets, from exchanges to futures.
Much also depends on governance of the agency. “As with any body with governing responsibilities, it (the SRO) must stay focused on its objectives and answer to its stakeholders and avoid abuse of power,” says Lam from Polymath.
In the absence of details about the Winklevoss twins' proposal, it is also not clear how an SRO will function within the crypto industry. For context, NFA conducts an assortment of activities within its umbrella. These range from conducting exams for trading futures to performing audits on members to offering swap execution facilities. The breakneck speed with which cryptocurrency markets have developed has left several big holes in their ecosystem. Whether a single organization or consortium can plug those gaps is still up for debate.
“This (self-regulation) will not be accomplished by a single entity of ecosystem projects,” says Joseph Weinberg, chair of Shyft Network, a blockchain-based solution for identity compliance, adding that the same problem is being tackled by the G20, OECD, and FSB. “The crypto markets can force transparency inherently via blockchain technologies and open-standard protocols. And as an industry, I think we can build a shared rule-set that enables openness in our markets and for the world.”
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