Regulators are reacting to the rapid expansion of the cryptocurrency markets, but crypto exchanges also need to incorporate surveillance into their infrastructure to ensure market integrity.
Bitcoin was originally created in 2009 to serve as a monetary system outside the controls of governments and central banks. Twelve years later, more than 6,800 different cryptocurrencies are trading across the world. The IMF has reported that the market capitalization of the cryptocurrency market almost tripled between January and early May 2021 to an all-time high of US$2.5 trillion. Notably, some cryptocurrency ETFs and private funds have been launched recently, and decentralized finance (DeFi) continues to grow in popularity.
Central banks and securities regulators worldwide have moved past the point of merely tolerating issuance and trading activity toward greater regulatory engagement. For example, the Swiss Financial Market Supervisory Authority (FINMA) approved its first crypto fund in September 2021. Germany’s Federal Financial Supervisory Authority (BaFin) issued its first cryptocurrency custody license in June. In a landmark decision, the U.S. Securities and Exchange Commission approved a couple of bitcoin-futures ETFs, which were launched on regulated exchanges in October. Canada, Dubai, Brazil and the Nordics had already approved cryptocurrency-based ETFs.
In addition, multiple central banks – from Germany, France, Sweden and the U.K. to Hong Kong, India and China – are evaluating the pros and cons of central bank digital currencies (CBDCs). Nigeria has already launched one, the eNaira. Significantly, El Salvador passed a law in 2021 requiring businesses to accept bitcoin for all payments, making it the second country (after Japan) to recognize cryptocurrency as legal tender.
The acceptance of cryptocurrencies is increasing, but at the same time, there is a reason for caution. The market is extremely volatile, and there have been many instances in which these assets are used to commit fraud and money laundering. Regulators have demonstrated their willingness to be proactive in issuing fines or even shut down non-compliant cryptocurrency businesses.
Regulators do not want to stunt innovation, and some recognize that cryptocurrencies could play a role in economic development. To this end, they have been working diligently over the last few years to create a legal framework that is modern and accommodative but also prudent. Significant progress has been made in defining token types and uses, figuring out how they fit into existing law and developing a licensing structure. Some regulators have encouraged an open dialog with the industry and created sandboxes for firms to test their solutions.
Global organizations have provided valuable input as well. The Financial Action Task Force (FATF) has issued and updated guidance for preventing money laundering and terrorist financing through cryptocurrencies. In addition, the Financial Stability Board (FSB) has published and updated a consultative document on the regulatory issues surrounding global stablecoins. Regulators in many countries have made some kind of statement about cryptocurrencies, and you can view a summary here – some jurisdictions are more progressive than others are.
Large institutional investors are adopting cryptocurrencies more widely, and their participation will benefit the long-term stability and growth of the cryptocurrency ecosystem. Investor protection is critical to allowing this market to reach its potential, and exchange infrastructure must have surveillance controls implemented. In fact, institutional investors will expect it. If cryptocurrency exchanges and their participants want this market to succeed, they can’t wait for the regulatory process to run its course. They need to act now and take it upon themselves to ensure fairness, transparency and market integrity.
Cryptocurrencies are maturing and becoming more mainstream. Trading has become faster, volumes have grown, and volatility is excessive at times. Having a 24×7 technology-based surveillance program that’s highly resilient and has sophisticated crypto-specific pattern detection capabilities that will hold up under regulatory scrutiny is critical in order to combat spikes in volatility. Ultimately, the crypto exchanges and participants that protect their marketplaces are most likely to inspire public confidence and emerge as market leaders.