East vs West? The New Frontier of Regulations in Crypto Assets
Global asset markets are a complex adaptive system that is constantly evolving and processing multiple sources of information which compounds in convolution. As such our investment process has to reflect this complexity and be adaptive in conducting “Mosaic Theory” to develop and implement our investment view.
In analysing the difficult year that 2022 was, we believe that all the abysmal challenges that best both the global financial markets and specifically the cryptocurrency and digital assets (“crypto assets”) markets, will lead to crypto assets market being made stronger in many ways. We agree with the view put forth in Fidelity’s 2023 Look Ahead Report: “Like a biological system that learns from and forms a response to an attack, adversity in the digital asset ecosystem has the potential to create a more resilient, or “anti-fragile,” industry.”
Update on Regulations
Regulation has become a more pertinent issue in the crypto asset space and many countries are no longer looking to the USA for leadership as they look for ways to both protect and stabilise their domestic financial markets, but also to grow and embrace innovation in the fintech sector, particularly in regards to crypto assets. The balance of power is shifting and we believe Europe and Asia represent the next frontier of growth and adoption by institutions in this space as these countries look to adopt and implement crypto asset regulations.
This is further evidenced by key Emerging Market countries such as Brazil, Russia, India, China and others such as Indonesia, El Salvador, Vietnam and the Philippines. These Emerging Markets will be driving innovation and adoption in crypto assets as they embody an entrepreneurial hunger and drive to disrupt incumbents. Another favour in their factor is their relatively youthful populations that ensure their respective governments embrace positive regulatory stances towards crypto assets.
We can see in Russia the major economic impact of the conflict in Ukraine was their ejection form the international SWIFT payment system. Major international credit card networks and banks exited Russia relatively quickly when the war began, but because Russia built a state-owned domestic debit network after the 2014 annexation of Crimea, the country’s payment systems were able to continue to function. This has led to Emerging Markets reassessing their use of the USD as the default global currency.
In tandem, Brazil has deregulated industries like payments, opening up merchant acquiring and payment processing services for local competition. This intervention in favor of disruptors has significantly reduced pricing, improved customer service, and increased the cadence of product innovation.
India has increased foreign direct investment in industries like insurance from 25% to 75%, allowing for an increase in global capital to flow into the industry and spur innovation.
Indonesia is favouring accommodative policy but is earlier in the process. Indonesia’s Financial Services Authority (known as OJK) has put together a Digital Finance Innovation Roadmap to help balance innovation and consumer protection.
A recent Bloomberg article stated that the “Chinese Government Approves of Hong Kong’s Crypto Plans”, and Hong Kong is therefore once again gearing up to become a crypto hub as the Chinese government is giving subtle hints of approval towards the plan. A Hong Kong regulatory body outlined conditions under which retail investors would be allowed to purchase cryptocurrencies.
This is really positive as it opens up the largest Emerging Markets in the world to the potential of participating Hong Kong’s Securities and Futures Commission proposed yesterday in a consultation paper to allow retail investors the ability to trade large-cap cryptocurrencies on licensed exchanges, provided they meet several requirements. The implementation of knowledge tests, risk profiles, and reasonable limits on allowable exposure would be necessary for exchanges to gain such licenses.
Given the challenges of 2022 we have seen increased calls for regulation. A bittersweet benefit of a bear market and commensurate lack of funding and liquidity is that unsustainable business models are shuttered, and it drives regulatory clarity, and improves methods of addressing bad actors.
We expect progress across several dimensions of regulation. One area is tokens, where clearer rules on a potential security definition may cause a challenging adjustment process but could also enable regulated tokens to be incorporated into more business models. Other potential areas of regulatory focus include stablecoins, custody, and intellectual property.
We also see greater attention to the privacy considerations in crypto. Though blockchain data is linked to anonymous account numbers, it is becoming increasingly easy to link one’s transaction record to one’s real-world identity. Striking the right balance between privacy and regulatory oversight is of paramount importance, particularly for users under oppressive political regimes.
Importantly, the shifting geopolitical landscape will have an impact on crypto adoption and regulation. Citizens in many countries do not have access to well-functioning financial markets, and for them, decentralized crypto protocols could present significant upgrades to their current systems. There is also a growing possibility that crypto becomes a foundation for a move away from a Western-centric financial system by some countries in an increasingly multipolar world.
Amid crypto’s recent volatility and negative headlines, it has been easy to lose sight of how some decentralized finance mechanisms fared quite well and demonstrated how the use of transparent blockchains in finance can improve the resiliency of a system. We see many potential ways in which crypto innovation can be a solution to regulatory challenges. Critically, there is a wide range of outcomes for crypto regulation and adoption around the world, and we believe it is important to explore a breadth of scenarios to better prepare for inevitable surprises along the way.
Mark Witten is CIO of Portal Asset Management
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