For all the grief it may have caused individual investors, the FTX debacle also had benefits. It exposed the flaws of a market that never had much to do with the underlying blockchain technology. It helped deflate the crypto bubble and eliminate some of the riskiest participants. He also vindicated officials who saw danger in the speculative frenzy surrounding virtual tokens with no intrinsic value.
Regulators might be tempted to sit back and hope that the crypto market will simply burn out, ending the whole bizarre episode. That would be wishful thinking. All cryptocurrencies in circulation still have a nominal value of about 850 billion dollars, and daily trading remains in the tens of billions of dollars. Officials must act on the lessons of the 2022 fiasco — from the collapse of stablecoin Terra to FTX — to ensure that renewed speculation never threatens the broader financial system.
Three steps in particular would help.
For starters: Make stablecoins stable. Much like money market mutual funds, stablecoins purport to maintain a constant value in fiat currency, typically $1. However, they are often backed by assets ranging from short-term corporate debt to nothing. That makes them highly vulnerable to panic withdrawals — which, if they involve real-world asset sales, could disrupt the credit companies need to fund their day-to-day operations. Solution: Bank regulators can create a limited charter for stablecoin issuers, requiring all dollar representations to be backed by actual dollars deposited with the Federal Reserve. This would ensure stability while leaving issuers to compete on the quality of their technology, which could still prove useful in cheaper and faster payments, especially across borders.
Next, curb the exchanges. FTX’s competitors, such as Coinbase Global Inc. and Binance Holdings Ltd., still do not face the security, reliability or asset segregation requirements of a traditional exchange. This leaves them free to expose clients to risk, including through proprietary trading and extreme leverage. There is no need to wait for Congress to determine which regulators should be responsible or to define digital tokens as securities, commodities or something else. Instead, the Securities and Exchange Commission and the Commodity Trading Commission should work together to establish an industry-funded watchdog — along the lines of the Financial Industry Regulatory Authority — to ensure that crypto-brokers meet the same standards as their traditional counterparts. .
Finally, maintain your firewall. Financial regulators have so far done a good job of keeping crypto away from traditional banks, which is one of the reasons why FTX’s fall hasn’t had wider ramifications. Whether or not they adopt specific rules, they should remain vigilant to prevent systemically important financial institutions — including non-banks — from being overexposed. Digital tokens may be useful as a representation of things of value, but by themselves they have no real-world use or cash flow for assets such as commodities, stocks, and bonds. Lending against them is a waste of good money.
Some worry that any regulation would unduly legitimize crypto. That doesn’t have to be the case. On the contrary, clear rules would provide the authorities with the framework they need to crack down on non-compliant actors — a category into which FTX, for example, would surely fall. In addition, officials should make it abundantly clear that regulation does not imply approval—any more than it does with, say, SPACs or meme stocks. Blockchain may still hold promise, but that doesn’t mean the value of cryptocurrencies as we know them won’t fall to zero.
More from Bloomberg Opinion:
• Here’s to Crypto Going the Way of Esperanto: David Fickling
• SBF’s apology was as hollow as his empire: Lionel Laurent
• Have change? Why Digital Cash Must Feel Real: Andy Mukherjee
The editors are members of the Bloomberg Opinion editorial board.
More stories like this are available at bloomberg.com/opinion