2020 brought critical changes in the decentralized currency space. Institutional adoption has permanently changed the landscape, brought in billion-dollar investments, pushed leading coins to new highs and, most importantly, created more confidence around digital assets.
The decentralized finance (DeFi) space thrived accordingly, witnessing nearly 40X growth in 12 months. Non-fungible tokens (NFTs) tripled their value last year and are said to be the hottest stars of 2021.
The decentralized industry is buzzing like an autonomous choir, with numbers of new voices constantly jumping in. For more than a decade, this choir operated without central authorities or governing bodies. Is this a state of anarchy crying out for regulation? Or is it a precious space of pure freedom where innovation can thrive?
The choir without a conductor
After an incredible bull run for Bitcoin and Ethereum, many other altcoins have rallied as well. Top currencies like Cardano (ADA), Polkadot (DOT), Litecoin (LTC), Chainlink (LINK) have all seen recent price spikes.
The GameStop saga sparked the phenomenon of powerful retail investors who can short squeeze professionals if they team up. Multiple social media channels emerged, initiating cryptocurrency-focused price pumps. Dogecoin (DOGE) can be the best-known example here.
In times of historically low interest rates, decentralized finance (DeFi), one of the most active blockchain sectors, sees hundreds of new projects launching each year: from crypto lending, yield farming to decentralized exchanges, payment networks, or crypto-insurance platforms. Many of them are still under the radar despite the massive potential.
In the surrounding of fierce competition, marketing (and shilling especially) becomes a critical tool to raise the project’s awareness and, certainly, its price. Shilling or, simply speaking, advertising or product endorsement is currently the most popular method to spread messages and reach goals.
The active promo triggers the users’ excitement and, as a result, makes prices go up quickly. The problem here is that price pumps lead to price bubbles. At some point, they pop, prices go down, and so investors’ general trust. This happens when the project founders are more interested in pumping and dumping than in creating sustainable investments.
FUD (fear, uncertainty, and doubt) is another popular tactic to spread false or misleading information to change investors’ opinions and create mistrust in competing projects. It targets a certain organization’s reputation and income and is neither an ethical nor marketing technique.
Since the crypto market is mainly built on market sentiments, it is highly vulnerable to manipulations. The FUD may wrap partial truth into the general fake information, which is enough to create doubts and mistrust in a certain project.
Not to mention the ethics of hidden endorsements and so-called “sincere” promotions, the much bigger problem is the shilling of scams. The crypto space is heavily flooded with Ponzi schemes, fake ICO’s, fake crypto exchanges, fake giveaways, celebrity impersonation scams and multiple other scam methods (including malware) that beat down the general trust in new projects.
In 2020 alone, the crypto scammers took nearly $2.7 billion in cryptocurrency, although a year before, they created much bigger damage, accounting for almost $7 billion. Accordingly, there are over 1550 dead coins at the time of writing.
Cryptocurrencies are speculative assets. They are all about trust. But with pumps and dumps, shillers, and scammers in mind, it is no surprise that the crypto space is in a kind of chaos. Not to mention money laundering, terrorist financing, and other forms of financial crimes. The industry is dealing with many challenges, and the need for legal clarity becomes critically important.
The stance towards regulations
However, different countries apply their own rules making the young crypto sector even more fragmented. There is still a lot of regulatory uncertainty in many parts of the world, including the United States.
European Commission published an ambitious proposal in 2020 to regulate digital assets, which aims to set global standards. If it gets approved by the EU governments and EU Parliament, the law sets clear digital asset classification and regulation of its issuers and service providers.
While the EU openly revealed its ambition to lead the way in global cryptocurrency regulation, the crypto regulations remain inconsistent worldwide. Asian countries, including China and India, have restrictive attitudes towards digital assets.
The United States deals with the varying laws among its different states. Although it maintains a positive look towards digital assets, the federal government has not passed unanimous laws.
The country’s current Treasury Secretary Janet Yellen criticized cryptocurrencies for terrorist financing and money laundering. She officially supports the need to regulate institutions that deal with digital currencies. This year, President Biden’s administration suspended the controversial crypto wallet rules, which aimed to regulate transactions to private digital asset wallets.
How could regulations benefit the crypto industry?
With institutional investors and governments opening for cryptocurrencies, it is no longer a niche space for nerds. Too many billions have been invested into it to ignore the need for a legitimate, regulated environment and legal protection.
The controlled environment is the opposite of chaos. Regulations establish order, meaning that any sector can operate more safely and with predictable outcomes. In a regulated ecosystem, digital currencies can be seen as assets whose risk can be managed and better protected.
Like in any other industry, regulations set the rules of play and provide a safer environment for investors and users. Investors need to clearly understand the environment in which a new asset class operates. They need to know the risk factors associated with the market before actively engaging with it. The existence of clear rules boosts confidence in a certain market, attracts new capital flows, and grows the whole sector.
As seen in 2020, institutional investors look for alternatives to allocate their capital in times of historically low interest rates. Traditional wealth managers and multiple corporations included cryptocurrencies in their investment portfolios as a new asset class to hedge against the inflation.
Applicable rules allow simplifying the process for entrepreneurs and give legal certainty for those issuing new digital assets. This means legal assurance that any newly issued coin meets certain criteria and is not simply created for quick scam purposes.
Accordingly, regulations can make the ownership of digital currencies more secure. In the past few years, malware attacks and hacks to crypto exchanges and digital asset wallets resulted in millions of losses. A more controlled environment could contribute to a higher security level, making the third-party crypto service providers (especially crypto custodians) more accountable when operating in clearer conditions.
The regulated environment encourages the development of innovations. The companies are more willing to invest in research, hire highly skilled professionals and create infrastructure when they see long-term stability and security in the field.
Finally, regulations may open the way for broader cryptocurrency adoption. There are multiple people worldwide that have not entered it yet, and for crypto usage to grow even further, it needs more trust and better access to it. Digital currencies may achieve this if they are perceived as trusted, secure, and easily available assets.
On the flipside
- Privacy issues and capital flight. Regulations require transparency, which means that tracking cryptocurrency transactions becomes much easier for governments and law enforcement institutions. Decentralized digital currencies are yet massively used within the darknet and as a surveillance-free payment method to support human rights and freedom fighters under authoritarian regimes.
- A barrier for innovation. Critics fear that regulatory authorities may overuse their power, create unbeatable barriers, and end innovations and crypto space evolution. For example, decentralized finance (DeFi) is a critical driver of innovation.
- Increased costs. The change in applicable laws may boost operating companies’ costs and make them a less attractive investment.
Crypto space, and especially the DeFi sector, is a driving force of innovation. It has a lot to offer and accordingly a lot to deprive of you. Financial frauds, asset bubbles, market manipulations are a few of the risks any investor faces in an unregulated environment.
There is a fine line between the advantages of clear regulatory rules and the freedom to adopt innovations. However, the regulations result in a more stable and thus more mature market that operates more consistently, safely, and with predictable outcomes. The benefits of regulation should outweigh its weaknesses in the long run.