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Crypto: Where Regulation Meets Innovation

Nigel Feetham QC
Partner, Head of Financial Services

I have been involved in regulatory work for many years and written extensively on regulatory matters, especially as a staunch advocate of the need for the law to be aligned to business innovation and entrepreneurial risk-taking.

One subject I have studied above any other is the evolution of segregated business forms and their use in innovative structures (at least at the time). Segregated business forms are now well established and recognised in many countries around the world. But in its early years it remained part of what I call ‘frontier law’, that space where the drive for product innovation challenges existing legal, regulatory and/or even insolvency boundaries.

The late Professor Larry Ribstein (himself a leading proponent of the dynamic processes of business innovation) writing the preface for the 2nd edition of my co-authored PCC book summarised it quite well:

“There is a question of how the development of the PCC may be affected by hostility toward financial innovation that has arisen in the wake of turmoil in financial markets and the Madoff scandal and PCCs’ association with offshore financial centers. The authors note that the suspicion and risk may increase as PCC deals increase in size and complexity and used for new purposes. They suggest that PCCs should be enforced if properly structured, marketed and managed and kept within the current legislative bounds. Surely this book will serve as an essential guide to accomplishing these goals. In the long run, as  authors suggest, there is a strong argument for protecting the PCC through an international convention.”

Over 10 years since the book was published, segregated business transactions are now commonplace in the financial markets of all kinds, with the book itself cited in US case law.

I see some tangential similarities with the crypto industry. The innovation we are seeing in this industry compares to nothing I have seen previously, although the scale is still relatively small by comparison to the mainstream financial markets which many crypto enthusiasts aspire to displace. All eyes are now on ‘what next’. Not a day passes without dozens of articles being published worldwide on what action policymakers are taking, or might take, to reset the regulatory boundaries, in what until now has largely been an unregulated sector. Not to mention daily commentary on the price fluctuation of Bitcoin!

Although the barrier to entry has not historically been high given the unregulated nature of the industry, this will not continue to be so as more and more jurisdictions seek to regulate this space. It is unlikely to happen anytime soon but as regulation becomes the norm (especially for cross-border transactions) I see a sector in the future dominated by fewer players and therefore one where speed to market today by technologically savvy entrants that gain market share will be the critical factor to future commercial success.

This is where jurisdictions like Gibraltar who have positioned themselves in the vanguard of regulation can do very well. But there are still two sides of the crypto argument. One side focuses on the decentralised nature of crypto assets operating on the blockchain, which they say can be trusted inherently and enhances democracy by making decentralised finance available to all. Also said that transactions that exist only in cyber space, cannot be regulated, or regulated in the same way as centralised financial markets. The other side argues that no system can ever be trusted inherently, less still one that is subject to no (or little) regulatory oversight and that regulation is itself a badge of trust. The truth probably lies somewhere in the middle. No financial system (decentralised or otherwise) is risk-free nor can be trusted blindly but also is never beyond the scope of regulation (or even taxation for that matter).

The question is not whether regulation is necessary but which parts of the decentralised finance industry should be regulated and which should not. The financial crisis of 2008 certainly proved that no or little effective regulation can come at a huge cost to society. Policymakers are not going to allow another banking (or shadow banking) crisis. Their focus is likely to be on consumer protection (perceived or otherwise). Intervention is therefore not an ‘if’ but ‘when’ and ‘how’.

Should we be concerned? Gibraltar certainly is not – where regulation meets innovation is our natural space, one where we thrive.

Article dedicated to SV, a crypto enthusiast.

 

 

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