Policymakers: search for effective regulatory outcomes while contemplating national digital currencies
“Regulatory clarity is often a journey, not a destination – and typically a slow one that evolves with changes in innovation and market environment,” says Katie Kummer, Global Deputy Vice Chair for Public Policy.
Policymakers are sensitive to regulation – over-regulating tends to hamper innovation, while under-regulating leads to market instability and leaves customers unprotected. Understanding the unique ecosystem of crypto and digital, as well as the risks, opportunities and tradeoffs, could foster more effective regulatory outcomes.
For policymakers, there are close analogies already available to drive regulation of digital assets with some modifications to support the digital nature of these ecosystems. We’re already seeing this emerge with fiat-backed stablecoins. There is growing consensus that such stablecoins have clear parallels with money market funds, provided they are backed by reserves in real-world currencies.
Private-public company collaboration is another way to achieve better harmony in regulating digital assets. Regulatory sandboxes are a proven example of how regulators can work with innovators to build consumer protection safeguards into their products and services before they are mass marketed. This approach only works if there is transparency and clarity on requirements and expectations.
Aside from regulation, some policymakers want to create their own digital currencies. The emergence of CBDCs is consistent with historical innovations in money that have reduced both holding and transaction costs over time, such as the introduction of the euro.
In developing CBDCs, policymakers need to be able to articulate the opportunities and risks for the crypto-asset market and the overall economy. Aligning technical requirements with policy objectives necessitates careful consideration of public policy implications, expectations and tradeoffs. Clear expectations are needed between the public sector and private sector as they relate to “know your customer” and data security and privacy.
Key actions for traditional finance firms and crypto natives
With more regulations on the horizon, traditional finance firms will need to decide soon why and how to engage prudently in a manner consistent with their risk and compliance frameworks. The big issue for crypto natives will be how to adapt their operating models to address risks that are top of mind for policymakers.
Key actions that can be taken now include:
1. For traditional finance firms
- Ensure that senior management plays a leadership role in evaluating the inherent risks and effectiveness of business models and internal controls
- Verify risks bespoke to digital assets are identified and assessed comprehensively and embedded in the internal control environment
- Provide informative, digestible and actionable internal reporting for senior management and the board regarding the inherent risks and effectiveness of internal controls as they relate to digital assets
- Evaluate whether marketing and communications strategies allow customers and users to make informed choices
- Provide services such as safeguarding customer digital assets, trade execution and settlement in a manner consistent with industry practices observed in more regulated markets
2. For crypto natives
- Establish product approval processes and controls to help mitigate potential risks posed by these products to the public and investors
- Monitor trends on the blockchain to help identify and mitigate risks such as fraud and anti-money laundering (AML)
- Develop extensive cyber controls and testing, particularly around smart contracts
- Evaluate third party validation of the entity’s exposure to vulnerabilities in smart contracts
- Assess the relevance and reliability of blockchain information evidencing the existence of digital assets held
The volatility in the digital assets market cannot be ignored by policymakers. Proactive risk management and governance by traditional finance firms and crypto natives can help drive responsible innovation and adaptability to new regulations.