Chainalysis VP Caroline Malcolm says US crypto policy needs to do three things.
Within the United States, there is a growing concern that instead of regulating cryptocurrency through enforcement, there will be a ban enforced instead. This approach comes at the expense of protecting American consumer and market interests.
The majority of digital asset players want to ensure compliance and safety for consumers. However, to achieve this, clear regulatory guidelines that take into account the nuances of the underlying technology are needed. These guidelines would provide the necessary investment certainty.
Caroline Malcolm is the Vice President of Global Public Policy at Chainalysis.
Enforcement actions alone, without an adequate regulatory framework or guidance, cannot accomplish this. They do not protect consumers nor do they provide clear guidelines. Each enforcement action changes the goalposts, and settlement outcomes that are not made public can leave matters relatively unclear.
Chainalysis data shows that consumers continue to enter the market, and therefore progress on true regulatory and legislative reform is vital.
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More and more, US-based firms are considering relocating to other jurisdictions where clear regulatory guidance exists. This limits market options for US consumers and may push a revolutionary technology outside the bounds of US law. Therefore, a comprehensive regulatory framework is the only sustainable path forward – even if the only goal is consumer protection.
Drawing on their experience working with governments and industry players worldwide, Chainalysis advocates that a holistic regulatory framework in the US is paramount to prepare the country for the future of digital finance and protect consumers from harm. Chainalysis believes that such a framework rests on three pillars, and they’ll evaluate and advocate for any legislative proposal through these three pillars.
1. Prudential safeguards
The digital asset sector can be volatile, and the safety and soundness of digital asset players rests on their ability to manage a range of risks. Some risks are common across businesses, such as exposure to asset price shocks, redemption surges, and counter-party failure. Others are unique to the digital asset space, such as operational and technological risk relating to the operation of the underlying blockchain and smart contracts.
Prudential regulatory requirements can help ensure that digital asset players are resilient to shocks and can continue to meet their obligations to customers under stress. The appropriate prudential measures will depend on each business’ risk profile, and can include capital and liquidity buffers, as well as business continuity and resolution planning to facilitate an orderly wind-down in the event of failure.
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For instance, sound regulation for stablecoin issuers could consider their unique token stabilization mechanism while digital asset custodians may be required to pay attention to technological and operational safeguards for the management of private keys. What is vital is to work with digital asset players to ensure that prudential requirements are well-tailored to the magnitude, locus, and nature of their risk.
2. Market conduct regulation
Market conduct regulation establishes standards around the behavior of market intermediaries and participants to secure confidence and integrity in markets. The events of 2022 have shown that this is as central to digital asset markets as it is to any other financial or physical asset market.
Market conduct is an expansive concept. One important facet in the digital asset space is the establishment of internal controls to manage conflicts of interest. This can include the clear segregation of customer assets from corporate assets, as well as the separation of reporting lines and information flow where a digital asset player takes on multiple functions.
Another important element is the detection and prevention of market abuse, such as market manipulation, wash trading, and pump-and-dump activity, all of which have been observed in the digital asset ecosystem. A variety of tools exist today for digital asset players to monitor unusual trade and price activity within and across trading platforms, and even to scrape social media platforms to detect planned collusive action.
Regulators also have a role to play in ensuring that industry participants have the policies, processes, and resources to promote fair and efficient markets, as well as the tools themselves to detect and investigate abuse.
Finally, there are concerns about financial integrity. Like fiat markets, digital asset markets can be abused for illicit purposes such as money laundering, terrorism financing, and sanctions evasion. Although data shows that the proportion of illicit flows on chain is very low – less than 1% of total on-chain transactions – such activity can nonetheless have an impact on economic and security outcomes.
The benefit of blockchain-based assets is that they are transparent due to the underlying blockchain infrastructure, which makes it easier to detect and stop illegal activities. Each digital asset player has access to tools to monitor their exposure to such activities and take measures to mitigate them.
3. Consumer protection safeguards
Consumer protection safeguards ensure that crypto users are treated fairly and understand the nature and risks of their engagement in digital assets. With digital assets becoming more mainstream, policymakers are concerned about speculative trading and scams.
See also: Marc Hochstein – You Want Crypto Regulation? I’ll Give You Crypto Regulation | Opinion
The financial sector provides comprehensive risk disclosures to protect consumers. Financial education, knowledge assessments, and due diligence procedures can also be useful in the digital asset space.
The longer the US delays this work, the more other countries will progress, putting the country at a competitive disadvantage and endangering consumer safety in the long run.