Global regulatory developments and the flight to safety: Lessons learned from the crypto sector crisis

Despite the many virtues and advantages such technologies offer, it is not without challenges. The confusing regulatory global landscape and weak links to the traditional finance industry have prevented wider crypto adoption. The recent industry turmoil in the slipstream of FTX’s collapse also severely impacted consumer trust and confidence in this emerging industry.

The rise of VASPs

A relatively new type of entity, commonly referred to as the Virtual Asset Service Provider (VASP), is gaining prominence in the industry. The most common example of a VASP today are cryptocurrency exchanges, which support end-users in buying and selling cryptocurrencies, such as Bitcoins, from one another. As VASPs continue evolving, many are zeroing in on where the most significant growth potential can be found; by scaling up and institutionalising within the financial landscape.

Regulatory bodies are taking the VASP industry seriously, while institutional investors are changing their stance from carefully monitoring the scene to actively engaging with it.  At the same time, there are several growing pains for VASPs, especially in light of the long history of interbank wire payments and the regulations governing these kinds of banking activities. With various institutions considering working with virtual assets (VA) service offerings, the proliferation of the asset class presents unique risks that need to be effectively addressed.

Trust and security are the obvious significant concerns. By adhering to evolving regulations, VASPs can increase security through strict customer onboarding and Know Your Customer (KYC) requirements. At the same time, they can build trust through Anti-Money Laundering (AML) and Counter-Terrorism Financing (CTF) practices. The recent stunning collapse of FTX and its sister company, Alameda Research, taught us a valuable lesson about the importance of having recognised accounting practices and systems and solid governance mechanisms arising from robust regulation.

The FTX fallout

The collapse of FTX put many industry issues into perspective. It has become clear that creating a secure, reliable and trustworthy ecosystem is vital for everyone in the industry. Still, the importance of this ecosystem correlates directly to the adoption rate of VAs. South East Asian countries, and Thailand in particular, are examples of countries which lead in the adoption of VAs and demonstrate unprecedented growth rates. And this is why it is essential to consider what is happening in adoption vs regulation and whether we have solid ecosystem foundations that will allow the industry to grow correctly.

One part of the solution is using technology via concepts of embedded supervision, zero knowledge-based compliance systems, and more. Several key elements need to be considered when planning regulatory initiatives; it is critical for policymakers and regulators to refrain from regulating the industry into stagnation or stifling innovations. Laws and regulations need to evolve. 

Although it is important to draw on previous experiences, the general approach should always start from a blank slate. This is the only way we bring the public and public sector together and understand the critical differences in the types of technologies and various businesses that need to be regulated.  We also need to realise that seizing the opportunity requires dropping the zero-sum game aggressive mindset, which sees the world as a battle between free-spirited entrepreneurs and regulators trying to control them. 

Solving the problem

We need to bring the brightest minds in the industry together in a non-confrontational way to identify new solutions and explore new ways to achieve the shared vision, which is greater protection for investors and consumers. Only then can we come up with clear guidance for the industry and a vision of how and where to develop without regulatory hurdles or unnecessary barriers. 

These are simple problems to remedy. The main point about this is that it is helpful to have a trusted intermediary be the custodian of your assets rather than leave it up to the vagaries of possession. This is where the genius of a traditional banking system comes into play. Even if a bank in a well-regulated jurisdiction is exposed as not well-managed or taking undue risks, there are mechanisms to protect you. The regulator will take enforcement action against the bank, and a deposit guarantee scheme will protect your deposits up to a certain amount should losses be incurred by you. 

It makes sense to trust a VASP tied to a bank located in a trusted regulated jurisdiction with a clear principles-based regulatory framework for VASPs. For example, Xapo bank is located in the financial centre of Gibraltar, a rock-solid jurisdiction with a 300-year history of stability and UK standards of law and protection of property rights.

Holding BTC at the Xapo VASP does not expose clients to any form of trading, lending or leveraged activity. The regulated standards simply do not allow access to member BTC, as these must be maintained in a segregated account unless it were to be licensed for that type of activity and its customers agreed to it. The VASP is required to have effective arrangements in place for the protection of client assets, and it is also necessary to have taken precautions and established corporate controls to protect customer assets and monies against any eventualities and threats, as well as to maintain custodial assets, wholly segregated from the VASP's own assets and monies.

Such platforms represent the future of the industry. They provide the necessary security and protection as an adequate response to the entry and exit points in the field. Although the impact of FTX’s collapse can’t be understated, with every Tower of Babel comes the opportunity to reassess, rebuild and strengthen. If we heed the lessons learned, we can move towards the democratisation of finance with confidence and fulfil the principles that launched blockchain-based VAs and infrastructure in the first place.

By Joey Garcia, Director and Head of Public Affairs, Policy and Regulation, Xapo Bank