By: Maha El Dimachki
Fintech has now become a mainstream player in the world of financial services. Fintechs are seen as the catalyst for innovation and with a digital economy here to stay, there is no surprise that the interest in what fintechs bring will continue to rise.
A prominent topic in today’s fintech dialogue is digital assets. They have gained momentum in both public and private sector. It is no longer the playground for young startups as we now see large institutions in wholesale and retail financial services flexing their balance sheet muscle to invest in these technologies.
Digital assets take many forms. Each have their own application and risk profile. Native crypto assets or crypto-currencies such as bitcoin are perhaps where it all started. These are typically assets native to a particular blockchain or distributed ledger and are standalone or unbacked. Backed or pegged crypto-currencies are widely known as stablecoins. They are backed by fiat currency or some other basket of financial assets. Tokenized assets on the other hand are real assets, financial or otherwise, that are represented in digital format. A digital token, as the name suggests.
An area that attracts quite a lot of debate and polarized views is the native crypto assets or crypto-currencies for short. The biggest debate is how, where and when will they be regulated.
The rise and fall of crypto-currencies
It has been fascinating to watch the rise and fall (and now the rise again) of crypto currencies. I’ll start with the rise and fall. The concept of a crypto-currency was a new innovation that entered financial services to seemingly serve a need. It quickly emerged that the key need was better returns with its rapid appreciation. It has gained much attention and entered the retail market where households and every day individuals started to invest. Then came the fall. The volatility of crypto-currencies, the large fluctuation and the lack of basic regulation on areas such as money laundering, financial promotions and safeguarding of client money resulted in many losses, scams and corporate fraud. Frankly nothing that we haven’t seen before, just on a new platform. The scams were typologies known to us such as get rich quick scams; invest and you shall be rewarded. The volatility wasn’t explained and real people lost a lot of money.
Is crypto on the rise again?
It seems to be. The market is now anticipating a rise in crypto and crypto-currencies have been gaining value with Bitcoin rising to over 100K as I write this. There are a couple of points of interest here.
First the view that the US will now be open to crypto firms starting and scaling with minimal restrictions and many firms will now flock to the US. As the new administration is preparing to take office, there is a view that this will be a crypto friendly time and there will be incentives for crypto firms to start up and scale up their operations in the US.
Secondly, and I believe this is the key point, the interpretation that a crypto friendly regime will impose no or low regulation. The level of regulation will determine who enters the market. Light regulation will lower barriers to entry.
A new dawn or a continuation of the past?
It is important to note that with or without this US election result, the US continues to be the largest market for fintech startups and scaleups by a margin compared to any other market. This is primarily due to incentives such as capital markets and investment policies. So how much will that change now? Many markets including the US are focused on fighting financial crime, money laundering, safety and security of the financial system and consumer protections that are suitable for the product. In my view these will not be compromised.
Regulation will impose a limit to how far the barriers can be lowered such that a market doesn’t attract low quality, thus impacting the integrity and confidence of consumers. Strong regulation offers certainty and support for fintechs where there is a balance between innovation that supports innovative businesses and the integrity of the financial system. We know enough about the risks in the crypto market. What is the balance between consumer protection, market integrity and attracting crypto firms to start up and scale up. A delicate balance to be struck.
What should crypto firms do?
The lessons from the failures and issues we saw in crypto firms will not be forgotten. These are the lessons that regulators and legislators will use to ensure a balanced and informed regulatory regime. Strong regulation doesn’t necessarily mean a high regulatory burden. It means certainty, clarity and consistency in its application.
There are a couple of points that crypto firms may want to consider here.
- The culture and business model. Taking advantage of a light regulatory environment should be balanced against what values and culture the company stands for and what they are looking to achieve. Investors will need to make the same considerations where key investments should be made against the company culture, values and the business model. Whatever the regulatory regime, becoming a vehicle for money laundering or allowing unfair consumer practices will likely not be seen as good corporate culture let alone accepted by regulators.
- Short term vs long term. While there may be a view that all will become easy for crypto firms, let’s learn from the lessons of the past. When things go wrong, there is a need for the regulators to act. A long term view on how the business will be resilient enough to withstand these changes in regulatory responses will serve a fintech well.
In my book, fintech regulation in practice, I offer practical frameworks on how fintechs can navigate regulation that doesn’t yet exist or is in transition. We now are in a moment where crypto firms can leverage the opportunity before them in a way that demonstrates maturity, growth and strong risk management.
