What now for the future of Cryptocurrencies and Digital Assets? (James Corcoran)

Crypto is having a coming-of-age moment. Admittedly, that moment currently looks like its awkward teenage years, wrought with angst, uncertainty, and self-doubt, but as the mighty George Harrison once sang, all things must pass, and when they do, what will
the future look like? 

At KX, we have talked about the sector moving from an existential to an institutional phase, where serious issues around criminality, regulatory oversight, and governance are gradually addressed to bring greater stability and oversight to the sector, which
in turn should lead to more market makers and players entering the space. 

However, as the ongoing crisis in the crypto markets shows, volatility and unpredictability are still the dominant themes and it’s not an exaggeration to say that its very future is in doubt. When private investors start losing their life’s savings on something
they invested in through an app on their phone, governments and regulators take note, confidence drains, and market makers and players start pulling back. 

We’re seeing this happen now with the Securities and Exchange Commission (SEC) investigating whether one of the world’s largest online crypto platforms let American citizens trade in digital assets that should have been registered as securities. The outcome
of that investigation could decide the future of the sector. 

Whatever happens, there are signs that the crypto sector is already becoming institutionalized simply due to its size. Ahead of a crunch meeting of the Federal Reserve in the US on whether to hike interest rates,
the crypto markets dipped, showing how they are becoming synched with traditional financial instruments and market events.  

And size matters. Regardless of how fiercely you feel about defending cryptos’ independence from intermediaries such as banks and stock exchanges (and avoiding interventions from organizations such as the SEC and the U.S. Department of the Treasury), it’s
clear that it’s now too big to effectively manage and regulate itself. The market volumes, venues, and number of digital assets in existence are too large and fast-moving. 

If it is to survive, and we think it will, the sector should consider adopting the technologies and procedures that enable other financial markets to innovate and trade freely while also providing protection for investors. Less of a sell-out and more about
growing up. 

Regulate to innovate 

While there is an inherent distrust of doing things the traditional way when it comes to crypto and digital assets, the technologies that provide both stability and agility in existing markets can be readily applied here, and they might prove to be crypto’s
salvation. 

A common fear in the community is that once the regulators and the established financial organizations get in on the act, they will stifle innovation. They argue that the very lack of oversight and interference has allowed the sector to develop and grow.
However, that unchecked growth has led to volatility and fraud, while also proving to be a blocker to putting in place the proper checks and balances. To illustrate the point,

the head of the SEC has gone on record saying he’s neutral about technology but not about investor protections. There is also a certain irony in the fact that despite transparency being the founding principle of crypto, it’s sorely lacking across the sector,
particularly in the
off-chain activity 

It seems clear that regulation is needed, but it shouldn’t be applied with a heavy hand. At KX we work with regulators, buy-side, and sell-side firms, and we know from our vast experience working with traditional assets classes that the transparency, traceability,
and accountability provided by technologies like ours are seen as having a positive impact on markets.  

When you strip everything back, the fundamentals behind trading and regulating crypto are similar to how traditional financial markets operate. Whether the goals are to drive alpha, reduce fraud, stay compliant, protect investments, or move faster to react
to market opportunities, everyone will benefit from greater stability, security, and efficiency which it can be argued will lead to more, not less, innovation, competition, and choice.  

But as mentioned earlier, that choice could be severely curtailed depending on who is left standing once the current volatility bottoms out and the likes of the SEC have finished their investigations. To add further complexity to the situation, while some
organizations look to take a hard line on the sector, other countries and regions are keen to promote their jurisdictions as being friendly toward hosting crypto exchanges and markets, and this is leading to a complex landscape.  Responding to the problem,
the European Central Bank has urged eurozone countries to harmonize different rules around crypto regulation before EU-wide laws come into force and the end of 2023. 

From the wild to the mild west?  

There are convincing arguments to be made on both sides of the crypto coin. On the one hand, the current volatility and regulatory scrutiny will likely bring an end to the ‘wild west’ days of the sector. Many coins and markets could disappear, assets like
NFTs (Non-Fungible Tokens) will be talked about with a mixture of nostalgia and bemusement and only a few business models will remain – with one school of thought being that we’ll see crypto being used to power an Airbnb/Uber type model for the compute economy. 

Equally, the benefits of having de-centralized financial markets could be considerable. A

Harvard Business Review piece from 2018 on the impact of digital currencies identified lower costs, increased security and safety, and real-time and more competitive payments as the most likely benefits to consumers and businesses in the near future, compared
to what they experience today. It also argued that such currencies could also connect the unbanked or under-banked to the wider financial system, a critical issue given the struggling state of the global economy. 

However, a note of caution was sounded around the need for robust legal and economic frameworks else assets like stable coins become anything but stable…and this has certainly been borne out in the current market conditions. 

Regardless of what the future looks like, the ability to better understand the real-time dynamics of crypto and digital asset markets seems a fundamental requirement. Whether the need is for greater surveillance to protect investors and mitigate fraud or
simply to take better positions on a trade, the technologies already exist to do this, and history shows that when used appropriately everyone can benefit.