A Sonata for Crypto Winter (Part 2)

Laws are constructing a new normal for crypto. The future looks bright (and boring).

by Edmund Yong, Co-Founder of Celebrus Advisory

Read part one.

Here’s the blunt truth why regulations are needed – the industry has no other choice.

  • Adoption has become an existential crisis. The industry raised so much money with the promise of blockchain tech. But 71% still have not progressed to any prototype or working product after one year (Ernst & Young). Those who do, have almost zero network for value creation. Out of the almost 1000 active apps on Ethereum, only three exceed 1000 users daily (Dappradar). You can Metcalfe’s Law, the average number of dapp users can literally be squeezed into a small room. It is a worrying sign when all those hype and (fake?) communities do not translate to user adoption. Marketing-led growth is “hitting a dead end” and now it’s crunch time for “real economic activity” (Vitalik Buterin).
  • There are no more quick and easy wins. Back in its heyday not so long ago, investors were like heat-seeking missiles, chasing after the biggest flash in the pan. Funds kept doubling down on this market with larger allocations and shorter term horizons. They were more like punters and were generally not interested in company building – the painstaking process of nurturing the early stage business for go-to-market success. And why should they? The coins go straight to listing before any product POC or MVP even appears, so investors can exit quickly. But the markets turned this year, and now they are stuck with an extremely long tail of deadcoins and can’t cash out.
  • Investors are shunning utility tokens. The existing ones mentioned above are badly burnt and losing patience. Utility tokens have hung them out to dry with no recourse. You cannot sell an ultra-growth story when the tide is this low. New investors are brought in, mostly from seasoned ‘old money’ sitting on the sidelines – but they distrust the vacuous nature of utilities and want real returns and asset backing. The only way to reinvigorate a falling ICO market is for the industry to grow up and start creating yields like normal assets do, a.k.a. securities. Ironically securities are in the cross-hairs of regulators, which the industry have hitherto tried hard to stay away from. As ICOs converge with crowdfunding (ECF) and interest schemes (CIS), these security tokens (STO) will supplement the capital markets, rather than supplant them.
  • All eyes are on smart contract enforceability. Digital assets will only matter if the courts recognize the legality of ‘smart contracts’ and the few strings of code it contains. But code is not law and courts can be whimsical. Thankfully the precedents so far are encouraging e.g. judicial decisions of Hangzhou and Shenzhen in China; state legislations in Arizona, Delaware, Tennessee, and Vermont in USA; even bankruptcy cases in Russia and Japan. But it is one thing to uphold the intent of contracting parties, or accord evidentiary value to digital signatures; the transfer of financial assets around the world is another creature and subject to a plethora of other laws.
  • The needle will not move unless regulators do. If STOs or PTOs are the new saviour of ICOs, they will be crucified at the gates. We are nowhere near salvation. Current laws are not ready for them yet. Possession might be 9/10th of the law for digital tokens but not so for real assets. Title transfer for properties via open trading of tokens is still years away, and don’t believe it if someone tells you otherwise Governments are not rushing to put land and cadastral registries on blockchain despite avowing its benefits. Ideally, national identity systems should be blockchained first (before land registries) to tag ownership and mitigate fraud (Graglia Mellon). Regulators may probably move faster for corporate shares, but most jurisdictions frown on bearer instruments so it is an uphill task.
  • Compliance now becomes a double-edged sword. It will make or break the crypto industry, and separate the men from the boys. It can hasten adoption, create onramps, and drive this industry top-down: a compliant entity is a credible entity. But compliance also levels the playing field and not necessarily in a good way: incumbent financial giants that are inured to compliances will have clear advantages over fledgling startups. In fact, the biggest competitors in crypto will soon be the traditional players who flip to crypto: your Goldmans, Shinhans, Nomuras. Crypto in 2019 will be a pale shadow of its scrappy former self. The price of growth is compliance and these guys have the resources to out-comply everyone else.
  • Finally, there is nowhere to hide anymore. Even though regulators are playing catch-up in this cat-and-mouse game, they know that crypto is a global ‘common market’ and will cast a very wide net, with uniform laws across borders. The G20’s Financial Stability Board (FSB) has been making pulse checks on systemic risks, EU Commission wraps its regulatory mapping by end of 2018, SECs the world over are coordinating and sharing info, and Financial Action Taskforce (FATF) will impose its global rulebook by mid-2019. The glory days of crypto refugees will soon end; the alphabet soup of KYC, CDD, AML, CFT is universal and mandatory even in safe harbors like Malta, Estonia, Lithuania (all members of EU). Even DEXes (decentralized exchanges) are complying.

Coming back to spring. Are prices going to move like hockey sticks soon? They just might, but their flight paths could be short-lived. From a technical standpoint, the ‘dead cat will bounce’ and this cat certainly has multiple lives. That aside however, it does seem a bit premature when we look at the regulatory timelines. Make no mistake: Rome will be built, a crypto civilization will rise, but not in a day. So don’t get too excited just yet.

Bulls are not going away but be prepared to play the long game.

Expect some regulatory inertia. Lawmakers are not rushing in this for a reason. Despite mounting pressure and lobbies (on both sides), the risks of over-regulating outweigh the risks of under-regulating. Turning up too much heat will kill growth. But finding an optimal temperature is also hard because the industry is evolving so rapidly, changes are unsettled, and there is no such thing as a goldilocks framework. South Korea is one of the first regimes to ban ICOs and drove local players offshore; now they are relaxing the rules. Japan is one of the first to license exchanges; now they are allowing them to self-regulate. Russia was initially cold to crypto, then they warmed up quicker than most of Europe.

Hence a wait-and-see approach seems justifiable. Those who lead must be prepared to iterate. Those who follow will benefit from empirics.

Regulators are being wary not lazy. The stakes are high. There is global competition to attract capital inflows and even a geopolitical race to dominate this technology. Regulators have learnt the lesson from the last waves of innovation and will not foot-drag on this. But they need to grapple with the meatier issues first and work down a long list, with money laundering, tax leakages, data privacy / security, investor protection and so on.

It will take time to bring order to the house. If we want to have a thriving normative crypto economy that co-exists in parallel with the current financial system, then it needs to be cleaned inside out. Even a frat party needs to set house rules. In fact, if current structural practices persist especially among exchanges, some experts believe the industry will be “on the brink of an implosion” (Juniper), and need further consolidation before the bulls can take over (Arthur Hayes).

One thing for sure, bitcoin has staying power. The Lindy Effect favours the long game i.e. the longer it stays in relevance, the more sustainable it becomes. When the tech wins, all its participants will win with it too. In the meantime, when you come across a bull who tells you to reach for the moon in short order, scepticism is probably the path of least resistance.


Disclaimer: The opinions expressed in this article are the author’s own. Readers should do their own due diligence before taking any actions related to the content, and are solely responsible, directly or indirectly, for any damage or loss caused or alleged to be caused by or in connection with the use of or reliance on any information in this op-ed article.

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