Cryptocurrency prices crashed in 2022 as tighter global financial conditions impacted the higher risk portion of capital markets, attracting huge media coverage and encouraging some investors to dismiss Digital Assets as a purely speculative phenomenon.
The Digital Assets ecosystem is certainly used to a great deal of volatility, and the implosions of the third largest stablecoin Terra USD (LUNA), crypto lending platforms Celsius and BlockFi, crypto hedge fund Three Arrows Capital, and cryptocurrency exchange FTX are making it a hard crypto winter. The period from 2017 to 2022 has been reminiscent of the dot-com bubble where, amid steep user growth (Figure 1), investors gave massive valuations to business models which were speculative and sometimes fraudulent.
Progress in fixing the crypto regulatory gap has been slow, largely because regulation always lags innovation, and blockchain technology is relatively new. However, the 2022 cycle that saw the implosion of opaque and unnecessarily complex business models – which was aggravated by high leverage, lack of oversight, no separation of duties and poor risk management – put pressure on global regulators.
In 2023 we believe regulators will finally take concrete steps to restore confidence and legitimize the use of Digital Assets and the underlying technology in the wider economy. Regulatory standards should mitigate downside risks while promoting innovation – an aim that is embedded in most recent legislation drafts. In 2022 the EU published its plan to manage the crypto industry ('Markets in Crypto-Assets agreement' or MiCA) and in the US the White House presented recommendations from its research on the space ('First-Ever Comprehensive Framework for Responsible Development of Digital Assets').
It’s likely that Decentralized Finance (DeFi) players will soon be obliged to hold 100% reserves when issuing stablecoins, disclose more information about their balance sheets when engaging in lending, limit asset concentration, and promote more careful risk management. Clear regulation would boost user trust and engagement, augmented by developers building solutions to real-world problems.
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