“Full of sound and fury, signifying nothing”: can crypto regulation work?

In Mel Brooks’ 1967 satirical black comedy, The Producers, Max Bialystock and his hapless co-producer Leo Bloom concoct a get-rich-quick scheme to sell 25,000% of the shares to a Broadway musical doomed to fail. Three hundred and thirty years earlier, Dutch tulip mania was in full bloom, with some tulip bulb prices rocketing skywards before a catastrophic crash.

Crypto assets are neither tulips nor Broadway musicals, but as we approach the festive period, a timbre of reflection often pervades: looking to the past to inform the present.

Over the past year, the crypto sphere has been plagued by a series of high-profile scandals that have marred the space. Crypto frauds have been steadily on the rise. In 2021, blockchain analytics firm Chainalysis reported that crypto thefts had risen by 516% compared to 2020. These astronomical figures are likely indicators of what’s to come. One only needs to look at the headlines to see that crypto controversies abound. 

The FTX collapse is but the tip of the iceberg. The $32bn crypto exchange filed for bankruptcy at the beginning of November after a run on the exchange was sparked by a series of accusations regarding its economic viability. Further allegations of potential fraudulent misconduct on the part of the former CEO, Sam Bankman-Fried, have now come to light. 

While there may be a glimmer of hope after news broke that FTX’s new management team had uncovered assets worth $1.24bn (making a small dent in the overall sums owed to creditors), the FTX fiasco is potentially the first piece to fall in a row of dominos. The ripple effect is in action as crypto exchange Genesis Trading, which had $175m on the FTX exchange, has started to teeter.

FTX’s implosion has forced the exchange to suspend withdrawals on some of its products after a spike in users pulling their funds. Now, as crypto firm BlockFi files for Chapter 11 bankruptcy protection, citing liquidity problems initiated by the FTX collapse, will the infection spread to the rest of the crypto community?

Clearly a crypto cure is needed to stop the contagion. A robust, yet adaptable regulatory framework, perhaps? Regulation, however, is often touted as a buzzword, without any meaningful solutions being provided. Could it be, as Macbeth once lamented, “full of sound and fury, signifying nothing”?

Salvation by regulation?

Cryptocurrency is largely unregulated in the UK. While the Financial Conduct Authority (FCA) does have some oversight over crypto asset businesses carrying out specific activities in the UK, the scope of its powers is woefully lacking. 

At its core, the FCA regime requires UK crypto asset businesses (such as crypto exchanges or custodian wallet providers) to be entered on the Financial Services Register, and to comply with anti-money laundering and terrorist financing obligations. Additionally, as of August 2022, those who wish to purchase 25% or more of a crypto asset business that is registered with the FCA must first seek FCA approval to do so. Failure to obtain approval is a criminal offence.

Yet, despite its best efforts, the FCA acknowledges the limit of its regulatory reach, admitting that, “our regulatory powers don’t cover how crypto asset firms conduct their business with you. Even if a crypto asset business is registered with us, we’re not responsible for making sure that they protect your assets, among other things. […] If you buy these types of crypto assets, you are unlikely to have access to the Financial Ombudsman Service (FOS) or the Financial Services Compensation Scheme (FSCS) if something goes wrong. […] If you invest in crypto assets, you should be prepared to lose all your money.”

Therefore, the UK’s Financial Services and Markets Bill may be just what the doctor ordered. The bill attempts to revamp the way the UK regulates digital assets, by (in part) enabling the Treasury to adapt and amend existing regulation, as well as create new frameworks.

Further clarification was provided in a recent amendment to “the Financial Services and Markets Act 2000 to clarify that the powers relating to financial promotion and regulated activities can be relied on to regulate crypto assets and activities relating to crypto assets”.

As the bill enters the reporting stage in the House of Commons, it is widely speculated that it will become law – a move that puts the UK on a par with the EU’s Markets in Crypto-Assets Regulation. 

“Tomorrow, and tomorrow, and tomorrow”

But only time will tell whether these new instruments will make any meaningful impact. Even if the bill does pass, it will likely come into force only next year. Clearly a solution is needed now.

The waves created by the FTX failure need calming, especially after it came to light in bankruptcy proceedings that Mr Bankman-Fried ran the firm “as a personal fiefdom”. Ironic, when but a few weeks earlier, Mr Bankman-Fried published a set of proposed industry standards on the FTX policy website, stating: “This document contains a draft of a set of standards that we as an industry could enact to create clarity and protect customers while waiting for full federal regulatory regimes.” 

Industry standards are needed to protect consumers. Regulation is necessary to enable wide-scale adoption of the technology. The hypocrisy of Mr Bankman-Fried’s story, however, has all the hallmarks of a Shakespearean tragedy. A Macbeth of modern times – the meteoric rise, followed by the inevitable fall.

Let us hope that we learn from this cautionary tale, lest we plummet further into crypto calamity.

By Keith Oliver, head of international, and Amalia Neenan, trainee solicitor, at law firm Peters & Peters Solicitors LLP.