The Case for Stringent Crypto Regulations: Reserve Requirements to the Rescue

The Case for Stringent Crypto Regulations: Reserve Requirements to the Rescue

Cryptocurrency
April 10, 2023 by Editor's Desk
571
The State of the Crypto Industry Since their earliest days, bitcoin and other cryptocurrencies have been marked by wild price fluctuations and prominently, a lack of regulation. In fact, much of the promise of decentralized blockchains is making transactions without government or industry oversight. Driven entirely by market forces, crypto has demonstrated a lack of stability that
The Case for Stringent Crypto Regulations Reserve Requirements to the Rescue

The State of the Crypto Industry

Since their earliest days, bitcoin and other cryptocurrencies have been marked by wild price fluctuations and prominently, a lack of regulation. In fact, much of the promise of decentralized blockchains is making transactions without government or industry oversight. Driven entirely by market forces, crypto has demonstrated a lack of stability that has made it difficult for several powerful investors and governments to trust the crypto market.

Currently, the crypto market is dominated by speculators looking to make a quick profit, rather than those who truly believe in the long-term potential of the technology. Leading exchanges have played a significant role in fueling this speculation, with many engaging in practices that artificially inflate the prices of certain coins. This has led to a market that is highly susceptible to manipulation and one in which the average investor is at a disadvantage. Of course, some of the biggest stories of inordinate practices in the echelons of crypto affairs came to the fore in 2022, with the collapse of FTX particularly weakening the fragile public trust in crypto.

In addition, the uncertain future of crypto presents both risks and opportunities. While the technology behind crypto has the potential to revolutionize the way we think about money and financial transactions, there are also significant risks associated with the market. Mixed reactions continue to trail, in particular, blockchain decentralization, which makes it easier for crypto asset holders to avoid traditional regulation.

The Promise and risk of Stablecoins

Whereas many crypto evangelists have denounced banks and bank-type regulation, preaching the gospel of decentralization as the way forward for world finance, there is a reason banks have survived to this point, for all their faults. As we have seen over the years, attempting to undermine the traditional banking structure could create danger for the entire financial system.

Created as a counter to the volatility of cryptocurrencies like BTC and to facilitate easier transactions, stablecoins have become a tool mostly used for speculation. According to Timothy Massad, who worries that stablecoins like Tether (USDT) may bring back 2008, a critical risk with stablecoins is that issuers are not required to protect their reserves or maintain liquidity. 

Hence, stablecoins remain susceptible to the same fate that has now befallen FTX, where the reserves are not sufficient to satisfy sharp rises in customer demand. Previously, the collapse of TerraUSD and Luna cast aspersions upon the potential of algorithmic stablecoins to deliver the stability so promised. The market was driven into panic and there was a resurgence of passionate calls for regulation. Yet, there has not been much progress recorded.

Reserve requirements to the rescue

One approach to forestall this scenario is for regulatory bodies, in addition to other proposals, to implement a reserve requirement for crypto companies, including exchanges, lending outfits, and others. This would be similar to the way that traditional banks are required to hold a certain percentage of their assets in reserve. In this scenario, cryptocurrency companies would be required to hold a certain percentage of their assets in cash or other short-term instruments, which would be held in trust by a regulated bank.

There is a semblance of this happening already, with the recent spate of crypto exchanges publishing proof of their reserves to instill in their customers the confidence that they have enough assets backing customer funds. Binance, OKX, and Crypto.com are among the few platforms that have done so, hiring third-party audit firms to publish attestations to the status of their reserves.

Slowly, this has become the new interesting thing about the crypto space in the last few months, and some stakeholders seek ways to make PoR attestations more crypto-native. However, concerns persist as to the lack of regulatory oversight. Any platform can make an appearance of publishing its PoR to give its customers a false sense of transparency. Hence, it is critical at this point for governments to step in and implement stringent measures to protect customers, and the entire financial system, by enforcing rules that ensure that all custodians have their crypto assets fully backed with complete transparency.

It should not be expected that non-stablecoins will someday transform into stablecoins and become pegged to cash or other short-term instruments. However, much of the fear is mitigated when we consider the fact that most crypto trades would happen via exchanges anyway and most crypto is held in digital wallets. Basically, requiring every company that holds crypto to be fully backed and tied to a bank-regulated trustee is what we need right now.

 

The Terms of Reserve Requirements for Cryptocurrencies

The specific details of how a reserve requirement for crypto custodians would be implemented would depend on the regulatory framework put in place by government leaders and financial regulators. However, some key elements that could be considered include:

  • Setting the percentage of assets that must be held in reserve: This percentage would be determined by regulators, taking into account factors such as the size and complexity of each company and its tokens, as well as the overall risk profile of the crypto market.
  • Defining what constitutes cash or other short-term, liquid instruments. To ensure that the reserve requirement is met, regulators would need to define what types of assets qualify as cash or other short-term, liquid instruments. This could include cash itself, government bonds, or other financial instruments that are easily convertible to cash.
  • It’s important to note that the reserve requirement would be a dynamic measure, and it would be subject to adjustment based on market conditions. For instance, if the market is experiencing a period of high volatility, the regulatory body may increase the reserve requirement to provide additional protection for investors. In contrast, during a period of stability, the regulatory body may reduce the reserve requirement to allow crypto platforms to have more flexibility in their operations.
  • Establishing oversight and reporting requirements: compliance with the reserve requirement should be enforced by regulators establishing oversight and reporting requirements. This could include regular audits and inspections, as well as the requirement for regular reporting on the assets held in reserve.
  • Gradual implementation: To avoid disrupting the crypto market, regulators could implement the reserve requirement gradually over time. This would allow relevant stakeholders to adjust to the new requirements and ensure a smooth transition.

Final Thoughts

Historically, cryptocurrencies have been highly volatile with no system in place to ensure stability. The present situation is no different, with speculation driving much of the market and leading exchanges feeding the hype. Given this reality, it is clear that stricter, bank-type regulations based on cash-backed reserves are necessary to protect investors and prevent market manipulation.

At the same time, it is important to recognize that crypto is a rapidly evolving technology and that regulations must be flexible enough to adapt to new developments. This will require ongoing monitoring and the willingness to adjust regulations as needed. Despite the recent spate of negative news, crypto has not hit a dead end. And it remains critical to have a well-balanced approach with transparency, accountability, and an open mind to the innovation that crypto can bring.

The author Guy Sheetrit is a rising authority in the crypto and marketing industries, recognized by prestigious magazines such as Forbes, Inc., and NYtimes for his expertise and contributions to these fields. He is an early investor in Bitcoin, Ethereum, and Solana, and has established himself as a leading voice in the crypto industry with PLT Finance. In the SEO and digital marketing spaces, Guy’s agency unconventional strategies have generated over $1 billion for his partnering clients in the last five years, earning him a ranking as one of the world’s top 5 SEO authorities.