Financialisation of Crypto: Building Regulation

Cryptocurrencies, blockchain and decentralised finance were designed as replacements for weaknesses inherent in traditional finance, such as the systemic risk and government profligacy at the heart of many financial crises. Yet, failures of prominent crypto firms highlight the flaws in this argument. Crypto is neither special nor immune. As we argue here, the crypto industry has come to feature all the classic problems of traditional finance. As the crypto ecosystem has evolved, the market failures and externalities of traditional finance have emerged, a process we term the “financialisation” of crypto. These include conflict of interests, information asymmetries, centralisation and interconnections, large numbers of poorly informed, over-enthusiastic market participants, as well as agency, operational and financial risks. We argue that the regulation of crypto needs to learn from the centuries of experience of traditional finance: in order to function properly, crypto requires appropriate regulation and supervision to address market failures and externalities. Yet, while it appears the “Crypto Winter” of 2022-2023 has prompted the world’s financial regulators to act, regulators need to overcome the difficulties posed by decentralization as the underlying paradigm of the crypto industry, which results in a multi-jurisdictional environment of crypto markets, participants, infrastructure and intermediaries. We argue that regulatory systems can (and must) now be instituted to ensure the proper functioning of crypto and its interconnections with traditional finance.