Why the Governments plan to regulate crypto could end up backfiring

After warnings to investors and threatening to intervene in the market, the UK Government has decided to step in on the world of crypto.

In proposals published on Wednesday and open for consultation from interested parties until the end of April, the Treasury says it will robustly regulate the sector, while still allowing it to grow to its full potential.

The proposed rules will include guarantees that customers will see their assets returned to them in the event of a crypto business holding their investment going out of business similar to the ring-fencing of up to 85,000 of savers deposits in regulated UK banks and beef up rules on promoting crypto in a way that is not misleading.

Crypto businesses, including trading platforms, will also have to report their data to regulators much more frequently and transparently. Crypto lending will also be regulated.

We remain steadfast in our commitment to grow the economy and enable technological change and innovation and this includes cryptoasset technology, says Economic Secretary to the Treasury, Andrew Griffith, echoing support Rishi Sunak pledged for crypto in his time as chancellor. But we must also protect consumers who are embracing this new technology ensuring robust, transparent, and fair standards.

The plans introduce layers of formality to a sector that has been built on its flexibility and wariness of central control which is why some fear it might not work.

Yet those who believe crypto needs to be cleaned up have supported the Governments approach. Its thinking of tackling all of the major pitfalls such as market manipulation and wash trading, while not being too overbearing on the exchanges, says Andres Guadamuz, reader in intellectual property law at the University of Sussex, who has tracked the rise of the crypto sector, and welcomes the plans.

In particular, Guadamuz believes the rules strike a good balance between intervention and allowing the market to develop freely something thats central to the idea of crypto, and what makes those who are so keen on its future such ardent boosters. I like that its using the concept of regulatory trigger points, he tells i. This means that for the most part the activity can take place unaffected, but some actions will trigger a response.

Such an approach shows that the Government is keen to act more as a custodian that can intervene forcefully if and when needed, rather than as an interventionist-heavy regulator.

However, not everyone believes that the plans, as currently devised, should be welcomed with open arms. My biggest worry with crypto regulation is the hurdles it creates for companies to set up in the UK, Patrick McCorry, a crypto researcher, tells i.

It is already notoriously hard to get a UK business bank account for a crypto startup as banks dont want the regulatory overhead to deal with it so they simply shut them down. Adding another layer of bureaucracy to a sector whose foundational principle is contradictory to the whole purpose of crypto, McCorry believes.

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McCorry doesnt want to discourage rules being established around the sector not least because it will help boost investor confidence in a sector that has in its early days been equated with the Wild West. But he sees the current UK plans as trying to create rules that will be enforced by humans in a central way. Thats the opposite of the decentralised ideal of crypto. We want to create rules that protect consumers, but it needs to be enforced by software in a decentralised way.

McCorry admits that some elements of the enforcement of rules will need human intervention, such as detecting and taking action on pump and dump scams, where particular cryptocurrencies are deliberately and fraudulently touted as the next big thing to build interest in them so its creators can earn big amounts of cash, then are left to wither and die. But for actual consumer protections like keeping the funds safe, you want software.

The mooted rules highlight the catch-22 in which the UK government finds itself. In regulating the crypto sector, any regulator has to try and serve two competing masters: the industry itself, which was established in contrast to many of the key principles that keep customers safe, and the customers, who will not invest in crypto at scale if their money is not protected. One cant survive without the other, but both have contradictory aims.

Crypto adherents believe they have the answer in self-policing through software solutions they develop but thats traditionally never been enough for governments, who are held to higher standards of account.

In trying to thread this complicated needle, the Governments plans could end up backfiring. By providing that firm backbone and confidence for investors, it could scare off providers to meet that demand.

Regulation is welcome of course, but it needs to both protect investors and make it easier for companies to actually set up in the UK without fighting at every hurdle, warns McCorry. Otherwise, theyll go offshore and the regulation is useless.