Cryptocurrency has been with us for some years now and yet there is no consistency regarding regulations to protect consumers and govern the crypto market. In a speech at the Piper Sandler Global Exchange & Fintech Conference in New York the chair of United States Securities and Exchange Commission (SEC) https://www.sec.gov/, Gary Gensler gave the keynote speech during which he likened the present crypto market to the stock market in the United States in 1920. He commented “…it is full of “hucksters,” “fraudsters” “scam artists” and “Ponzi schemes…” and further indicated that just as the securities laws in 1933 and1934 cleaned up the stock market at the time, so can the crypto market be made sound by applying similar laws.
The alarming rise of crypto frauds has resulted in a 183% increase in SEC’s legal actions related to crypto.
Demetri Bezaintes, an associate, commented “in the United Kingdom the central banks, such as the Bank of England, issue and administer the money that is in daily use. Cryptocurrency is developed by groups, sometimes individuals and companies.” Demetri further pointed out “the information available relating to such organisations is often vague and as crypto dealings are not subject to regulation in the UK, should things go wrong there is no safety net as there is with other types of financial fraud. The market is decentralised and which many crypto investors believe reduces the risk of theft by hacking. However, the removal of the second pair of eyes that trusted intermediaries like financial institutions bring means that there is greater exposure to fraudsters. Many investors are lured by the promise of high levels of return on investment and close their eyes to the volatility of the crypto market and the fact that if the market drops it drops extremely swiftly with little or no warning, nearly always resulting in wiping out any gains. Similarly, the ever-present risk of fraud is ignored.”
Giambrone & Partners banking and financial fraud litigation lawyers are leading lawyers in the fight against financial fraud, crypto fraud in particular and have considerable success in recovering our clients’ funds lost to various crypto frauds. Our lawyers ground-breaking case D’Aloia v Persons Unknown & Others was the first case in Europe (second in the world) where the court was persuaded to serve legal papers as a non-fungible token (NFT) through the blockchain thereby ensuring that the previously anonymous fraudsters could not escape the consequences of their wrongdoing.
The International Monetary Fund (IMF) https://www.imf.org/en/About warns that early promises that crypto would transform the way finance was delivered by advocates of the crypto market, that many policymakers accepted at face value, now seem quite hollow. Far from transforming the financial markets for the better, the negative impact has caused greater harm. The IMF suggests that policymakers must scrutinise and recognise that the crypto market may not be able to deliver on the early promises. Therefore, strict regulation is required for the crypto market and associated structures such as the blockchain.
The European Supervisory Authorities (EBA, ESMA and EIOPA – the ESAs) have set out a range of steps consumers should take to ensure they make informed decisions. As with other regulatory bodies they warn that investors should recognise that they may lose all the money that they have invested if they consider the crypto market and that there next to no recourse should the worst happen.
This warning comes in the context of growing consumer activity and interest in crypto-assets and the aggressive promotion of those assets and related products to the public, including through social media.
In their warning, the ESAs highlight that these assets are not suited for most retail consumers as an investment or as a means of payment or exchange, as consumers:
-
- face the very real possibility of losing all their invested money if they buy these assets;
- should be alert to the risks of misleading advertisements, including via social media and influencers; and
- should be particularly wary of promised fast or high returns, especially those that look too good to be true.
The ESAs also warn consumers that they should be aware of the lack of recourse or protection available to them, as crypto-assets and related products and services typically fall outside existing protection under current EU financial services rules.
In the 14 years since Bitcoin emerged, proponents have made promises that crypto will revolutionize money, or payments, or finance—or all of the above. These promises remain unfulfilled and look increasingly unfulfillable—yet many policymakers have accepted them at face value, supporting crypto experimentation as a necessary step toward some vague innovative future. If this experimentation were harmless, policymakers could let it be, but the ills of crypto are significant. Given these negative impacts, policymakers must train a more critical eye both on crypto assets themselves and on their underlying databases (known as blockchains) to determine whether crypto can ever deliver on its promises. If it cannot, or is even unlikely to, deliver, there must be strong regulation to rein in the negative consequences of crypto experimentation.
Among its negative impacts, the rise of crypto has spurred ransomware attacks and consumed excessive energy. Bitcoin’s blockchain relies on a proof-of-work validation mechanism that uses about as much energy as Belgium or the Philippines; the Ethereum blockchain keeps promising to shift from proof of work to the more energy-efficient proof of stake, but this never seems to happen.
A crypto-based financial system would perpetuate, and even magnify, many of the problems of traditional finance. For example, the amount of leverage in the financial system could be multiplied through a potentially unlimited supply of tokens and coins serving as collateral for loans; rigid self-executing smart contracts could deprive the system of the flexibility and discretion so necessary in unexpected and potentially dire situations. More generally, the crypto ecosystem is extremely complex, and that complexity is likely to be a destabilizing force (both because complexity makes it hard to assess risks even when there’s plenty of data and because the more complex a system is, the more susceptible it is to “normal accidents,” when a seemingly minor trigger cascades into significant problems). So any crypto-based financial system would likely be subject to regular destabilizing booms and busts.
Crypto’s complexity arises from attempts at decentralization—by distributing power and governance in the system, there is theoretically no need for trusted intermediaries like financial institutions. That was the premise of the initial Bitcoin white paper, which offered a cryptographic solution intended to allow payments to be sent without involving any financial institution or other trusted intermediary. However, Bitcoin became centralized very quickly and now depends on a small group of software developers and mining pools to function. As internet pioneer and publisher Tim O’Reilly observed, “Blockchain turned out to be the most rapid recentralization of a decentralized technology that I’ve seen in my lifetime.” Although the Bitcoin white paper’s promise of decentralization did not deliver, the underlying complexity of the technology that tried to do so remains—which is also true of crypto writ large.
Policymakers should not be swayed by the dubious promises of decentralization and democratization.
Over the spring and summer of 2022, we saw a number of other purportedly decentralized crypto players stumble and fail—and as they did so, it became abundantly clear that there were intermediaries calling the shots. A stablecoin is a type of crypto asset designed to maintain a stable value, and as the Terra stablecoin lost its peg to the dollar in May 2022, holders looked to founder Do Kwon’s Twitter feed for guidance. Before Terra failed, it received an attempted rescue package of crypto loans from a nonprofit established by Kwon. The loaned crypto was allegedly deployed to allow some of Terra’s largest holders—commonly referred to as “whales”—to redeem their Terra stablecoins at close to par value, while smaller investors lost nearly everything. In the crypto market turmoil that followed the failure of Terra, multiple episodes showed the power of founders and whales in platforms ostensibly administered by decentralized autonomous organizations. Many crypto proponents were quick to criticize the affected platforms, saying that they were never really decentralized in the first place and that only the “truly decentralized” deserved to survive. All of crypto, however, is centralized to varying degrees.
The European Supervisory Authorities (EBA, ESMA and EIOPA – the ESAs) today warn consumers that many crypto-assets are highly risky and speculative. The ESAs set out key steps consumers can take to ensure they make informed decisions.
This warning comes in the context of growing consumer activity and interest in crypto-assets and the aggressive promotion of those assets and related products to the public, including through social media.
In their warning, the ESAs highlight that these assets are not suited for most retail consumers as an investment or as a means of payment or exchange, as consumers:
-
- face the very real possibility of losing all their invested money if they buy these assets;
- should be alert to the risks of misleading advertisements, including via social media and influencers; and
- should be particularly wary of promised fast or high returns, especially those that look too good to be true.
The ESAs also warn consumers that they should be aware of the lack of recourse or protection available to them, as crypto-assets and related products and services typically fall outside existing protection under current EU financial services rules.