LONDON: Sixteen years ago, I often joked that what the financial system needed was a “Goldilocks crisis” – a shock that was just hot enough to force investors and regulators to wake up and see the swelling risks in credit markets, but not so hot that it caused the entire system to burn down.
Sadly, back then, that crisis never occurred; instead, credit derivatives and subprime mortgage lending continued to explode until they sparked the 2008 crisis that almost did “burn” the financial ecosystem down (until the central banks arrived with those quantitative easing extinguishers).
But the intriguing question today, amid another financial innovation boom, is whether that Goldilocks moment has now arrived for digital assets ? The crypto sector has recently exploded as dramatically as credit derivatives once did – and many investors are about as clueless about its workings as they were about collateralised debt obligations in 2006.
COLLAPSE IS IMMINENT BUT STILL AVOIDABLE But this month we have experienced “one of the biggest catastrophes crypto has ever seen”, as Ran Neuner, a prominent crypto enthusiast, recently admitted.Most notably, Terra and Luna, the two so-called “ algorithmic stablecoins ”, imploded, creating US$50 billion of losses in three days.Ouch.
Some now argue (or hope) that this shows crypto should completely burn down, given that the sector has failed to live up to its promise of offering a reliable store of wealth or truly efficient payment mechanisms.
Maybe this will happen.The overall US$2 trillion-odd crypto market has already shrunk in value by around 30 per cent, and if a crisis now hits the US$80 billion Tether stablecoin (which is entirely possible), it will shrink further.
Related: Commentary: Why I’m still not taking crypto seriously Commentary: Cryptocurrencies have huge appeal despite holes But if you think (as I do) that the crypto revolution has a kernel of potentially valuable ideas around blockchain technology, it is foolish to demand a Chinese-style ban.
Yes, Luna always looked nutty, as respected crypto experts such as Alex Lipton, a finance professor, warned last year.
But Lipton still thinks that blockchain could transform sectors such as foreign exchange trading and carbon markets, while some stable coins have payment uses.
So the US$50 billion question is whether the key players and policymakers can now embrace reform to weed out the bad, while retaining some of the good? Can a Goldilocks pattern occur?
FIVE AREAS OF REGULATORY REFORM It is unclear.
But there are five key issues which investors should watch to determine the answer.
The first is whether the sector’s language becomes less confusing.Consider “stablecoin”.This word is currently used to market an array of different practices, ranging from algorithmic coins (which are really more akin to a synthetic derivative) to the USDC coin (which is more like a mini narrow bank).
This obfuscation needs to change.
Second, regulators need to extend some oversight.In America, tokens that act like funky derivatives or mutual funds are best overseen by the Commodity Futures Trading Commission or Securities and Exchange Commission.
Coins that operate like mini banks are better monitored by the Office of the Comptroller of the Currency.(Circle, which issues USDC coins, is now in active discussions with the OCC for precisely this.).