Crypto — ’tis the season to be regulated, but SA should find the right fit

Before I get to explain what the Financial Services Conduct Authority said, I know this sort of stuff is happening all over the place — the US, UK, EU, Japan, suddenly and simultaneously. Seems to be contagious. 

Regulators, now finally understanding that crypto is not going to simply shrivel up and die, are scrambling to find the right straitjackets to put on the industry. I say this with all due respect. Sometimes straitjackets are needed to ensure consumer protection or efficient tax collection or anti-money laundering monitoring.

On the other hand, straitjackets sometimes don’t fit, and that is because the term “crypto-asset” refers to a constantly mutating, notoriously slippery creature, and the only country that seems like it may get things right is the UK. More on that in a moment.

The statement from the Financial Services Conduct Authority defined a “crypto asset” as having three properties

The first is that it is not issued by a central bank, but can be traded, transferred or stored and used for payment or investment purposes.

Yes, got it.

The second is that it “applies cryptographic techniques”. 

Er, what? Applies cryptographic techniques to what? The whole of the Internet and finance is awash in cryptography! Tighten up, guys.

The third is that it “uses distributed ledger technology”.

 Um — a definition would be nice.

It then declared that crypto assets would henceforth be “financial products”, which are indeed well regulated.

In looking at the background documents and public responses, the lurking problems with this declaration quickly become obvious. It is that not all blockchain crypto-assets fit. NFTs, for instance. One could simply buy an art NFT to own the art. The NFT is a receipt of ownership. No payment or trading or investment intent. Oops, the regulators decided when this was pointed out, let’s leave out NFTs for the moment… we’ll come back to that.

I don’t want to be too harsh here. My understanding is that very smart people worked on this, and the industry should be grateful for regulatory clarity without which institutions will not play, and without which shady operators proliferate.

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But here is the real problem. Crypto assets are a new breed of “thing”. Forcing them to submit to regulations that have been around for ages recalls the old cliché of round pegs being forced into square holes.

This brings me to the UK. There is a body called the Law Commission of England and Wales, which is occasionally called upon by parliament to research matters of polity and governance and to produce recommendations. Such a request was made for crypto. On 28 July, the Law Commission released a report simply titled, “Digital Assets”.

It is more than 500 pages long and is a profound work of marvellously clear thinking (I have been reading it for a book I am writing on crypto). This is exactly how regulation should be approached. The authors recognised immediately that crypto assets cannot be regulated under legacy legal structures — financial or otherwise. They need something entirely new.

And so they set up to define this new thing from first principles. Here is the nub: 

“The law of England and Wales has traditionally assumed that all objects of property rights must fall within one or other of the two categories — all personal things are either in possession or action. The law knows no third thing between the two.”

In possession — like your laptop. In action — like your car loan.

Yes, well. The authors suggest a new thing — a new type of property. A third thing, never before seen in law.

They call it a “data object”.

And they spend 500 pages defining it, situating it, contextualising it, arguing its necessity in a changing world. The details of which are as long as they are profound. For those with the stamina and commitment (as might befit a regulator), you can find it here.

And here is the point. If you want to legislate and regulate something as new and transformative and complex as the progeny of blockchains, start with the foundations.

Far better than round pegs in square holes. DM

Steven Boykey Sidley is a Professor at JBS, University of Johannesburg.