(Opinion) Special rules for crypto pose unacceptable risks

TECHNOLOGY

By: Jamie Forte

As crypto moves into the mainstream, led by crypto companies and fintech startups seeking to capitalize on this economic moment, there have been numerous calls to forgo existing standards in the name of strengthening innovation in the marketplace.

Proponents of crypto worry that, should it be subject to the same rules as traditional finance, it could greatly limit crypto’s potential in areas where it differs from traditional assets.

But we must also ask ourselves what crypto’s true “potential” is, for its new tools cannot substitute for core market rules and regulations. The disclosure of important factors — like who is behind a transaction — isn’t there. In truth, the anonymity and decentralization crypto offers come at a significant cost.

Anonymity is often pitched as a freedom-enhancing, privacy-protecting core feature of the blockchain, which makes transactions themselves publicly visible. But it does little to help the individual investor, while enabling predatory behavior by insiders with unfair market advantages.

In a fully anonymous scenario, there are no restrictions on my ability to abuse insider status and information, nor can other participants prevent me from manipulating the assets I own on the market.

Massive insider trades may raise eyebrows and draw media attention and scrutiny, but without the ability to prove who is behind a transaction, there is no way to enforce accountability, whether by law or through market mechanisms.

Suppose, for example, I own a significant share of a token’s supply. To perform a classic pump-and-dump operation, I need only to hide the extent of my ownership, while promoting the token to others. Once enough people have bought in and pumped up the price, I can dump my supply and cash out the value stored therein, leaving the others with now-worthless tokens.

If investors can see that I hold a significant share of the supply before buying in, they may get cold feet and back out or even advertise my involvement to warn others of the potential risk. With my identity exposed, my ability to manipulate the market is thus a prominent risk visible to other participants, and I may struggle to attract new investors as a result.

Absent safeguards like disclosure requirements, participation will always be limited to a select few with extremely strong risk tolerance, or preexisting market advantages that give them confidence in their ability to prevail.

This all but rules out institutional investors, whose participation is critical for long-term market growth and flourishing, because their fiduciary obligations demand a higher degree of fairness and certainty than the unregulated market can provide. These investors cannot participate in a system that is susceptible to being rigged, for their failure is not merely their own but also that of their customers.

Modern financial markets are the culmination of centuries of trust-facilitating institutions and mechanisms. These have evolved because trust is a net-positive resource; it benefits everyone but is not inherently limited in supply. Without a framework for trust, economic actors cannot engage with strangers, limiting options for trading and investment to local strong tie social networks where trust has already been established.

With frameworks for trust, I can afford to trust strangers I do not know personally, because the framework gives me sufficient grounds to do so. We must be able to trust our markets, because trust is a precondition to all other activity. Without it, markets cannot grow and thrive.

Tokenization — the conversion of realworld stocks into digital assets on the blockchain — poses a similar if not greater risk. Insider information about a specific stock is far more impactful for stocks than for broader assets like bitcoin, and crypto’s facilitation of insider trading magnifies this risk for any tokenized stock.

Moreover, tokenized asset markets remain open 24/7 and lack typical cooling-off periods that can otherwise mitigate volatility. Tokenization cannot be allowed to proceed until these are addressed, for they not only pose unacceptable hazards to most market participants but can easily spill over into the broader financial system as well, despite the rules already in place.

Crypto’s potential shines brightest as a pure technology evolution, rather than a reconceptualization of our financial system. If crypto assets are subject to the same robust transparency and disclosure requirements as traditional stocks, and token holders must disclose their identities and ownership, a plurality of these issues can be resolved.

This would prevent the full anonymity desired by many crypto advocates from being realized, but it would also allow our markets to function in a manner that is safe and fair for all.

Jamie Forte lives and works in Washington, D.C. He is a graduate of Phillip Exeter Academy (2018) and the College of William & Mary (2022).