The Goldilocks crisis could have arrived for crypto

Sixteen years ago I often joked that the financial system needed a "goldilock crisis"-a shock that was just hot enough to force investors and supervisory authorities to wake up and see the increasing risks on the credit markets, but not so hot that it caused the entire system to burn down.

Unfortunately, this crisis never occurred at the time; Instead, loan derivatives and subprime mortgage loans further exploded until they triggered the 2008 crisis that almost "burned down" the financial ecosystem (until the central banks arrived with these quantitative loosening agents).

But the fascinating question today, in the middle of another financial innovation boom, is whether this gold lily of the vigilation has now come for digital assets? The crypto sector has been as dramatically exploded lately as once a loan derivatives - and many investors are roughly as unsuspecting in terms of its functioning as in 2006 with secure bonds.

But this month we "experienced one of the greatest disasters that crypto has ever seen", as Ran Neuner, a prominent crypto enthusiast, recently admitted. Especially Terra and Luna, the two so -called "algorithmic stable coins", imploded and caused losses of $ 50 billion in three days. Ouch.

Some argue (or hope) that this shows that crypto should burn completely because the sector has not redeemed its reliable asset memory or really efficient payment mechanisms.

Maybe this will happen. The entire cryptoma market of around $ 2 trillion has already shrunk by around 30 percent, and if a crisis is now the 80 billion dollar-tther stable hits coin (which is quite possible), it will continue to shrink. But if you think (like me) that the crypto revolution has a core of potentially valuable ideas about blockchain technology, it is foolish to ask for a ban on the Chinese model.

Yes, Luna always looked crazy how well-respected crypto experts like Alex Lipton, a financial professor, warned last year. But Lipton still believes that blockchain could change sectors such as foreign exchange trading and carbon markets while some stable have coins.

The 50 billion dollar question is whether the main actor and political decision-makers can now take on reforms in order to eradicate the bad and at the same time to maintain some of the good? Can a Goldilocks pattern appear?

It is unclear. But there are five key questions that investors should consider in order to find the answer.

The first is whether the language of the sector becomes less confusing. Consider "stable coin". This word is currently being used to market a number of different practices that are from algorithmic coins (which actually rather resembles a synthetic derivative) to the USDC (which is more similar to a narrow minibank). This veil must change.

Secondly, the supervisory authorities have to expand the supervision. In America, tokens that behave like crazy derivatives or investment funds are best monitored by the Commodity Futures Trading Commission or Securities and Exchange Commission. Coins that operate like minibanks are better monitored by the Office of the Compotroller of the Currency. (Circle, which spends USDC coins, is currently in active conversations with the OCC for exactly this.)

Thirdly, if regulatory authorities are involved, you should place stable requirements Coin issuers must provide tested, detailed information on your assets and impose high minimum reserves. That sounds obvious. But above all, it is not what Tether, the largest stable coin emittee, did.

Fourthly, the supervisory authorities should demand that crypto exchanges comply with fundamental listing standards. And finally, clarity is urgently needed for custody, since the stock exchanges not only act as platforms for the completion of shops, but often also keep customers' assets.

This often ignored concentration of power mocks the mantra of decentralization, which supposedly drives the crypto dream (and, as I recently noticed, is only a contradiction in the creation mythology of this sector).

But it also creates a practical risk: failure could trigger market panic. Some small non-jurisdictions have custody rules that protect investors when an exchange goes bankrupt. Not at the federal level in America, as the executives of Coinbase had to admit last week to investors. That must change.

These ideas are not remotely revolutionary; Similar principles were previously imposed on other innovation areas. In fact, many were clearly presented in a report published by the President’s Working Group on Financial Markets in seven long months ago, in which "urgent" laws were required to address the growing risk.

But since then the congress has not acted in particular; Although this is a rare topic in which there is a non -partisan interest. Most mainstream crypto players have also dismissed the problems. Although, for example, the issuer of Tether was fined due to accounting errors, investors continued to use this.

Hence this Goldilocks question. If the industry and the political decision -makers now (late) react to the fact that they are burned by introducing a reasonable framework, the world will finally see whether crypto can be used a little more than a wild marginal casino. If not, you can expect further scandals, shocks and investor pain. In my opinion, it is still unclear which scenario prevails.

gillian.tet@ft.com