The UK, which was at first cautious, is now running full tilt into a crypto regulatory framework. Yet, is this embrace one of a warm hug or a suffocating grip? Are we about to witness the unintended consequence of good intentions: the death of DeFi innovation on British soil?
Chasing Stability, Losing Innovation?
The FCA’s efforts to place crypto in the framework of our existing financial system may seem promising. However, financial frameworks are designed for centralized models, for institutions with bricks and mortar headquarters and centrally recognizable CEOs. DeFi, by its very nature, is decentralized. It's borderless. It resists easy categorization.
Ignoring ecosystem unique needs and trying to jam a square peg (DeFi) into a round hole (traditional finance) is a surefire way to crash and burn. It would be as absurd as trying to regulate the internet under 19th century postal regulations! So while we welcome the FCA’s consultation, the proof will be in the pudding. Will they actually engage the industry, or just nod their heads while before rolling out a pre-set regulatory agenda?
I fear the latter. The FCA's history, including the email deletion controversy (conveniently sweeping away potentially incriminating evidence after a year!), doesn't exactly inspire confidence. It speaks to a culture of an organization more focused on control than on working together. This isn’t just consumer protection, it’s narrative protection.
Let’s be frank, the pace they’re adopting, especially considering how slow they started, seems hurried. So, are these people really believers in crypto’s transformative potential? Or are they simply responding to clearly articulated demands from above, to make the UK the poster child for agile, finance-fuelled growth industries? Even the UK’s much heralded strategic pivot comes across as a last ditch attempt to remain important in a focused, fast-paced, changing environment internationally.
Innovation Flight, Regulatory Arbitrage?
What happens when the UK’s regulatory environment becomes too restrictive? Innovation goes elsewhere. Capital goes elsewhere. Talent goes elsewhere. It's a simple equation. Killing off DeFi in the UK won’t do away with it globally. Rather, it will push the industry out to sea to countries with a more welcoming regulatory environment.
Think of it like this: if you make it too difficult to start a business in one country, entrepreneurs will simply move to another. The same applies to DeFi. Otherwise, the UK may find itself a regulatory island, cut off from the innovation it professes to be seeking.
And what about regulatory arbitrage? And the FCA will likely make every effort to impose a tall fence around the UK crypto market. Intrepid developers will soon find loopholes here that they’ll learn to exploit. They’ll use every loophole available to them, set up shop in more welcoming jurisdictions, and still be able to serve UK customers from outside their borders. The rules are going to be like a dam with too much water – you can’t hold back the tide, it will break eventually.
Protecting UK Citizens, Or Limiting Access?
The FCA’s first and foremost argument for tougher regulation is, naturally, consumer protection. No one wants to watch seniors lose their life savings to scams or DeFi projects they don’t fully understand. So is the answer to get rid of all activities that involve some level of risk?
Risk is inherent in any investment. But with the potential for high reward comes the potential for high loss. People of every age should be able to exercise their personal financial judgement, including making high-risk choices. They need to be completely cognizant of the dangers beforehand.
What overly restrictive regulation does is not protect people, but instead infantilize them. It says, "We don't trust you to make your own choices." On the contrary, it restricts access to potentially life-changing financial opportunities, especially to those who are historically underserved by traditional financial institutions.
The 12% of UK adults who own cryptoassets aren’t all stupid gamblers. It’s not that people aren’t intelligent or educated. At the same time, they understand the enormous promise of DeFi to create a more inclusive and efficient financial system. The FCA’s unwillingness to change is choking off innovation, and that’s doing real damage to the industry. This move would endanger the very people it professes to protect. Make no mistake, this is a classic case of the cure being worse than the disease.
Just last week, the DOJ charged the crypto company for allegedly laundering money for Russian entities that had been sanctioned. This enforcement action emphasizes the grave dangers lurking in the crypto space. This is a question of law enforcement, not wholesale prohibition. What we need is a more targeted set of measures to uniquely address wrongdoing, not a regulatory sledgehammer that flattens all innovation in its path.
Ultimately, the UK’s crypto gamble will come down to balance. A new equilibrium of consumer protection and innovation development. And finally, the ongoing tension within these efforts is the balance between regulating risk and protecting personal freedom. If the FCA gets it wrong, the UK risks being left a crypto backwater. It would become a graveyard for innovation. And that would be a travesty, not only for the nascent crypto industry, but for the UK writ large.
The SEC's evolving stance, as pointed out by Paul Atkins, shows even the US is grappling with the right approach. We need to take the cue from these success stories. We cannot afford to take a path that is likely to lead to unintended and catastrophic consequences.
