CFA Institute: Cryptoassets: Beyond the Hype
10 January 2023
Valuation, Fiduciary Duty, and the Challenge of Custody: An Investment Management Perspective on the Development of Digital Finance
A new report by CFA Institute, the global association of investment professionals, brings forward a dispassionate review of the development of digital finance from the point of view of investment practitioners. The report establishes a series of recommendations for institutional investors and policymakers. CFA Institute believes that cryptoassets demand a strong and clearly defined regulatory framework to protect investors, and without such a framework, crypto will be unable to gain mainstream acceptance.
The report, Cryptoassets: Beyond the Hype: An Investment Management Perspective on the Development of Digital Finance, distills the findings from CFA Institute interviews with investment professionals and crypto experts, and discusses three key emerging issues that the market will need to clarify before cryptoassets can progress from the perspective of investors: valuation, fiduciary duty, and the custody of assets.
The report offers an objective viewpoint about merits and risks that the crypto market poses to a typical investor, while highlighting the perils of a system where traditional intermediaries would no longer be responsible for guaranteeing and securing transactions, facilitating price formation, or raising capital. The report offers recommendations for fiduciaries, investors, and policymakers.
Olivier Fines, CFA, Head, EMEA Advocacy, CFA Institute, comments:
“A strong regulatory framework needs to be established for the benefit of both crypto providers and users. Policymakers must either agree on the application of existing laws to various components in the crypto ecosystem or craft new laws to fill in any gaps. Trust in the integrity of crypto markets is essential to attract investors and build crypto networks to scale.
“Crypto platforms combine many of the functions that in mainstream finance are kept separate, such as the roles of brokerages, exchanges, market makers, custodians, and clearing agencies. Existing regulations that intend to prevent traditional finance firms from using customers’ assets to fund their own or affiliated businesses may not always provide similar protections for investors in crypto. The debacle at FTX shows the harm that can come to investors and platform participants when client assets are not kept safe. The example of FTX further underlines the importance of custody issues and the responsibility of investors to base their decisions on the investment case and not on hype and speculation.”
Recommendations for policymakers:
- To the extent possible, policymakers should harmonize regulatory frameworks at an international level. Agree on definitions and supervisory programs that take account of the specific nature of cryptoasset services.
- Determine if cryptoassets are securities, other forms of financial instruments, commodities, or currencies and harmonize this definition at the international level. CFA Institute believes that several cryptoassets would meet the definition of securities under US Securities laws, for example, while in the European Union, this debate is taking place in the context of MiFID II. CFA Institute would argue against designing new extensive regulation as a simplistic response to the difficulty of qualifying cryptoassets.
- Regulation on cryptoassets and digital finance should remain technology neutral. Regulators should not adjudicate which technological developments or orientations offer markets, investors, and consumers the most benefit. Nor should policymakers compromise investor and consumer protections because a technology is new.
- Regulate Stablecoins for systemic risk potential. Stablecoins, one subset of cryptoassets, should be properly regulated from a prudential, business conduct, and investor protection standpoint. The method employed to maintain the peg should be scrutinized and their collateral verified independently. These instruments create ties and ramifications with traditional financial markets in ways that may represent systemic risk to financial stability if left improperly supervised.
- Monitor the cryptoasset market to ensure it remains driven by sound competition forces and avoids undue consolidation. Monitoring programs should be established with a specific focus on costs, fees, and business practices. The potential for consolidation should not result in a new value chain working in the interests of a selection of technologically advanced companies.
- Monitor and control market abuse risks. Regulators should harness advanced forms of data science to monitor such activity to maintain market integrity. The fragmented nature of the cryptoasset market will require regulators to establish information sharing mechanisms to ensure a coherent and comprehensive understanding of transactions in this market.
- Monitor and measure financial risk build-up in the DeFi sector. Depending on the pace of the development of decentralized finance (DeFi) services, regulators should develop metrics to measure and quantify the build-up of risk. It is possible that lending and borrowing in the DeFi sector will require similar prudential measures to those related to financial institutions for their securities lending business dealings.
- Custody of cryptoassets needs to be regulated and secure. Policymakers should place a high priority on enacting a framework of laws and regulations to ensure the safe custody of customers’ cryptoassets. Crypto platforms and firms should not be allowed to use customer assets to fund their own businesses. Customer assets should be segregated and protected even if the platform or firm becomes bankrupt.
CFA
© CFA Institute
