Introduction
Crypto market events over the past year demonstrate the risks inherent in an extremely volatile asset class that operates largely outside of existing regulatory frameworks. Turbulence in crypto asset markets in the spring of 2022 led to the collapse of a large algorithmic stablecoin project, which, in turn, triggered a wave of high-profile failures, ultimately including that of FTX, then the world’s third-largest exchange. Amid allegations of pervasive fraud, millions of FTX customers
were unable to access their crypto assets, and have little recourse in recovering assets that are missing due to mismanagement and malfeasance.
These events have revealed widespread failures in investor protection, risk management, and governance. In response, many policy makers and commentators are calling for more regulatory oversight of crypto asset markets, while others are advocating for further marginalization of crypto assets by keeping them outside the regulated financial system.
For its part, the crypto industry has used the FTX collapse to tout the benefits of decentralized finance (known as DeFi), whereby market participants maintain custody of their own crypto assets and transact over smart contract–enabled protocols without the overt participation of intermediaries like FTX. At the same time, many in the industry vociferously oppose the regulation of DeFi.
We argue that investor protection and market integrity are foundational public policy goals that should be upheld regardless of whether transactions involve centralized intermediaries or are conducted in a decentralized manner through a web of smart contracts. Since most investment and trading activities in crypto assets closely resemble activities in traditional finance that are regulated, public policy should seek to achieve similar outcomes with respect to crypto
exchanges and DeFi.
