If financial regulators want to continue protecting investors as new technologies like cryptocurrencies and non-fungible tokens proliferate, they’ll need to give investors the tools to protect themselves.
Indeed, regulators may have little other choice. The world of investing is in the early stages of a transformation that will upend the U.S.’s century-old system of financial regulation. That system came into being during the Great Depression after the stock market crash of 1929. In those days, investment options were limited mostly to stocks and bonds of U.S. companies, which is why the bulk of U.S. financial regulations still relate to public companies and the intermediaries — exchanges, dealers, brokers, advisers and funds — that deliver those stocks and bonds to investors.
The idea was to prevent companies and intermediaries from swindling investors, mostly by requiring honest disclosure of financial information. Congress tasked regulators with enforcement, although the job has become much more difficult over the years as the menu of investment options has grown to include foreign stocks and bonds, derivatives and private assets. Regulators are stretched thin these days, as my Bloomberg Opinion colleague Shuli Ren pointed out recently.
But however difficult it is to keep up with expanding markets, the task regulators now face is even trickier. With the advent of distributed ledgers, the line between purveyors and consumers of investment products is disappearing. Anyone will soon be able to turn anything into an investment that can be bought and sold anywhere in the world without intermediaries. That already includes thousands of cryptocurrencies and a burgeoning market for digital art traded as NFTs.
And that’s just the beginning. NFTs also include digital sports memorabilia, videos and virtual real estate; other non-fungible items in the digital realm, such as concert tickets and music recordings, aren’t far behind. It’s only a matter of time before physical assets that are non-fungible are also tokenized, such as houses, diamonds and collectibles. Eventually, tokens could even combine multiple assets and be owned fractionally by multiple investors, much the way funds operate now.
How do you supervise decentralized global markets where billions of people worldwide are both creators and consumers of investment products? Regulators can try squeezing NFTs into the existing system by extending anti-fraud and manipulative trading rules to tokens and requiring them to be registered with the Securities and Exchange Commission. But good luck enforcing those rules. While companies and intermediaries that want access to U.S. stock and bond markets have no choice but to comply with regulations, there are no comparable gates around decentralized cryptocurrency markets. There’s no incentive to play by governments’ rules.
That’s why crypto markets are the Wild West, in the words of new SEC Chair Gary Gensler, which is a feature, not a bug, according to adherents. Regulators aren’t likely to tame them or prevent U.S. investors from participating in them. Yes, ordinary investors have long been banned from buying what regulators deem to be “sophisticated” investments, such as hedge funds, private equity and venture capital — never mind that private assets are much easier to understand than the derivatives available to teenagers on trading apps. But those exclusions seem increasingly antiquated as markets open to more investors, and in any event, decentralized markets can’t be gated easily.
Rather than fight a losing war with decentralized markets and play whack-a-mole with every token that comes along, regulators should devote more resources to educating investors about how to manage their money responsibly. A few basic principles, explained in plain English, would go a long way. Investors should know how to properly diversify a portfolio and understand the fees they’re paying. They should also be able to distinguish between investments that can be expected to grow over time and speculative bets that are likely to wipe out their savings. Many people lack that basic knowledge, particularly the millions of young investors who are encountering markets for the first time during this pandemic.
In fact, Gensler may be just the person to lead this new era of financial regulation that builds up investors rather than swaddles them in bubble wrap. Gensler’s YouTube series addresses investors directly, the first of its kind from an SEC chair. Gensler can build on that platform to further educate investors and promote regulators’ efforts to improve financial literacy. Only good can come of it — if regulators somehow wrangle cryptocurrencies and NFTs and whatever follows, investors will still be better off knowing how to navigate markets.
That doesn’t mean regulators should stop regulating. Companies and intermediaries still need watching over, and perhaps attempts to control crypto markets, as Gensler has already said he plans to do, will give participants some incentive to play nice. But it won’t be enough to protect investors. In this new world of decentralized finance, an educated investor is worth a thousand regulations.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
More Alternative Investments Topics >
