The fintech industry and cryptocurrency firms have always prided themselves on the fact that they are not like traditional financial institutions. Traditional institutions can be slow and full of bureaucracy. Additionally, traditional banks can be quite expensive when it comes to facilitating even simple transactions like international wire transfers and fiat currency conversions or when providing personal banking services. The fintech industry can offer solutions that bypass much of the red tape that consumers experience when participating in the traditional banking market. It is because of these solutions and conveniences that the fintech industry has exploded in popularity as a viable alternative to traditional financial institutions.
Today, fintech can provide numerous innovative ways to help individuals and businesses exchange money. From commercial and retail banking services to investment opportunities and crowdfunding solutions, fintech has established itself as a credible alternative to traditional financing. Because of this recent explosion in popularity, fintech companies and cryptocurrency firms have without a doubt attracted the attention of conventional financial institutions as well as federal and state regulators. This is not entirely a bad thing. The fintech industry as well as cryptocurrency firms have much to gain from working with the traditional financial sector and regulators. Regulations can build consumer confidence and increase market share and revenue growth.
There are four main mandates that financial regulators are looking to address when it comes to the fintech industry. They are financial stability, conduct & fairness, competition & development, and prudential regulation.
Main Factors Addressed by New Regulations
Let us take a closer look at how financial regulation is being shaped to address the above-mentioned mandates.
The fintech industry, and more specifically, cryptocurrency, has carved out a large portion of the US economy. The total market cap of cryptocurrencies in the US is $2.079 trillion as of April 2022. That is a significant amount that cannot be taken lightly when considering the financial stability of the cryptocurrencies themselves, the investors, both investment funds and individual investors, and the overall crypto marketplace.
The use of stablecoins presents further concerns to regulators. Stablecoins are cryptocurrencies that never vary in price and that are indexed using a base reference like the US dollar or Euro. These stablecoins act as a bridge between digital currencies and fiat currency. To ensure the value of the stablecoin, the corresponding value must always be kept in reserve to the number of coins in circulation. These stablecoins then have a market value that is similar to a bank.
The main concern for financial regulators lies in whether or not the firms behind these stablecoins actually maintain the necessary reserves to back them up. As more transactions take place, the more stablecoins there become in circulation. If any of these stablecoins were to fail, or if they lacked the reserves to back the number of coins in circulation, wider impacts could be made on the traditional market. For these reasons, financial regulators feel it is their obligation to have some oversight and be able to help manage the stablecoin market. Regulations could help ensure that cryptocurrency firms that manage these stablecoins always have enough fiat currency in reserve to support the coin and that consumers are not shorthanded when wanting to exchange their digital assets for hard currency.
Conduct & Fairness
When it comes to fintech companies and cryptocurrency firms, the lack of regulation has led to an increased concern about fraud and consumer protections. Specifically, when it comes to cryptocurrencies, the mechanisms that determine how coins are valued, the way that they are exchanged, and how they are stored, present many opportunities for fraud with little to no recourse for victims. Regulators are extremely concerned about the increased reports of false initial coin offerings, pump and dump schemes, market manipulation, Ponzi schemes, theft, fraud committed by brokers, and the use of unscrupulous promoters to overvalue coins. Increased oversight by the FTC, SEC, and other regulatory bodies is expected as an attempt to reduce the number of fraud cases, the ability of fraud to take place and to provide consumers with the protection they desire to feel that cryptocurrencies are a safe and viable investment opportunity.
Competition & Development
A major challenge for financial regulators is how they should develop regulations that foster competition and that do not stifle development. Specifically, when it comes to startups, funding and working capital may be limited. If a startup is required to comply with the same regulations that larger established fintech companies and crypto firms are required to, could it ultimately suffocate their development? Regulations that inadvertently stifle innovation and development could have long-lasting effects on the fintech industry that could decrease competition and have larger impacts on the conventional financial market.
Prudential regulation is a legal framework focused on the financial safety and stability of institutions within the broader financial system. The main goal of financial regulators is to institute rules that ensure that all entities within the fintech industry can meet the financial commitments they make to a core group of customers.
What does this all mean for fintech companies, startups, and cryptocurrency firms?
The bottom line is that it has been established that financial regulators are aiming to close the gap between what has traditionally been seen as conventional financial institutions and the fintech industry in regard to regulation. Some fintech companies and startups have and may take the approach of becoming a chartered institution, others will maintain all regulation compliance in-house.
Regardless of how these fintech companies approach the inevitable and forthcoming financial regulations, their success relies upon taking the steps to maintain compliance. By maintaining compliance, fintech companies and cryptocurrency firms have the potential to increase market share and grow revenue. The level of confidence that regulatory compliance can give key entities like consumers, investors, and analysts may be instrumental to developing a cohesive fintech industry as well as fostering the individual success of the companies that operate within that industry.