How should Nigeria approach cryptocurrency regulation?

It's no secret that there's an argument for regulating the crypto space. 

For starters, the collapse of TerraUSD, one of the largest algorithmic stablecoins, sent shockwaves across the world. The token it was backed by—Luna—saw its market value drop by over 98% in just one day, which cost the market about $40 billion. You also can't forget the multiple claims of money laundering transactions that happen on the blockchain.

These data points support the idea that regulatory intervention is needed to protect investors from losing more money to the rise of decentralised finance or "DeFi". 

But it's not so clear cut.

On the one hand, there is agreement that many crypto investors have been victims of this burgeoning ecosystem. As such, regulators worldwide now feel the need to step in to protect investors like you and me from the adverse effects of market fluctuations (just like we saw with Luna). However, at a time when people live even more of their lives online (a trend that the global pandemic has accelerated), the crypto-revolution is hard to ignore. We see this with young fintechs muscling in to enable cryptocurrency transactions or governments launching their own versions of digital currencies. 

Therefore, as DeFi approaches a more ambitious terrain, the tension between state regulation and an invention intended to allow people to transact and transfer money without bureaucracy and intermediaries is hard to ignore.

But this isn't the first time the world has had to reckon with a form of decentralised finance. 

You get a bank; you get a bank…

In the late 19th and early 20th centuries, many countries operated semi-free banking systems where private banks could print their own money—which later became a medium of exchange. 

And in some instances, they were successful. For example, in Canada, the free banking method where banks issued their own money (mainly pegged to a central currency) was deemed successful. According to research about free banking in Canada, the banks were not prone to inflation, did not show signs of natural monopoly, and boosted economic growth by delivering efficiency in payment practices and intermediation between savers and borrowers.

In some cases, however, these free banks were very inefficient and ended up crippling the financial sector of the countries. Australia's free banking situation is an excellent example of this. Like the events that led to the 2008 recession, Australian banks gave out several loans for real estate projects, many of which went bad. This led to banks becoming undercapitalised, which caused the real estate bubble to burst, and the financial institutions to go under. 

The idea of free banking sounds quite similar to cryptocurrency, at least for stable coins. Someone creates the currency, and people buy it—either through an initial coin offering or when the coin is launched. As more people buy it, the value of the coin increases, and as people sell, the value reduces. However, the value crashes if a considerable volume of the currency is taken out at once—if a whale takes out its money at a time. 

However, unlike in the free banking era, cryptocurrency issuers and exchanges are not required to keep any reserves which they would use to redeem the cryptocurrency if or when there is a market crash. Here's where part of the problem lies, Crypto issuers don't always have enough reserves to maintain the currency's value. A case in point is what we saw with Luna when the token lost so much value even after the parent company attempted to sell off most of its bitcoin to maintain its value. 

This is not to say that the centralised alternatives are any better. For one, the Central Bank of Nigeria (CBN) 's handling of Nigeria's monetary policy has not always improved Nigeria's macroeconomic situation. You only have to read some of our articles about all the ways the CBN has been providing expensive loans to the federal government through ways and means financing to see a practical example of this. 

Regardless, we cannot deny that a genuinely decentralised financial system leaves users at the mercy of creators. Without rules to govern this space, that could quickly become disastrous.

If it looks and acts like money, maybe it's money

Generally, though, a rule of thumb for regulation is a proper understanding of the business environment before intervening with a new law or policy that will govern operators' actions. That's because there is a widespread belief that regulation can be disruptive and when it's heavy-handed, can stall progress. We showed this in our coverage of Rubies bank and how regulatory policies knocked an entire network offline. 

So unsurprisingly, people will typically call on regulators to be at pace, rather than entirely undermine technology developments. This will help to get broad agreement on who should have regulatory oversight for a space. Side note: as with many things, when it comes to regulation, the "who" matters. 

That's one of the challenges regulators interested in the crypto space face. Who gets to regulate crypto activities? Is it a currency or is it a security? That agreement hasn't been set in stone.

In Nigeria, for instance, we've seen the Securities and Exchange Commission (SEC) release its regulation on digital assets while the CBN still maintains a crypto ban. Such regulatory overlap can be quite confusing for investors and stakeholders in the market, making it difficult for stakeholders to abide by the regulation. How do you register to be a digital asset custodian when you can't even transact business through the banking system in Nigeria?

Before deciding whose purview crypto falls under, here's why the regulators care. The CBN cares because one of its roles is to maintain or ensure monetary stability in the country through monetary policies. How people spend money,in whatever form, largely affects how these monetary policies translate to macroeconomic results. A granular example of this is that if the CBN increased the interest rate to reduce inflation, but no one is getting loans in Naira, then it would fail to achieve its goal of reducing inflation. Likewise, if the CBN attempted to keep the exchange rate at a certain level, but people kept demanding dollars instead of Naira, it would fail to maintain its exchange rate.

Maintaining the monetary stability in the country also means ensuring money does not get into the wrong hands—that is, preventing money laundering and terrorism financing. 

On the other hand, the SEC is responsible for regulating investment and securities in Nigeria by ensuring its transparency, efficiency, and fairness. For starters, it ensures that every investor is protected and fully informed of the kinds of investment it is going into. It also ensures that intermediaries such as the brokers and exchanges are acting in fairness, for the benefit of investors. It's safe to say that the SEC ensures that the capital market in Nigeria is well run and investors are always protected. 

Now that we know what both goals are, let's go into defining crypto to know who should regulate it. Let's start with currencies.

By definition, a currency is an acceptable medium of exchange in a country, usually issued or accepted by that country's central bank. If the country's central bank does not issue it, it must be accepted and approved for use in said country to guide the central bank in implementing its monetary policy. Although the central banks in many countries do not issue US Dollars, they accept it as a medium of exchange.

The reason it must be acceptable by the central bank is so that it can be easily exchanged for local currency. If I were holding dollars in cash and wanted to change it for Naira, I could walk into a bank to change it, but it might be difficult with currencies that are not globally accepted. 

Based on the definition, it must be accepted as a medium of exchange for a coin or token to be a currency. However, the thing about cryptocurrency today is that exchange does not have to happen through the official financial intermediaries—banks; I can exchange Bitcoin from my wallet to another person's wallet without involving my bank. 

But it still hasn't been accepted by many as a medium of exchange because of its volatility. The value of one bitcoin changed from $47,000 at the beginning of the year to $29,000 today. Such drastic (and sometimes sudden) changes make it difficult to use it as a medium of exchange. 

Although it is established that crypto is not widely used as a medium of exchange, especially in Nigeria, the CBN still seems quite interested in it and that's because of its relevance in the financial sector. Nigeria is one of the largest adopters of crypto, investing as much as $566 million on Paxful, one of the largest crypto exchanges in the world. This means that although crypto might not be used as a medium of exchange, its use is still relevant to the country's financial stability because of its volume.

Also, because crypto is mostly exchanged anonymously, it could easily be used to transfer money to the country, bypassing limitations placed by the CBN. One example is how crypto was used to raise $150,000 for the EndSARS protests, after the CBN locked organisers' accounts. This is an example of how crypto can be used to defy the plans and goals of the CBN, hence their desire to regulate it.

Are cryptos assets then?

The other category crypto might fall under is security. Securities are certificates of ownership of a share in an asset. Again, cryptocurrency falls into this category in that some cryptocurrencies issue initial coin offerings, which allows buyers to own a portion of the coin. This is also the case with Decentralised Autonomous Organisation (DAO) tokens. People put together money for a project they believe in to benefit from the proceeds of the project based on their shares. 

In such cases, since the issuance and trade in securities are managed by the SEC of countries, crypto will be regulated by the SEC. In Nigeria, for instance, we've seen the SEC release its regulation on investment in digital assets, with the assumption that crypto is a digital asset. 

Similar to the free banking situation, securities were also once deregulated. However, due to the lack of disclosure of the companies people were investing in, the stock market crash of 1929 happened. In summary, just like with crypto, the brokers (in crypto's case, the founders, supporters and exchanges) tell you to come and invest in this great asset that would yield significant returns. Without sufficient information on how the company was genuinely faring, people invested, and when they realised the companies were fraudulent, they lost money. So, the US government launched two acts in the US to prevent the stock market crash from repeating itself: the Securities Act and the Exchange Act. 

The Securities Act aimed to ensure that companies disclose the true nature of the companies that investors were entrusting their money to. At the same time, the exchange act is used to regulate brokers and securities exchanges. 

Again, this is similar to the crypto situation where the securities, in this case, are the tokens or coins that are issued for people to use or invest in, while the exchanges are the platforms used to invest in these crypto assets. The Nigerian SEC regulation takes on a similar approach where it regulates the initial coin offering, ensuring that information required to authenticate the legitimacy of the digital asset is well stated to the public. Then regulation for the exchange is also in place to guarantee the financial safety of the investors. 

From this, it is clear that one first step to determining what regulation should look like in the crypto space comes from resolving who should regulate. As long as definitions remain unclear, we will continue to face issues of regulatory overlap as different stakeholders will respond differently to the development of this technology.

Regulate or die

In conclusion, we can see that decentralised finance did not start with crypto. Yes, the technology (blockchain) and operations of crypto are pretty nascent, but the idea of decentralising money is not new. In fact, like crypto, while some of the free banks back in the day were pretty stable and had minimal losses, many failed. These failures were rampant, and there were several banking crises in different parts of the world. Hence, the need for some form of regulation. 

We see this playing out again as the crypto space develops. Observers and critics are right to be worried about the adverse effects of decentralised finance, even with its promises of fixing existing failures within the global financial system. Ultimately, regulatory intervention is inevitable, and it's much harder to say where a line should be drawn and who should draw it. 

Regardless, the potential benefits of cryptos and their growing popularity (despite the multiple market crashes) means that regulators will need to align on who should be setting these rules. The next step would involve regulators engaging with the way the industry is developing and using what they learn to make smart and context-led decisions.