• Adam Harper

Getting comfortable with crypto

History suggests that pragmatism – and necessity – often prevail when innovation collides with convention. We don't expect the future to be any different.

A disruptive new practice challenged values and customs in medieval Italy: banking.

Photo by Davide Cantelli on Unsplash

The FT’s piece this week about the impact of prospective crypto regulation in Hong Kong made us think about the history of financial innovation. This has always involved conflict, which is hardly surprising because it always involves a consensus – if not laws and regulations – being challenged by new business models and markets. But these conflicts are usually resolved and the innovations are accepted. We don’t see why digital finance should be any different in the long term.

Take charging interest on loans, for example. This was outlawed at times in ancient Greece and the Roman Empire. During the middle ages in Europe, the Church opposed the charging of any interest. But banking as we know it took off in Italy in the 15th century and spread from there. The rest is history.

The $27 trillion international bond market provides a more recent example. Students of capital markets history will know that the Eurobond market began in 1963 with what might politely be described as regulatory arbitrage (and less politely as tax evasion). When US dollar-denominated bonds were issued outside the United States, the interest received on them could be free of a new US tax and foreign issuers could continue to raise dollars.

In both cases, the challenge to custom and regulation served a purpose, whether it was to facilitate the repayment of Genoa’s debts or enable ‘eurodollars’ outside the US to be invested without hefty taxation. The innovations brought together willing buyers and willing sellers. In time, authorities accommodated the changes: no-one today thinks that cross-border bonds are disreputable and many societies think interest on loans is a problem only if it is punitively high.

Back to the future

We don’t expect the future of finance to be any different to its past in this respect. Whatever you think of digital assets, this is already a $2 trillion market and it’s not going anywhere. On the contrary, demand is growing and is increasingly driven by institutional investors: a Fidelity Digital Asset study in July showed that seven in 10 institutional investors expect to hold digital assets in the future, while 71% of Asian institutional investors surveyed already have exposure to this asset class.

As this tide rises, regulators are weighing the value of this new activity against the risks it presents and the extent to which it conflicts with their principles – the same dilemma that faced authorities in medieval Europe during the early days of banking.

Of course, regulators have the leverage to require operators to modify their business models by restricting access to digital asset exchanges, for example, or requiring operators to implement tougher controls against financial crime. But since digital asset exchanges are mobile – as the US dollar bond market proved to be in the 1960s – financial supervisors are also aware of the risk of pushing too hard.

History suggests that pragmatism – and necessity – often prevail when innovation collides with convention. Today’s banks and the cross-border bond market are testament to that. If you believe that digital finance is an important part of the future, then the reasons for different jurisdictions to find a way to live with it are pretty compelling.

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