Europe is on the verge of regulating the cryptocurrency industry, a long overdue and necessary step that will offer greater protection to investors, while allowing innovation to thrive. Changes include provisions on supervision, consumer protection and environmental safeguards for crypto-assets. But as Europe becomes the first continent to regulate what MEP Stefan Berger describes as the “Wild West of the crypto-world”, greater attention must also be placed on financial literacy. Better regulation on its own is not enough to prevent the myriad risks facing those who choose to invest in cryptocurrencies.
Interest in crypto-assets is on the rise, but their inherent risks, when combined with a toxic mix of a lack of proper information and an excess of online hype, can lead investors to material loss. CySEC is playing an important part in improving investor education on the risks posed by crypto-asset investment and remains vigilant in anticipation of the European Union’s implementation of the Regulation on Markets in Crypto-Assets (MiCA), which will provide for more comprehensive regulatory supervision of the sector.
CySEC is seeing the consequences of a lack of financial literacy first-hand. A few weeks ago I came across an advert promoting investment in crypto. Featuring a celebrity influencer and promising to give away free crypto, it was clearly targeted at younger – and inexperienced – investors, playing on that very common human fear of missing out. Promotion to naive investors is the scourge of the investment industry and, of course, is not limited to the crypto space. But it is for these reasons that we have been proactive in launching our investor protection campaign which aims to improve the level of financial literacy amongst new investors.
The rapid growth of the crypto-asset markets and the eco-systems that support them pose new challenges and risks for all regulating bodies across the world. While technological innovation offers many promising possibilities – such as improved access to financial services – the immaturity of the ecosystem and the underlying assets themselves could inhibit the cultivation of trust in the sector.
A key challenge is liquidity risk which can prevent investors from being able to convert crypto back into money as and when they wish. The lack of tangibility in most crypto-assets also means that, unlike traditional securities such as stocks or bonds, they have no fundamental value, their price being dependent exclusively on supply and demand. Then there is the issue of aggressive or over-blown marketing – campaigns promoted via online media, social media channels and often employing celebrity endorsement or influencers. These often include insufficient or inaccurate information and risk disclosures when promoting increasingly complex and inappropriate products.
Additionally, the lack of comprehensive regulation at the international level means that crypto-assets remain unregulated in many jurisdictions. As a result, there are few redress systems or deposit protection schemes, and this complicates any claim against the crypto-asset issuer, wallet provider or intermediary, leaving crypto-asset owners exposed to counterparty risk.
This recently proposed EU Regulation on MiCA will set regulatory requirements for the public offering and marketing of crypto-assets and the provision of services related to them, as well as include provisions to prevent market abuse involving crypto-assets. MiCA also aims to bring crypto-assets, crypto-assets issuers, and crypto-asset service providers under a common regulatory framework, to protect investors and preserve financial stability, while allowing and fostering innovation in the crypto-asset sector.
Whilst these developments are laudable and timely, they do not go far enough. The crypto-assets market carries technical and operational risks, most prominently cyberattacks, failures of IT and blockchain infrastructures, and loss of access codes by the crypto-asset owner. And while fraud may be a common risk across other asset classes, the high complexity and technicality of the blockchain system and the very fluid nature of the business model make unwary investors easy prey to fraudsters. Investor education is therefore not just desirable, but essential in order that they understand the simple truth that capital invested in crypto-assets is not guaranteed and they always run the risk of a partial or total loss of their investment.
Recognizing the importance of financial literacy to investor protection, the International Organization of Security Commissions (IOSCO), has brought together the Supervisory Authorities of over 100 countries to collaborate to spread key messages to educate and protect investors and the general public, in its annual campaign World Investor Week 2022.
This is one of the ways in which regulators can take a key role. CySEC, for example, has developed and disseminated educational materials around key themes, notably for the young and vulnerable. We have also made extensive use of social media and enriched the educational content of a dedicated Financial Education Portal which includes articles, guides and booklets using simple terms and plain language.
The underlying message throughout our recent Investor Protection Campaign was that investors need to do their homework and only invest money they can afford to lose. This advice is not just for cryptocurrencies, but for investments in general.
