Financial market expert on cryptocurrencies: “Without regulation like the Wild West”

Trading in Bitcoin, Ethereum and Co. is largely unregulated. Financial market expert Jan Pieter Krahnen explains why more control would be important – and what potential there is in cryptocurrencies.

tagesschau.de: Mr. Krahnen, how does trading with crypto exchanges actually work? How can I imagine that as a new investor?

Jan Pieter Krahnen: Crypto exchanges are companies that bring together supply and demand for and from cryptocurrencies in one place and continuously determine trading prices. Although these companies are called stock exchanges, unlike regular stock exchanges, they are not subject to financial supervision.

They can therefore be described as part of the so-called shadow banking system. This means that the conditions under which trading takes place are not monitored by a third party: who can participate in trading, how are prices determined, how does settlement take place, and what are the requirements for the operator of the exchange? All these regulations are optional and they are not supervised.

“Fraudulent Offers”

tagesschau.de: A major issue that occupies authorities around the world is regulation. Are regulations constraining crypto exchanges and investors, or is regulation necessary for this sector to grow?

cranes: Without regulation, the crypto sector can be like it was in the proverbial Wild West. Because product and trade offers can be created with fraudulent intent without this having to be noticed immediately. There are no clear rules that are controlled by independent specialist institutions such as a financial regulator. It is therefore not surprising that scammers who establish themselves in this sector are often not recognized until it is too late.

State regulation, on the other hand, would mean that investors could place much more trust in the products and commercial structures offered to them. One can assume that a regulated crypto financial market could be of greater importance – it would be promoted.

The crypto industry can then be much more integrated into traditional financial markets than it is today. In fact, cryptocurrencies such as bitcoin are now purely private ventures without a trustworthy control structure. Politicians must now think carefully about whether they want to regulate this world comprehensively at all – and thus make it presentable to a certain extent.

How is it serious?

tagesschau.de: Key word: where there is a lot of money, fraudsters are usually not far away. As an investor, how do I recognize reputable crypto exchanges?

cranes: In my opinion, reputable crypto exchanges will only exist if their working methods are transparent and are constantly monitored by an independent party – i.e. they are subject to an external supervisory architecture as we know it from regular exchanges.

This would also mean that the actors involved would have to comply with certain rules such as transparency and equity capital rules. Requirements imposed on banks and other financial institutions today would then also apply to the crypto sector.

“Big Disclosure and Control Issues”

tagesschau.de: Again and again you hear about crypto exchanges being hacked. Is my money safe there?

cranes: A crypto exchange is not only insecure when hacked, but also because of its own way of operating. Where is the customer’s money actually kept, and who monitors whether it has been used differently than announced?

For example, we are currently seeing the insolvent trading platform FTX, which characteristically wanted to be much more than just an “exchange market”, that many billions of dollars in customer funds have disappeared or been shifted to other parts of the company.

The disclosure and control problems in connection with cyber security, but also with internal structures, are overwhelmingly large. This is probably true on the whole for all exchanges and facilities in this segment. As long as there is no good control, there will not be a solid and trustworthy structure.

“Cryptocurrency remains a gray theory without actors”

tagesschau.de: What steps should crypto exchanges take towards transparency to gain investor trust?

cranes: Interestingly, a frequently heard argument for investors in cryptocurrencies is that no external institution is needed to control transactions. The system controls and monitors itself using the underlying algorithm, the blockchain.

This relies on decentralized control, so a key argument in favor of these alternative currencies is often that their control is internal. Unfortunately, the argument does not apply to the actors involved in a transaction – and without actors, a cryptocurrency remains gray theory.

Has the crypto scene had its day?

tagesschau.de: How much potential is there in the crypto industry?

cranes: Today’s crypto scene, in my opinion, will hardly have a great future in our financial system – simply because the opportunities for fraud are too great, too easy. And because any government regulation, if it comes at all, will take away the appeal of decentralization and remoteness from the state, which characterizes cryptocurrencies in the eyes of many investors – and will also make transactions even more expensive.

However, there is likely a future for cryptocurrencies on the fringes of our financial system, as countries like Russia use these tools to circumvent sanctions. For private investors, on the other hand, I can see a major potential for loss, above all, because there are too many players in this industry who want to enrich themselves at the expense of the investors.

This is extremely easy in this scene, and one must not forget that a cryptocurrency that does not become legal tender always only has the properties of a Ponzi scheme and is therefore not permanently valuable.

On the other hand, I see a brighter future for digital financial products in general and for digital central bank money in particular. I expect them to be introduced sooner rather than later.

Waves of bankruptcies are an “eye opener”

tagesschau.de: Suppose cryptocurrencies are banned. What will happen to the crypto exchanges then? Will these then be nationalized and will the investors’ money then be gone?

cranes: Banning cryptocurrencies is not that easy as the system is completely decentralized. There is no easy starting point for state regulation. With regard to the blockchain, the events at the crypto exchange FTX are an eye-opener for many investors, who have said that there is absolute transparency and credibility here. The crypto sector uses the blockchain as a basis, but behind it often changes business processes that invite theft and are difficult to recognize as such.

The blockchain that underlies all of this is an ingenious invention. It is a technical booking system without the need for a control body to check the correctness of the bookings. That’s a great achievement. But what can be done with this service as an economical product is still unclear to this day.