By Alan Silbert, Executive Managing Director of INX Limited
“I had to abandon free-market principles in order to save the free-market system,” President George W. Bush famously said of his 2008 decision to bail out the banking system to avoid a financial collapse in the U.S. It was a telling recognition by the Republican president, who had spent his entire career touting free markets, that changing facts on the ground require changing tactics, not a stubborn cling to ideology. Bush’s moment of truth represents exactly the kind of realization the crypto community needs in order to move past its hatred for the Securities and Exchange Commission and finally achieve the widespread adoption of cryptocurrency and digital assets.
Markets heavily depend on retail investors, who have been legally barred from participating in digital asset markets in the U.S due to a lack of regulatory protections. The floodgates are now starting to open to these retail investors, and the crypto community must embrace the SEC’s regulatory framework to propel its industry into mainstream financial institutions.
Crypto purists oppose the very idea that retail investors, or those the SEC deems to be less financially savvy, require greater protection from the government. The policy lends itself to an unfair power dynamic, they argue, in which only the big wigs can trade and the little guy is left on the sidelines twiddling his thumbs until big brother gives him the green light to participate. Cryptocurrency’s entire purpose is to prevent such a dynamic. So why get in bed with the government organizations, such as the SEC, that have perpetuated it for decades?
While the purist standpoint is right to emphasize the importance of the retail investor, it ignores the perils she faces without regulatory protection, as were witnessed by the unusually high number of Initial Coin Offering (ICO) scams, “pump and dumps,” and other events of the 2017-2019 ICO market boom—all unregulated.
A coherent regulatory framework to protect unsophisticated retail investors had to be established before the U.S. were to open the doors of digital asset trading to the average students, teachers, and engineers of the world—for their own good.
A less financially savvy reader might be wondering, at this point, why retail investors are so important to markets to begin with. It’s true that the words “finance” and “stocks” often conjure up images of Wolf of Wall Street-type accredited and institutional investors. Indeed, institutional investors dominate equities markets in terms of overall shares, owning about 62 percent of all equities in the U.S. as of 2018, compared with the 37 percent held by retail investors. While 37 percent is still a sizable chunk, retail investors play a different, equally as vital role to markets. Such investors drive trading volume, with a smaller chunk but at much higher trading frequency, thus facilitating the liquidity needed for markets to function.
As vital as they are to markets, retail investors are assumed to be less financially sophisticated than institutional investors by the SEC because, well, they generally are. The term “retail investor,” or “Main Street investor,” itself implies a non-professional investor—someone who might be incredibly intelligent and successful, and even financially knowledgeable, but still not a finance-industry professional. As such, retail investors rightfully face greater restrictions on what they can invest in and trade than accredited and institutional investors.
The purpose of regulation is to prevent financial giants from taking advantage of retail investors, barring such investors from taking part in high-risk investments.
If anyone needs their memory refreshed on both the importance of retail investors in capital markets and the risks of trading without regulatory protections, think back to the ICO boom that began in 2017, during which ICO funding hit a record $800 million in the second quarter of that year. The ICOs, which constituted startups selling newly minted crypto coins based on Ethereum in exchange for company funding, saw fraud run rampant and investors lose millions. The debacle propelled cryptocurrency as an industry by the sheer sums of cash accumulated from, yes, retail investors. They fueled the ICO boom, and the crypto market wouldn’t be where it is today without them.
The ICO boom also illustrates why regulation is important, and why retail investors must accept it as their shield. Only 48 percent of ICOs were successful that year, meaning the investors of the other 52 percent lost every penny they put into coins. Sure, some made millions. But others were scammed in the most potent sense of the word. The SEC seeks to ensure such scams are exposed before they even begin.
The ideals crypto purists espouse are admirable and have proven to inspire the innovation that will serve as the groundwork for financial enlightenment across the globe for years to come. But when ideals leave textbooks and whitepapers, they have to adapt to their environment: the real world. Just as President Bush understood the limits of his beloved supply-side economics, crypto purists must move beyond their ideological puritanism. Only once they lay down their arms in their bitter fight against the SEC will the crypto industry thrive, and when they do, the world of finance will change forever.
About the author:
Alan Silbert is a director of the Company and Executive Managing Director of INX Limited. He joined the Company in March 2018. Mr. Silbert is responsible for launching the INX operations in North America, including facilitating the build-out of the director and advisor team, raising capital, growing operations and infrastructure for North American operations, and leading the registration processes for broker-dealer and alternative trading system licenses.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.