Following the FTX collapse, JP Morgan stated that crypto will soon be regulated and emphasised the significance of self-custody, asset security, and customer safety.
According to its most recent Global Markets Strategy study, Wall Street banking giant JP Morgan & Chase expects that significant regulatory changes will affect the cryptocurrency business in 2023 and would probably lead to a convergence between crypto and the traditional financial system.
In the document, JP Morgan discussed the FTX and Alameda Research fiasco and the “cascade of crypto entity collapses,” raising questions about how the crypto ecosystem is expected to change and the key changes the company anticipates for the near future.
Urgent Regulation
The Markets in Crypto Assets (MiCA) bill of the European Union is one of the existing regulatory initiatives that the document examines the accelerating.
With the exception of final approval by the EU parliament, the majority of the EU legislative processes have already been completed. JP Morgan predicts that final approval will most likely occur before the beginning of 2023.
The bank also stated that the new legislation will probably go into force “at some time in 2024” after a transitional period of up to 18 months.
Focused Regulation On Custody
According to JP Morgan, new regulatory initiatives focusing on “custody and protection of customers’ digital assets as in the old financial system” are likely to materialise.
Following the FTX crash, hardware wallet providers Ledger and Trezor experienced exponential growth, the company noted, as it “sparked a spike in crypto self-custody.”
Regulation of Unbundling Activities
The letter made note of the probability that further regulatory initiatives aimed at separating broker, trading, lending, clearing, and custody activities will be put out.
JP Morgan said:
For exchanges like FTX that incorporated all three activities, “[these restrictions will have the] biggest ramifications, raising concerns about consumers’ asset protection, market manipulation, and conflicts of interest.”
Laws Governing Transparency
The investment bank also made a note of the likelihood that new regulatory initiatives aimed at promoting transparency will be introduced into the cryptocurrency space, such as requirements for routine reporting and auditing of reserves, assets, and liabilities on “exchanges, brokers, lenders, custodians, Stablecoin issuers, etc.”
The company predicted that these rules would likely be adopted from the conventional financial system, which would result in:
“The crypto ecosystem’s convergence with the established banking system.”
Crypto Derivatives Move to Regulated Locations
The Chicago Mercantile Exchange (CME) will probably benefit from a shift in the cryptocurrency derivative market to regulated venues, according to the document.
There will probably be a bigger shift toward regulated venues like the CME for both futures and options because many institutional investors, like hedge funds, got trapped by their derivative positions at FTX.
Given that U.S. derivative markets are governed by the CFTC, JP Morgan observed that such a change will probably strengthen the Commodity Futures Trading Commission’s (CFTC) influence in the crypto markets.
Shift Away from CEX to DEX
“Skeptical about a structural move away from controlled exchanges (CEX) onto decentralised exchanges (DEX),” JP Morgan stated in the document’s conclusion on November 24.
As decentralised finance (DeFi) spreads, the following challenges will be faced by the developing industry:
- Price discovery — mainly provided by exchanges via oracles for now
- Smart contract risks (hacking/protocol attacks)
- Management/audits and governance without compromising security
- Systemic risks arising from automated liquidations if collateral drops below certain levels
- The over-collateralization disadvantage of DeFi over traditional finance
- Front running in DEXs
- No limit order/stop-loss functionality
- Risk/return trade-off being harder to assess in DeFi
- Pooling of assets into liquidity pools (LPs) may make institutional investors uncomfortable
As a result, “despite the FTX collapse, we expect that controlled exchanges will continue to play a significant role in the crypto ecosystem in the near future, particularly for larger institutional investors.” said JP Morgan.
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