Rating agencies, not regulators, can restore confidence in crypto after FTX

The past year has been turbulent for the crypto space. The collapse of the Terra ecosystem and its algorithmic stablecoin TerraUSD (UST) has seen 50 billion dollars erased from the market in a flash. And more recently, FTX, an exchange that many thought was “too big to fail,” collapsed. There has been no shortage of drama in the space, which has seen name companies and projects disappear along with investor funds.

Given the events of this year, serious government attention to space is inevitable, in all major jurisdictions – and on a timescale of months to years at most, not decades. This was pretty clear to most industry watchers even before the recent FTX debacle, and now it has become glaringly obvious.

There’s a lot of debate in the space about whether this is a positive. The purpose of financial regulation is to protect end users from the defrauding and deception of financial operators of all kinds and to promote the overall health of the economy. And it is clear that current financial regulations vary widely in their effectiveness in this regard. Moreover, it is unclear what type of regulation could be put in place that would truly benefit the industry and its customers.

Maybe instead of regulating, we should focus our efforts elsewhere to make sure crypto is in order. Below are three key benefits of crypto rating agencies — community organizations that rate projects — and how they might address crypto-related issues.

Rating agencies can keep pace with crypto

The crypto space is ever-changing and fast-paced. Between November 2021 and November 2022, almost 2,000 new cryptocurrencies were created, an increase of almost 25% in the total number of currencies. New tokens and projects are constantly appearing.

While some of the projects that appear are innovative and push the boundaries of technology, there can be many dangers for participants to navigate. The cypherpunk ethos that underpins early cryptographic innovations holds that space should be anonymous. However, when you mix that anonymity with a large number of relatively naive consumers, it creates a nice environment for fraud, scams, and pyramid schemes.

Related: What Paul Krugman is wrong about crypto

This could be a problem for regulators, as policy implementation takes time. For example, it took more than two years to draft and approve the framework for European Union crypto-asset markets. Time to review and put in place protective measures, space will have already evolved towards new dangers.

Crypto rating agencies would be the antithesis of this. They would be at the forefront of the industry. They could provide consumers with a relatively unbiased and open-minded analysis of the algorithms, structures, communities, risks and benefits underlying various products – at a rapid speed commensurate with the development of these new products.

Terra was a great example of how this would work. Some in space knew that Terra had weak tokenomics, which ultimately led to its downfall. Those without a background in quantitative finance and tokenomics would not have the same understanding. Moreover, Regulators weren’t even aware of Terra until it collapsed; thus, they could not protect investors from it. By having knowledgeable and recognized bodies that review cryptocurrencies and companies in the space, investors can be quickly made aware of the underlying issues of projects and make informed decisions about whether they want to take the risk.

Bad actors can be stopped before they cause trouble

Although regulations are in place to deter malicious actors and protect people, they don’t always work. And it’s not just exclusive to crypto. There will always be law-breaking projects in space that investors should avoid.

This is obviously clear when looking at FTX. The exchange promised to hold client funds with a fully collateralized reserve. However, when FTX’s sister company Alameda Research went public with its track record, both companies were found to be illegally using investor funds. This caused FTX users to try to withdraw their money. However, since FTX did not fully support its reserves, it was unable to refund users. This is fraudulent activity, and the regulations currently in place should have deterred FTX from doing so, but they did not.

The establishment of rating agencies could have avoided this catastrophe. Nine months before the fall of FTX, research was conducted on the platform and links between it and Alameda Research were discovered. However, this information was not widely disseminated and never reached the majority of FTX users. If rating agencies had been in place, this information could have been made more publicly available, allowing users to deposit their funds in safer exchanges.

Rating agencies would play a watchdog role against illicit activities. These would be in-depth and reliable sources of information on the quality of different blockchain networks, presented at different levels of accessibility and detail. They would also serve to reduce the gross over-generalization of crypto present in the media, as well as the wealth of misinformation available online. Rating agencies could provide investors with the necessary information they need to avoid bad players.

Rating agencies would be created by crypto and for crypto

The financial market is currently set up to favor institutions and the wealthy. In the United States, there are laws prohibiting ordinary citizens who do not meet a wealth or income threshold from being “accredited investors”. This means that for an ordinary person to gain access to the stock market, they must go through a third party, such as a bank or brokerage firm, which usually charges an access fee. Retail investors have less freedom and market access, and their profits are often passed on to other parties.

One may wonder why the market is organized this way. If the goal is to prevent people from being sucked into losing trades, why are those same people allowed to gamble their life savings in casinos or buy state-issued lottery tickets with obviously losing odds? ? It’s almost as if the government’s goal is to ban non-wealthy people from any form of gambling where they have the opportunity to exercise their insight and judgment and actually have a chance of winning.

Related: Federal Reserve’s Pursuit of ‘Inverted Wealth Effect’ Is Undermining Crypto

Without careful consideration, this current setup could be replicated in crypto. Traditional financial regulators can impose policies that are present in the existing financial market, such as the aforementioned income threshold to become an “accredited investor”. These arbitrary policies may be implemented under the guise of protecting people, but could instead exclude retail investors from the crypto space.

Crypto rating agencies, on the other hand, would be created by crypto natives with retail investors in mind. The goal of rating agencies is to give the best possible advice to investors, which requires a deep understanding of the space. Also, rating agencies are not performers – they are simply guides. Participants would still have the freedoms they currently have, just with much better knowledge.

Regulators have turned their attention to crypto, and it is clear that new policies are coming very soon. However, they will likely be outdated and ineffective upon arrival. If the crypto space wants to improve, it needs to take action, setting up rating agencies that can make sure bad players are highlighted and removed from the community.

This article is for general informational purposes and is not intended to be and should not be considered legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.