Square Pegs, Round Holes: Why Crypto Demands a New Regulatory Playbook

The world of finance is in a perpetual state of evolution, but rarely has it faced a disruption as fundamental as the rise of digital assets. From Bitcoin to decentralized finance (DeFi) protocols, this new wave of financial technology is challenging the very foundations upon which our global economy is built. Yet, as innovation accelerates, regulators are often found trying to apply century-old rules to 21st-century technology—a classic case of forcing a square peg into a round hole.

This fundamental mismatch was succinctly highlighted in a letter to the Financial Times by Michael Ledzion, who pointed out the inherent challenge of “applying old regulation to new technology.” He champions a more forward-thinking approach, suggesting that instead of contorting existing securities laws to fit crypto, we should create a “new bespoke legal and regulatory framework.”

This isn’t just an academic debate for lawyers and fintech developers. The resolution of this regulatory puzzle will have profound implications for investors, businesses, and the future trajectory of the global financial system. It will determine whether blockchain innovation flourishes in transparent, well-regulated markets or is driven into the shadows by uncertainty. In this deep dive, we will explore why the old playbook is failing, analyze the promising new models being proposed, and consider what’s at stake for the future of finance and investing.

The Old Playbook: A Framework Forged in a Different Era

To understand why existing regulations are a poor fit, we must first appreciate their origin and purpose. Much of modern securities law, particularly in the United States, was born from the ashes of the 1929 stock market crash. The goal was simple and noble: protect investors, ensure market integrity, and mandate transparency from entities seeking to raise public capital.

The cornerstone of this system is the definition of a “security.” In the U.S., the widely-cited Howey Test, derived from a 1946 Supreme Court case, defines a security as an investment of money in a common enterprise with the expectation of profit to be derived from the efforts of others. This framework has been remarkably effective for regulating traditional assets like stocks and bonds. When you buy a share of Apple, you are investing in a common enterprise (Apple Inc.) with the expectation of profit (dividends, stock appreciation) derived from the efforts of its management and employees.

This system works because it is built around a centralized model: a clear issuer, a defined corporate structure, and identifiable promoters whose efforts generate value. For nearly a century, this has been the bedrock of capital markets, fostering trust and enabling immense economic growth. The problem is, the world of blockchain and digital assets was not built on this model. In fact, it was designed to be its very antithesis.

The Square Peg: Why Cryptoassets Defy Traditional Classification

Applying the Howey Test and similar securities frameworks to cryptoassets is like trying to use a map of New York City to navigate the internet. The underlying architecture is fundamentally different. Here are the key reasons why the old rules don’t apply:

• Decentralization: The hallmark of many foundational cryptocurrencies, like Bitcoin, is the absence of a central issuer or controlling entity. There is no “Bitcoin CEO” or board of directors whose efforts determine its success. Value is derived from the collective, decentralized actions of miners, developers, and users across a global network. This directly challenges the “efforts of others” prong of the Howey Test.
• Duality of Purpose (Utility vs. Investment): Many digital tokens serve a dual purpose. A token like Ethereum’s ETH is not just a speculative investment; it is also a utility token required to pay for computational services (“gas fees”) on the Ethereum network. Is it a security, a commodity, or a new type of digital fuel? Securities law, with its black-and-white definitions, struggles to accommodate this functional duality.
• Programmable and Autonomous Nature: Digital assets are more than static entries on a ledger; they are programmable. Smart contracts and Decentralized Autonomous Organizations (DAOs) can execute complex operations and govern entire ecosystems without human intermediaries. These autonomous systems have no direct parallel in the world of traditional corporate finance.
• Global and Borderless: Securities are typically issued and traded within specific jurisdictions. A blockchain, however, is a borderless network. Attempting to apply the laws of one nation to a globally distributed, pseudonymous network presents immense logistical and philosophical challenges for regulators.

This mismatch creates a state of perpetual legal ambiguity that stifles innovation and exposes investors to unnecessary risk. A new approach is clearly needed.

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To better illustrate the fundamental differences, consider this comparison between traditional securities and cryptoassets:

A New Path Forward: The “Horses for Courses” Approach

Recognizing the inadequacy of old laws, forward-thinking jurisdictions are beginning to explore bespoke solutions. The approach advocated by Michael Ledzion in his letter—and formally recommended by the UK Law Commission—is a powerful example. In July 2023, the Commission published its final report, recommending that cryptoassets be legally recognized as a new, distinct category of personal property.

This may sound like a subtle legal distinction, but its implications are profound. Classifying digital assets as property rather than securities shifts the regulatory focus. Instead of concentrating solely on the moment of issuance and promotion (the domain of securities law), a property-based framework provides clear rules for:

• Ownership and Transfer: It establishes clear legal principles for who owns a digital asset and how that ownership can be proven and transferred.
• Collateralization: It allows digital assets to be used more reliably as collateral in lending and other banking activities, unlocking vast amounts of capital currently locked in the crypto economy. The Total Value Locked (TVL) in DeFi protocols regularly exceeds $50 billion (source), representing a massive pool of potential collateral.
• Inheritance and Insolvency: It creates a predictable legal process for handling digital assets in cases of death or bankruptcy, a critical component for long-term market maturity.

This “horses for courses” philosophy—using the right rules for the right asset—is gaining traction globally, though the specific approaches vary. The European Union has moved forward with its comprehensive Markets in Crypto-Assets (MiCA) regulation, which creates a dedicated framework for crypto-asset issuers and service providers. While different from the UK’s property law approach, it shares the same core principle: new technology requires new rules.

This stands in contrast to the current situation in the United States, where regulatory agencies have largely pursued a strategy of “regulation by enforcement,” suing crypto firms for allegedly violating decades-old securities laws. This has created a climate of uncertainty and has been criticized for prioritizing litigation over legislation.

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The Stakes: Why Getting This Right Matters for the Global Economy

The debate over crypto regulation is not a niche issue. The outcome will have a significant impact on the future of finance, investing, and the broader economy.

For Investors and Traders: Regulatory clarity is paramount. A clear, bespoke framework reduces the risk of sudden regulatory crackdowns, protects consumers from fraud, and fosters a more stable and predictable market for trading and long-term investing. It separates legitimate projects from scams and allows capital to flow toward genuine innovation.

For Fintech and Business Leaders: The current ambiguity is a major barrier to innovation. Businesses building on blockchain technology operate under a constant cloud of legal risk. A well-defined regulatory environment would unleash a wave of investment and development, allowing the full potential of financial technology—from more efficient payment systems to novel forms of capital formation—to be realized.

For the National Economy: Jurisdictions that create clear, effective, and innovation-friendly regulatory frameworks will attract talent, capital, and a new generation of financial services companies. They will become the hubs of the new digital economy. Conversely, those that stick to outdated models or create hostile environments risk a “brain drain” of talent and technology, falling behind in a critical area of economic competition.

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Conclusion: Building a Bridge to the Future of Finance

The “square peg, round hole” problem is a defining challenge of our financial era. The rapid evolution of blockchain and digital assets has exposed the limitations of a regulatory architecture designed for a centralized, analog world. Continuing to force this new technology into an old framework is not only ineffective but counterproductive—it creates uncertainty, stifles innovation, and fails to provide adequate protection for consumers.

The path forward lies in the “horses for courses” approach. By recognizing cryptoassets as a unique technological and financial phenomenon, and by building bespoke legal and regulatory frameworks like those proposed in the UK and EU, we can create an environment that fosters both innovation and safety. This requires a shift in mindset from regulators, a willingness to understand the technology on its own terms, and a collaborative effort between industry and government. Building this bridge to the future of finance will not be easy, but it is essential for unlocking the next wave of economic growth and ensuring the continued dynamism of our global financial system.