Andrew Wright

Merge Ahead; Billions Flow into Crypto Funds; ECB and Fed Look at Licensing; Tether’s Fortunes Change

Thomas Murray Digital Newsletter

The Merge (Ethereum.org)
The Merge (Ethereum.org)

In this issue:

  • Exploring the implications of the Ethereum blockchain’s upcoming major upgrade, known as ‘The Merge’.
  • Billions more dollars are going into cryptoasset, blockchain and metaverse asset trading and venture capital funds, including those run by Steve Cohen, Brevan Howard, Invesco, Andreessen Horowitz, CoinFund, and Temasek.
  • In regulatory news, the European Central Bank seeks to head off more country-level differences from emerging in the regulation of crypto-related activities by banks – and corresponding regulatory arbitration opportunities – by looking at introducing an EU-wide licensing regime. In the US, the Federal Reserve opens the door for non-bank financial institutions to access master accounts and payment services.
  • The beleaguered Tether stablecoin has seen a small reversal of fortunes as it appoints a more prominent audit firm to attest to its reserves and divests the commercial paper holdings that they currently contain, while its decision not to block addresses related to the sanctioned Tornado Cash crypto mixer is at odds with that of rival Circle.

Major Digital Asset Developments

Ethereum Blockchain Upgrade Approaches, Reducing Energy Use and Making Ether a Deflationary Asset
Ethereum, the second largest public blockchain network by market capitalisation and most popular as a host to thousands of crypto tokens, is due to migrate to a new Proof-of-Stake (PoS) protocol on or around 15 September. Staking entails depositing ether and using it in a voting mechanism to validate transactions, with rewards for correct behaviour and penalties for dishonesty. This system makes it economically unviable for bad actors to attempt a ‘51% attack’ to take control of the blockchain. The upgrade will replace the current Proof-of-Work system that is similar to that used by Bitcoin and a number of other first-generation blockchain projects. The Merge (Ethereum.org), as the upgrade is commonly known (borrowing a term from software engineering), is being heralded as an important step that helps to solve elements of the ‘blockchain trilemma’ of decentralisation vs scalability/speed vs security (CertiK). Until now, the Ethereum blockchain has suffered from low transaction throughput and high gas (transaction) fees despite, or as a result of, its great popularity as the most popular platform for tokens and smart contracts. By moving to PoS, Ethereum expects to be able to introduce a number of measures to improve its speed and usability, adding scaling solutions such as Zero-Knowledge Succinct Non-Interactive Argument of Knowledge, aka zk-SNARKs (Consensys) and sharding (Ethereum.org). Additionally, PoS will also offer greatly improved green credentials, as the new model replaces the need for the mining of new tokens with staking rewards, and is estimated to reduce electricity use by 99.95%. The Merge will see the existing execution layer that is used today (known as Mainnet) adopt a separate consensus layer called the Beacon Chain, which is currently running in parallel in the background. Concluding a successful merge, the Mainnet will act as the consensus engine for all network data, including execution layer transactions and account balances. At the same time, the issuance rate of new ether tokens will drop by 90%. This, coupled with tokens that are ‘burned’ as transaction fees, deducted as penalties from validators’ stakes, or simply lost, should combine to make the available supply of ether deflationary (Pantera Capital) as new token issuance will drop to about 1,600 ETH per day for staking rewards, which is approximately equal to the amount of ETH burned as base transaction fees.
ECB Supervision Newsletter: Licensing of Crypto-asset Activities
Following on from the draft Markets in Crypto-Assets (MiCA) legislation (Finextra) and the latest proposals on capital adequacy from the Basel Committee on Banking Supervision (Bank for International Settlements), the European Central Bank has announced a framework for the licensing of banks on a pan-European Union basis (European Central Bank). The approach will be similar to existing requirements in Germany. The move is an attempt to avoid fragmented national-level approaches that are already emerging within the EU (CoinDesk). The framework is based on the Capital Requirements Directive (CRD) and will examine the risks and capabilities of providers of crypto services, including their business models, internal governance, and risk management practices – which include cybersecurity, AML/CFT and fraud risks – under ‘fit and proper’ assessments. A workstream of the Single Supervisory Mechanism (SSM) will report more broadly on banks’ digital transformations, including their adoption of crypto technologies, by the end of 2022.
More Asset Managers Set Up Crypto-related Funds
Hedge fund mogul Steve Cohen – former founder of insider-trading fund SAC Capital Advisors and now running Point72Asset management – is reportedly establishing a cryptocurrency-only investment firm (Blockworks). It is believed the firm will trade spot cryptocurrencies as well as digital asset derivatives. It has also been reported that BH Digital, Brevan Howard’s crypto-focused fund, raised over USD 1 billion on its launch earlier this year (Blockworks). BH Digital claims the figure exceeds the capacity of the current cryptocurrency market for liquid investment, leading it to invest some of its capital in VC deals and to leave some uninvested for the present time. Its VC activity goes up against that of Andreessen Horowitz, which raised USD 4.5 billion earlier this year for its own fund called a16z (Axios). Meanwhile CoinFund, a VC firm that claims already to have invested over USD 1 billion in over 100 crypto companies since 2015, has raised USD 300 million to start a new web3 fund, CoinFund Ventures I (Yahoo! Finance). Invesco – with USD 1.6 trillion AuM – launches its Invesco Metaverse Fund (Finextra), an actively managed approach to the ‘metaverse value chain’ that it says could contribute USD 1.4 trillion to the global economy by 2030. It follows similar funds launched by Axa, Fidelity and HSBC. Singapore’s Temasek has also invested SGD 100 million in convertible bonds issued by Animoca Brands (Blockworks), a metaverse company that owns properties such as The Sandbox and Decentraland.
Tether Moves Towards Greater Transparency, Reduces Commercial Paper Holdings
Tether, the embattled issuer of what remains the most widely adopted stablecoin, has appointed BDO Italia (CoinDesk) to succeed MHA Cayman in producing attestation reports on the reserve assets that back its tokens. It will also move from a quarterly to a monthly publication schedule. The move marks a further step towards a full audit of those reserves, the lack of which – together with alarming reports of the quality of assets that make them up – has become a major reputational risk for the firm in past months, as well as a cause of potential financial stability concerns should the widely-used stablecoin fail. Tether has cited the reluctance of major, reputable accounting firms to take on crypto businesses as clients as the main factor in its lack of progress towards full transparency. It has also promised to assuage concerns by reducing its once-dominant form of backing, commercial paper, to zero (BeInCrypto). It stated that such holdings would be reduced to USD 3.5 billion by the end of July (out of a total issuance at the time of over USD 66 billion) from a March figure of USD 20 billion. It has also denied that it holds any Chinese commercial paper or that it remains exposed to Celsius Network or Three Arrows Capital. Tether has stated that it expected commercial paper holdings to decline to just USD 200 million by the end of August and for them to be eliminated from its balance sheet completely by year end (CoinDesk).
Federal Reserve Board Announces Final Guidelines for Reviewing Requests to Access Fed Master Accounts and Payment Services
The US Fed is considering ways to open up the Central Banking system to ‘novel financial institutions’ including crypto banks, by providing access to its master accounts. The Federal Reserve Board has published final guidelines (Federal Reserve), following the 2021 publication of initial proposals, on how Reserve Banks should transparently and consistently evaluate fintechs’ requests for access to their master accounts and payment services. The result is a three tiered structure (Finextra) comprising 1) banks that are federally insured, 2) banks that are not federally insured but still subject to prudential supervision by a federal banking agency, and 3) firms that are neither insured nor subject to federal supervision, but that may be set up in jurisdictions such as Wyoming that have introduced laws for ‘special purpose depository institutions’ (SPDIs) (Wyoming Banking Division) such as digital asset bank custodians Custodia Bank and Kraken Bank, which may be able to access these accounts in future without an intermediary. Those holding federal deposit insurance will be subject to fewer additional requirements than those regulated by federal banking agencies, and those engaging in ‘novel activities’ or for which regulations are still under development will be subject to the most stringent checks. Some involved in the consultation process have suggested that tier 2 and 3 institutions should be held to the same standards as federally insured businesses. Custodia (formerly Avanti) and Kraken Bank, also established in Wyoming, are reported to have received routing numbers earlier this year, however neither have received regulatory approval within the mandatory one-year deadline and subsequently Custodia is suing the Fed (Pymnts).

Other News and Links

Federal Reserve Board Provides Additional Information for Banking Organizations Engaging or Seeking to Engage in Crypto-asset-related Activities (Federal Reserve)
Mindful of the wave of interest from banks in supporting digital assets, the Federal Reserve Board has released additional information to the market designed to define for FRB-supervised banks (including those with USD 10 billion or less in consolidated assets) the steps they should take prior to engaging in crypto-asset-related activities. These include ensuring the bank is legally permitted at the state and federal level to do so, and that is has adequate systems and controls in place to mitigate operational risks associated with loss of assets, consumer protection, AML and CFT (Federal Reserve).
US Regulator ‘Improperly’ Pushing Banks to Avoid Serving Crypto Companies, Lawmaker Says (CoinDesk)
Senator Pat Toomey claims that he has received complaints that the Federal Deposit Insurance Company (FDIC) is deterring banks from working with cryptocurrency-related businesses under an extension of an ostensibly shuttered (Politico) programme called Operation Choke Point (Wall Street Journal) that was initially intended to limit the banking of ‘questionable financial ventures’ such as payday lenders and other legal but controversial businesses such as gun sellers. FDIC regional offices are said to have been sending letters to banks asking them to limit their relationships with crypto businesses, whether by providing them with banking services or by partnering with them to provide bank customers with access to crypto trading. These actions are consistent with the FDIC’s open letter (FDIC) requiring its supervised entities to discuss any crypto-related activities with it prior to their commencement, and a new batch of reminder letters from the Federal Reserve to banks that it oversees to do the same.
Still Waiting: SEC Delays VanEck’s Third Bitcoin Spot ETF Application (Cointelegraph)
The SEC has once again deferred a decision on an application by VanEck to create a Bitcoin spot ETF. The decision is now due by 11 October. VanEck made its first application in 2017, but the SEC continues to cite lack of faith in the cryptocurrency markets and their ability to resist manipulation as reasons for denial. This time around, VanEck claims that American investors are taking advantage of the now well-established range of spot ETFs available over the border in Canada.
Canadian Securities Regulators Expect Commitments from Crypto Trading Platforms Pursuing Registration (Canadian Securities Administrators)
The Canadian Securities Administrators (CSA) expects crypto exchanges to agree, publish and abide by a set of undertakings to be permitted to continue operations in the country pending their full compliance with  Canadian securities laws and registration with (i.e. approval by) the CSA. The first undertakings, from Coinsquare Capital and Crypto.com, were published earlier this month.
EU Considers New ‘Anti-money Laundering Authority’ (Blockworks)
The Council of the European Union looks set to introduce a new Anti-Money Laundering Authority (AMLA) that would, according to the proposal, ‘boost the efficient functioning of the Anti-Money Laundering and Countering the Financing of Terrorism (AML/CTF) framework of the Union’. The proposal, first issued last year as an amendment to the current AMLD6, looks to help the EU combat money laundering but will also provide new powers to directly supervise types of credit and financial institutions such as digital asset service providers.
Australian Securities & Investments Commission Report 735 – Retail Investor Research (Australian Securities & Investments Commission)
ASIC has published results of a survey of over 1,000 retail investors conducted in November 2021. 44% reported having cryptocurrency investments, making it the second-most common asset type after Australian equities. A quarter of investors indicated that they only held cryptocurrency investments. Despite their unregulated and volatile nature, only 19% of cryptocurrency holders considered that they own risky or speculative products. ASIC raises concerns over limited state ability to protect retail investors from risk and calls for increased regulation.
Abu Dhabi to Launch Blockchain and Virtual Assets Strategy (Abu Dhabi Government Media Office)
The Abu Dhabi Blockchain and Virtual Assets Committee (ADBVAC) has been convened and held its first meeting under the Chairmanship of H.E. Mohamed Ali Al Shorafa, Chairman of the Securities and Commodities Authority (SCA) and the Abu Dhabi Department of Economic Development. The ADBCVAC’s goals are to develop strategy for virtual assets, including AML/CFT regulation, the building of a cryptoasset ecosystem for the UAE, investor protection, and custody risk. The UAE was put onto the Financial Action Task Force’s ‘grey list’ of jurisdictions subject to increased monitoring of AML/CFT risks earlier this year (Reuters).
New UCC Amendments to Establish Ground Rules for Blockchain Transactions and Crypto-Backed Secured Financings (JD Supra)
A joint committee of the Uniform Law Commission and the American Law Institute has published a draft amendment to the Uniform Commercial Code (Uniform Law Commission) that governs sales and other commercial transactions through most of the United States and its Territories. Among other updates, the draft explicitly covers digital asset transactions and in particular the use of crypto as loan collateral, with considerations of ‘how security interests in digital assets can be perfected’, an area of particular relevance to the current legal disputes surrounding the rights of various stakeholders in bankruptcy proceedings such as those of Voyager Digital and Three Arrows Capital. A new Article 12 also defines digital asset sub-classes, referring to the overall asset class as ‘controllable electronic records’ (CERs) which may extend in future beyond today’s DLT concepts.
 Qatari Government Consults on New Regulations for Blockchain Technology (Pinsent Masons)
The Government of Qatar has published a National Blockchain Blueprint (State of Qatar), a co-authored consultation by the Communications Regulatory Authority, Hamad Bin Khalifa University and Qatar University. It offers a roadmap for the development of blockchain in the country. Through a combination of regulation and innovation, Quatar plans to increase its domestic and foreign investment through the sector. Key requirements include an ‘efficient regulatory foundation’ that encourages user protection, innovation and adoption, oversight of cryptocurrencies and ICOs by Qatar’s Central Bank, and a new legal framework that would be enforced by the National Cybersecurity Agency. The consultation on the blueprint closes on 15 September, 2022.
South Korea’s Money Laundering Watchdog Flags 16 Crypto Firms for Operating Without Registration (CoinDesk)
Crypto.com Secures UK Registration for ‘Cryptoasset Activities’ (Cointelegraph)
New Brazil Bill Wants to Tokenize Mined Gold on Blockchain (Cryptoslate)
Revolut Gets Regulatory Approval to Offer Crypto Services to its 17 Million European Customers (Finbold)
Vitalik Cheers Ethereum Community Push Back Over Harsh Canadian Crypto Rules (Cryptoslate)
Vitalik Buterin, co-founder of Ethereum, has been cheering on members of the Canadian crypto community who have been pushing back at Ontario’s increasingly restrictive crypto rules. The Ontario Securities Commission has implemented a CAD 30,000 buy-limit on most tokens in an attempt to protect crypto investors. The limits do not apply to a number of tokens including bitcoin, ether, litecoin and bitcoin cash. One prominent crypto author and commentator, Simon Dixon, has pointed out on Twitter that the rule does not take into account an individual’s net worth, and perhaps more concerningly creates a two-tier token system which goes against the remit of the regulator who is supposed to observe neutrality. The limits do not apply to residents of British Colombia, Alberta, Manitoba, or Quebec.
Class Action Lawsuit Blames Coinbase for Security Failures and Repeated Thefts (ClassAction.org)
A class action lawsuit coordinated by BraunHagey & Borden LLP (BHB) is alleging that breaches have led to plaintiffs’ losses through the ‘repeated theft of ordinary customer accounts’. It also claims that, despite high fees and commissions, Coinbase’s customer service processes subject consumers to a never-ending cycle of automated responses to complaints that have already been the target of regulatory fines. BHB claims that Coinbase must repay stolen funds under the Electronic Funds Transfer Act due to its role as an operator of custodial accounts and its claims of using bank-level security standards, despite any small print disclaimers to the contrary. Its latest 10-Q filing to the SEC states, ‘we are required to safeguard customers’ assets using bank-level security standards applicable to our wallet and storage systems, as well as our financial management systems related to such custodial functions.’ Coinbase is said to hold itself out as more secure than competitors but its claim to be ‘the only crypto exchange to have never been hacked’ is challenged as ‘false and misleading’, with BHB citing a breach targeting SMS-based authentication codes affecting over 6,000 users in 2021 (later compensated in full) that its says Coinbase admitted in a filing to the California Attorney General. Coinbase is also said to have acknowledged vulnerabilities allowing hackers to access and amend customer account details, leading to further hacks despite use of alternative two-factor authentication procedures.
Galaxy Digital Ends Agreement To Buy BitGo (Blockworks)
Galaxy Digital has walked away from its acquisition of BitGo, a leading digital asset custodian. That decision has led to an acrimonious war of words in which both sides are claiming that the other party failed to deliver on undertakings. Galaxy Digital suggested the acquisition process had been frustrating and that BitGo had failed to deliver satisfactory audited 2021 financial statements by a 31 July deadline. In response, BitGo claimed it had done so, and that it intends to hold Galaxy Digital ‘legally responsible’ for its decision to terminate the merger. It is seeking damages in excess of USD 100 million and/or a USD 100 million reverse break fee (TechCrunch) promised by Galaxy in March as an inducement for BitGo to extend the merger agreement. BitGo has pointed to Galaxy’s recent financial struggles (BitGo) as it reported a USD 554.7 million loss for the latest quarter, while its stock has also been struggling, dropping from a high of CAD 46.50 in April 2021 to a low of CAD 7.33 the day after Galaxy’s announcement to terminate the acquisition. Galaxy Digital is still pursuing a Nasdaq listing, pending SEC approval.
State Street Sees ‘Significant Opportunity’ in Tokenization (Blockworks)
State Street’s Nicole Olson, vice president of digital product development and innovation at the bank, indicates that tokenisation of traditional assets remains the custodian bank’s top focus for the coming years, as investors are reportedly demonstrating a growing interest in its potential to improve market efficiencies and increase accessibility to traditional assets, private assets and funds. In particular, Olson makes the point that tokenisation opens the door to more efficient processes for funds, increasing access to investors and distribution for the fund issuer. State Street has a partnership with Lukka to offer fund administration capabilities for digital assets including cryptocurrencies, a service which is currently being offered to State Street’s private fund clients.
SIX Digital Exchange Launches Ethereum Staking for Institutions (Ledger Insights)
Switzerland’s digital asset infrastructure, SDX, has announced plans to launch a non-custodial Ethereum staking service for institutions. The service will enable clients to generate yield from staking their holdings in ether, the token of the Ethereum blockchain, potentially extending to tokens held by their underlying clients. Staking forms part of SDX’s Web3 strategy which was announced in June this year (SDX). The service is expected to launch between 10-20 September, following the greatly anticipated Ethereum Merge, in which the blockchain moves from a Proof-of-Work protocol like Bitcoin to one of Proof-of Stake, which is currently anticipated for 15 September. The largest Ethereum mining pool, Ethermine, has also launched a staking service (Cryptoslate) enabling yield from deposits as low as 0.1 ETH, far lower than the 32 ETH minimum needed to become an independent validator.
Google Parent Alphabet Invested $1.5B into Blockchain Startups Since September 2021 (Cryptoslate)
Alphabet’s concentrated investments in four startups, including DapperLabs, comprised a quarter of a total of USD 6 billion invested by 40 public companies between September 2021 and June 2022. Its large bets have been followed by smaller but sizeable investments from BlackRock, Morgan Stanley, Goldman Sachs, Samsung, Microsoft, United Overseas Bank, and Citi.
Tether and Circle Stablecoins See Reversal of Fortune on Varying Tornado Cash Stances
Tether’s USD stablecoin has seen a 2.6% monthly uptick of nearly USD 2 billion in circulating supply while Circle’s rival USDC has fallen 2.1% over the period (Cryptoslate). The reversal in the prior trend of the past several months is linked to differing stances on the treatment of wallets linked to Tornado Cash, the recently-sanctioned crypto mixer. Circle has frozen over USD 75,000 in USDC tokens associated with 81 sanctioned addresses (Forkast). However, Tether has published a statement (Tether) saying that it will not act unilaterally and will await an order or a positive match to a name in a sanctions list before freezing funds, citing existing rigorous checks on inbound and outbound transactions, close cooperation with law enforcement agencies, and the risk of disruption to investigations to justify its stance.
Seven S. Korean Brokerages Plan to Start Crypto Exchanges Next Year: Report (CoinDesk)
Seven brokerage firms including Mirae Asset Securities and Samsung Securities have made preliminary applications to establish exchanges in the context of new President Yoon Suk-Yeol’s crypto-friendly stance, despite a crack-down by regulators following the collapse of the Terra algorithmic stablecoin.
Ripple Launches Crypto-enabled Enterprise Payments in Brazil with Travelex Bank (Finextra)
Brazil’s Travelex Bank has partnered with Ripple to use its On-Demand Liquidity (ODL) service – based on Ripple’s XRP payment token – to facilitate cross-border payments. The new service will ensure high speed and low cost, and remove the need to pre-fund capital in the market of remittance, and will begin with a corridor between Brazil and Mexico before expanding to further markets and use cases such as treasury and business payments.
Itaú to Trial DeFi for FX as Part of Brazil’s Central Bank Lab (Ledger Insights)
Blockchain Industry Workforce Grows 80% This Year, Study Shows (Bitcoinist)
Australian Securities Exchange Takes Step Towards Tokenized Asset Trading (Cointelegraph)
Zerocap, a digital investment platform, has successfully tested integration with ASX’s Synfini DLT settlement platform – distinct from the delayed CHESS replacement initiative – opening the door to the tokenisation and trading of traditional assets such as bonds, equities, funds and carbon credits. It aims to launch these services in the near future having received legal approval. The use of ASX’s platform is expected to increase confidence through reduced counterparty risk.
Mid-year Crypto Crime Update: Illicit Activity Falls With Rest of Market, With Some Notable Exceptions (Chainalysis)
Blockchain analysis firm Chainalysis has published an assessment of blockchain-based financial crime for the first half of 2021, highlighting a 65% year-on-year decline in the proceeds of scams to USD 1.6 billion, albeit largely correlated to the decline in cryptocurrency values. However, the firm also says that the number of fraudulent transactions has fallen to a four-year low, and none have netted anywhere near as much as large outlier scams in previous years. Darknet revenue is also down 43% year-on-year, driven by a sudden drop after the shutdown of Hydra Marketplace, a darknet site that had become the dominant player since the closure of the infamous Silk Road platform. These declines are offset by small increases in funds lost to hacks, largely of DeFi protocols.
DTCC’S Project Ion Platform Now Live in Parallel Production Environment, Processing Over 100,000 Transactions Per Day on DLT (DTCC)
DTCC’s R3 Corda-based settlement platform is now parallel processing bilateral equity transactions, with peaks of up to 160,000 transactions per day. DTC’s existing settlement system remains the ‘authoritative record’ for the present time. DTCC’s aim is to provide a voluntary transition option to the DLT system once its resilience and safety have been firmly established. The platform will support netted T+0, T+1, T+2 and extended settlement cycles. Future plans include expansion to other DTC activities and to central counterparty National Securities Clearing Corporation (NSCC).
‘Post-Quantum’ Cryptography Scheme Is Cracked on a Laptop (Quanta)
One of four supposedly ‘quantum-resistant’ cryptographic algorithms selected by the National Institute of Standards and Technology in a competition (National Institute of Standards and Technology) in early July has been cracked by two researchers on a laptop. The protocols were supposed to form the agency’s post-quantum cryptographic standard (National Institute of Standards and Technology). The algorithm, known as the supersingular isogeny Diffie-Hellman protocol (SIDH), uses the same elliptical curve theory that forms the basis for existing cryptographic protocols but in a novel way. Metadata necessary for the algorithm was exploited using an even more complex mathematical theorem to ascertain the way in which the data were encrypted. Subsequent research has reduced the possible speed of breaking encryption to just a few minutes.

Key: Legal/Regulatory             Technology            Ecosystem              Markets 

CBDC Corner

Fed Promotes FedNow as Alternative to CBDC and Updates Release Date to Mid-2023
US Federal Reserve Governor Michelle Bowman has claimed that a CBDC may not be necessary since many of the challenges that CBDCs are designed to solve, including 24×7 real-time payment and settlement, may be covered by the planned FedNow payment service (Federal Reserve). The Fed has also refined its 2023 target for the production rollout of FedNow to the May to July 2023 window, and has expanded its pilot test programme to over 120 organisations (Federal Reserve).
Tech Industry Consortium to Run CBDC Pilot with Sterling Stablecoin (Finextra)
The Digital Financial Market Infrastructure (DFMI) consortium has announced a test of retail CBDC use cases based on a live Sterling-denominated stablecoin under ‘Project New Era’ principles set out in a white paper (The Payments Association) authored by the Payments Association, Dutch payment infrastructure provider paywith.glass and Boston Consulting Group. With other DFMI members including IBM, Finastra, FinClusive, Ibanera, Mattereum, Trust Payments and Accomplish Financial on board, the pilot is also intended to expand to other jurisdictions.
Reserve Bank of Australia Says a Live CBDC Likely to be Wholesale (Ledger Insights)
Further to our coverage in our last edition of the Reserve Bank of Australia’s (RBA) initiation of a year-long CBDC research project that would cover both retail and institutional use cases (Thomas Murray Digital), the synopsis of a payment systems board meeting has revealed that there will be a particular focus on wholesale applications such as cross-border payments and securities settlement. These plans are in line with ASX’s ambitious but increasingly delayed plans for a DLT-based post-trade infrastructure (Finextra) and with Project Dunbar (Bank for International Settlements), a multi-CBDC cross-border payment project in conjunction with the Monetary Authority of Singapore and the central banks of Malaysia and South Africa overseen by the Bank for International Settlements.
Nigeria Cuts CBDC Fees and Enables USSD
The Governor of the Central Bank of Nigeria (CBN) has announced that Nigerians are able to transact with their eNaira wallets and open new wallets using Unstructured Supplementary Service Data (USSD) codes on their mobile telephones (Punch), enabling instant payments for merchants and consumers to any bank account. The Governor also announced in a speech that eNaira has been used for almost USD 10 million worth of transactions, and the app has been downloaded 840,000 times with 270,000 active wallets (CoinDesk) for the country’s population of about 200 million, about 40% of which is unbanked. However, in June – roughly 6 months on from eNaira’s launch – retailers remained slow to accept the CBDC and a survey revealed that only 4% of respondents had used it, with 67% not aware of it at all (Punch). As Quartz points out, this averages to just 1.35 transactions per active wallet (Quartz). Perhaps reacting to this, CBN’s Deputy Governor Dr Kingsley Obiora has now said that the bank is cutting merchant fees for using eNaira by 50% (Daily Trust) to increase adoption.
Colombia: Petro Government Will Seek “Creation of a Digital Currency” (Semana)
The Director of Colombia’s National Directorate of Taxes and Customs has announced plans to create a CBDC with the aims of making financial transactions easier and preventing tax evasion, which is estimated to be worth between 6% and 8% of GDP, by ensuring traceability of transactions over a certain value.
Brazil CBDC Trials: Farm Lending Explored by Digital Asset, Oliver Wyman, VERT (Ledger Insights)
This project is a participant in Banco Central do Brasil’s Real Digital Lift Challenge, a series of tests of CBDC. Initially using tokenised commercial bank money, it will test ensuring an ongoing role for commercial banks in processing loan applications while keeping their balance sheets free of current low-interest ‘directed’ lending, and will see the creation of a marketplace where the banks can bid to provide loans.
Russia to Start Digital Ruble Pilots in 2023 (Ledger Insights)
Reserve Bank of Zimbabwe ‘Developed a Roadmap for Adoption of CBDC,’ Says Governor (Bitcoin.com)

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Asset Managers Move Into Digital Assets; CBDCs Could Be ‘Holy Grail’ of Cross-border Payments

Thomas Murray Digital Newsletter

CBDCs: A Holy Grail for Cross-Border Payments? (Public Domain)

BlackRock, Charles Schwab and Abrdn have joined the likes of Fidelity and Schroders in moving into the digital asset sector through tie-ups with Coinbase and Archax, and the launch of a new crypto thematic index and associated exchange-traded fund. Meanwhile, the European Central Bank believes that CBDCs could solve the centuries-old challenge of establishing a cross-border payment system that is ‘cheap, universal, and settled in a secure settlement medium’.

Digital Asset Developments

      

      		Asset Managers Move into Crypto in Numbers
Prominent asset management firms including BlackRock, Abrdn and Charles Schwab have moved en masse in recent days with tie-ups and new services that extend access to cryptoassets to more institutional and retail investors. These names join the likes of Fidelity and Schroders in entering the digital asset space.
  • Last week, Coinbase announced that it has been selected by BlackRock to enable its clients to access crypto trading and custody via Coinbase Prime (Coinbase). Clients will be able to access cryptoassets through Aladdin, Blackrock’s investment management platform, starting with bitcoin. Clients of the USD 21.6 trillion investment platform will be able to manage their exposure to digital assets directly from their existing accounts, with a holistic ‘portfolio view of risk across asset classes.’ BlackRock has also now launched a bitcoin private trust for institutional investors (BlackRock), designed to track the price of the oldest cryptoasset.

CPMI Consults on Increasing PvP for FX, Supported by DLT Solutions
The Bank for International Settlements’ Committee on Payments and Market Infrastructures (BIS CMPI) has launched a consultation (Ledger Insights) on ways to lower global financial stability risks arising from FX transactions by increasing payment-versus-payment (PvP) settlement. The FX market has the largest turnover, and bank exposures to FX risks in some countries such as the UK, Hong Kong and Singapore exceed their regulatory capital requirements. The aim is to reverse the decrease in FX transactions with PvP protection arising from increased trade with emerging markets that lack PvP abilities. Four of the ten proposed solutions are based on DLT, and one is Citi’s Regulated Liability Network concept (Citigroup).
Santander Brazil Launching Retail Crypto Offering and Tokenising Traditional Assets
Santander Brazil is to launch a retail crypto offering (Ledger Insights), citing significant client demand for the asset class. CEO Mário Leão added in the bank’s quarterly earnings call last week that it intends to use blockchain to tokenise traditional assets such as debt securities. This announcement comes a month after Latin America’s largest bank, Itaú Unibanco, launched its tokenisation platform and digital asset custody solution. The solution is part of a new unit, Itaú Digital Assets (Coindesk) and will be available to institutional clients first, with a retail version expected towards the end of 2022.
US Treasury Sanctions Cryptocurrency Mixer Tornado Cash; Dutch Authorities Arrest Developer
The U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) has sanctioned Tornado Cash (US Department of the Treasury), a protocol used to ‘mix’ crypto transactions to provide transaction anonymity. OFAC asserts that Tornado has been used to launder over USD 7 billion of stolen cryptocurrencies. The move raises the long-standing question of the liability of platform operators for the uses to which their services are put, just as regulators continue to debate the responsibility of other services such as Facebook or YouTube. Ethereum founder Vitalik Buterin has stated that he used Tornado Cash to donate funds to Ukraine (Forkast) in order to protect the recipients. In a development that has implications for the free speech rights of software publishers, Dutch authorities have today arrested the developer of the open source software behind Tornado Cash (Cointelegraph) on suspicion of money laundering.

Reserve Bank Innovation Hub: Interoperable DLT POC Closure Report
The Reserve Bank of India’s Innovation Hub (RBIH) has reported on the results of a proof-of-concept exercise (Reserve Bank of India) to move domestic trade finance processes – revolving around Inland Letters of Credit (LCs) – onto a distributed ledger platform. RBIH worked with a consortium of 11 banks and other fintech startups on the test, which was conducted using technology from IBM Hyperledger, R3 Corda, and Billon’s FIS. Following successful results, it now plans to facilitate the adoption of DLT ‘at scale’.

Crypto Takes a New Hit as Thousands of Solana Wallets Hacked
Security flaws in wallet software used to store assets for the Solana ecosystem were exploited to steal over USD 5.2 million of value from more than 7,900 wallets. Security researchers suggested that the Slope wallet was storing users’ seed phrases – used to create their private keys – in plain text (The Block) on a centralised server that was compromised. This follows an exploit of the Nomad ‘bridge protocol’ (Bloomberg) that transfers cryptoassets between blockchains that led to assets worth almost USD 200 million being lost. These stories, on top of several other hacks of similar cross-ledger bridge services that have led to estimated losses totalling over USD 2 billion this year (Chainalysis), highlight both the complexity of securing DeFi protocols and the dangers of relying on untrusted centralised services rather than regulated custodians.

News Links

SEC’s Gensler Wants Crypto Exchanges to Segregate Market Making, Custody (Ledger Insights)
Gary Gensler, Chair of the SEC, has proposed that crypto exchanges should segregate market making from custody activities, as is the requirement for traditional securities markets. He argues that clients are not expected to hand their assets to the New York Stock Exchange, and given that private keys are a proxy for ownership it would be more appropriate for the assets to be kept with a third party digital asset custodian.
Joint Statement on the UK-U.S. Financial Regulatory Working Group (US Department of the Treasury)
On 21 July, the UK-US Financial Regulatory Working Group convened and reconfirmed their commitment to addressing the cryptoasset market, with a focus on broadening their collaboration – and in particular strengthening the ‘regulatory outcomes for stablecoins across jurisdictions.’
UK Proposes Changes to Personal Property Laws Around Digital Assets (Ledger Insights)
The UK’s Law Commission of England and Wales has published a consultation paper suggesting that the law needs to be updated to account for the unique characteristics associated with cryptocurrencies, NFTs, and the metaverse more broadly. The objective would be to introduce the right legal foundation, in order to limit the potential impact of imposing existing structures on these new forms of assets that might stifle their development.
UK Legal Taskforce Probes Rules Underpinning Securities Issuance on Blockchain (Finextra)
More regulatory consultation in the UK, where the UK Jurisdiction Taskforce (UKJT) is examining support in English law for digital securities models in an effort to address concerns that the legal basis for digital securities in the UK is less supportive than that in other countries.
Crypto Inquiry 2022 (CryptoUK)
The UK’s Crypto & Digital Assets All-Party Parliamentary Group (APPG) has announced details of its assessment of the UK’s crypto and digital assets sector. It seeks feedback from the wider community on current approaches to regulation, the UK government’s plan for the country to become a crypto hub, the role of regulators, CBDCs, and investor protection.
Celsius Facing Legal Action by Aggrieved Custody Customers over $180M Deposit (Cryptoslate)
Bankrupt crypto lender Celsius is facing a lawsuit from a group of 400 customers of its custody service – distinct from its Earn programme, under which customers relinquished title to their crypto – whose assets remain stuck in the network. Celsius’s lawyers are resisting requests for refunds and claiming that even title ownership of deposited assets may not assure recoverability of funds in Celsius’s bankruptcy case. This is a further chapter in the debate on the status of crypto following the SEC’s guidance that custodians should move client assets on-balance sheet pending clarification of this issue in law (Thomas Murray Digital).
SEC/CFTC Proposed Amendments to Form PF (Securities and Exchange Commission)
In a joint proposal by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), there are to be New Crypto Reporting Rules for Large Hedge Funds (The Block) that would oblige qualifying hedge funds – reported to be those with more than USD 500 million of net assets – to provide information to the regulators that pertain to the hedge funds’ investment strategies, counterparty exposures, and trading and clearing mechanisms.
Over 70k XRP Holders Join Class Action Lawsuit Against SEC (Cryptoslate)
Tens of thousands of holders of Ripple’s token from all around the globe have now joined the challenge to the SEC’s assertion that XRP represents an unlicensed security token, in an alleged expansion of the principles of the Howey Test.
   EBA Warns Talent Shortage Will Hamstring Crypto Regulation (Finextra)
The European Banking Association (EBA) has warned that difficulties in attracting and retaining talent will limit regulators’ ability to supervise the digital asset sector. This follows a multitude of high-profile exits of leading regulators and industry experts into the clutches of the cryptoasset industry.
   Zodia Custody Gets Approval to Provide Cryptoasset Custodian Services in Ireland (Irish Times)
Zodia Custody has received approval from the Irish regulator to provide cryptoasset custody in the country, making it one of the first licensed Virtual Asset Service Providers (VASPs) there and the first dedicated custodian. As CEO Maxime de Guillebon articulated in a LinkedIn post, this will mean that Irish authorised Alternative Investment Funds will now be able to take advantage of institutional-grade safekeeping.
   Binance US Delists Token After SEC Labels It a Security (Blockworks)
Following the SEC’s categorisation of several crypto projects as securities, Binance US has delisted one, Flexa Network’s Amp token, that it previously supported on its exchange.
   Pando Asset Lists First Crypto ETP on SIX Swiss Exchange (Coin Speaker)
The Pando Asset Crypto 6 ETP offers investors the opportunity to participate in the performance of a basket of digital assets consisting of the largest cryptoassets by market capitalisation.
Ripple Casts Eye Over Bankrupt Crypto Lender Celsius (Finextra)
In other Ripple news, the firm has registered an interest with the bankruptcy court in acquiring assets from failed crypto lender Celsius.
Major Insurers Pull the Plug on B3i Insurance Blockchain Consortium (Ledger Insights)
Swiss insurer B3i is to close after its consortium of over twenty insurers and reinsurers failed to commit sufficient funds to its latest investment round, triggering its insolvency.
Bitcoin Fanatic Michael Saylor Steps Down as MicroStrategy CEO (Decrypt)
Saylor takes on Executive Chairman role in order to devote exclusive attention to the firm’s crypto activities, leaving management of the original software business to former company president Phong Le, who assumes the CEO role.
Virginia Pension Fund Invests in Crypto Lending in Bid to Boost Returns (Financial Times)
Virginia’s Fairfax County Retirement Systems Pension Fund is reportedly investing in crypto lending markets following earlier investments in cryptocurrencies, made alongside the Fairfax County Police Officers Retirement System. Its new venture into ‘yield farming’ entails lending assets in return for a fixed stream of payments, akin to securities lending. Katherine Molnar, CIO of the police retirement fund, cited the recent bankruptcy or withdrawal of other lenders as a factor that makes returns from the activity attractive.
Binance and Mastercard to Bring Streamlined Crypto Payments to Argentina (Blockworks)
Sygnum Bank Expands Bank-grade Staking with Cardano (ADA) (Sygnum Bank)
The leading Swiss digital asset bank has expanded its blockchain capabilities to support clients who wish to wish to earn rewards by staking their ADA tokens, the native token of Cardano’s Layer 1 protocol.
Bank of America “Disagrees” that Crypto Has No Intrinsic Value (AltFi)
In the July edition of its Global Cryptocurrencies and Digital Assets report, Bank of America contradicts the Governor of the Bank of England’s recent comments that the crypto industry has no intrinsic value, referring to the GBP 9 billion in transaction fees that blockchains have generated to date, in addition to network validation services and NFT transactions.
Ex-PwC Crypto Head Launches $75m Hedge Fund for Institutional Investors (FNLondon)
Henri Arslanian has launched Nine Blocks Capital Management in Dubai with backing from other hedge funds.
ASX Calls In Accenture to Assess CHESS Replacement Project (Finextra)
The Australian Securities Exchange (ASX) has engaged Accenture to assess the gaps in the current development plan and draw up a new timeline for the project’s completion. Originally slated for April 2021, the replacement for the aging CHESS system has suffered several setbacks. Current estimations suggest it will be delayed until late 2024.
Digital Assets — A World of Possibility (Wells Fargo)
In its August report, Wells Fargo states that digital assets are ‘a transformative innovation on par with the internet, cars, and electricity’. Its argument is that the ‘Internet of Value’ is likely to be as disruptive to the world of finance as the original internet was to communications and information.
Chinese Municipal Bank Issues First-ever Digital Yuan Loan Using Intellectual Property as Collateral (Coin Telegraph)
Agricultural Commerce Bank of Zhangjiagang has made the loan of e-CNY 500,000 (USD 74,000) directly to a manufacturer’s digital wallet.
Galoy Launches Synthetic Dollars Backed by BTC, No Stablecoins Needed (The Tokenist)
Galoy, an open source banking company that specialises in Bitcoin acceleration and integration, has launched Stablesats, a synthetic dollar backed by bitcoin that uses inverse perpetual swaps and forgoes the traditional fiat peg that most stablecoin operations implement.
ZK-Rollups Likely to be Main Layer 2 Solution for Ethereum, says Vitalik Buterin (The Block)
Vitalik Buterin, the founder of Ethereum, has suggested that ZK-Rollups are likely to win out over Optimistic Rollups as the main Layer 2 solution for scaling up the blockchain’s capacity due to their faster speed. Rollups move processing of transactions off-chain, posting batches of aggregated results to the main network. Optimistic Rollups – as the name suggests – save effort by assuming the validity of transactions without further verification, but allowing a challenge period during which they can be disputed, with staked ether used as an incentive to process only legitimate transactions. In ZK-Rollups, transactions are always presented with proof of their validity. This is slightly more computationally expensive, but reduces transaction finality from 7 days to near-instantaneous.
Bitcoin Network’s Power Demand Drops by Over 20% in 2022 as Shift to Renewables Accelerates (Finbold)
Crypto Investments Products See Inflows of $474M in July (Crypto Slate)
The end of July saw the fifth consecutive week of inflows. Total cryptocurrency market capitalisation exceeded USD 1 trillion once more in a slight recovery from the bear market.

Key: Regulation             Technology            Ecosystem              Markets 

CBDC Corner

Working Paper Series: Towards the Holy Grail of Cross-border Payments (European Central Bank)
The ECB’s latest paper assets that CBDCs could solve the challenge – ‘as old as international commerce and the implied need to pay’ of finding a cross-border payment system that is ‘cheap, universal, and settled in a secure settlement medium’. It expects this system to be developed over the next 10 years.
Reserve Bank and Digital Finance Cooperative Research Centre to Explore Use Cases for CBDC (Reserve Bank of Australia)
The Reserve Bank of Australia has initiated a year-long research project to consider use cases for a CBDC in Australia. Industry participants will submit proposals, and some will be selected to take part in a ring-fenced pilot scheme that will use a pilot CBDC that is a real claim on the Reserve Bank. The study aims to explore the economic benefits of applications of a CBDC for households and businesses in addition to technical aspects, as these are seen as a gap in existing CBDC studies for markets such as Australia that already have efficient and well-functioning payment and settlement systems.
Millicent Completes World’s First Test of a General Purpose Full-Reserve Digital Currency (FRDC) (Crypto.news)
Millicent, a fintech company partly funded by the UK Government, has used a sandbox to issue and test use cases for a pegged token fully collateralised by cash deposits held at the Bank of England. It claims it is effectively the first retail test of a synthetic CBDC.
Seven Out of Ten Tell Fed They Don’t Want Digital Dollar: Cato Institute (Ledger Insights)
The Libertarian think tank finds concerns over financial privacy, financial oppression, and fears of the disintermediation of banks. This may be a case of self-selection of respondents, or of a misplaced belief that the financial system simply needs a ‘faster horse’ rather than substantively newer technology.
Thailand’s Central Bank Extends Retail CBDC Study to Pilot Phase (CoinDesk)
Nepal Prepares Laws to Enable CBDC Issuance (Ledger Insights)
China’s Central Bank to Expand Digital Yuan Pilot Program (Yahoo)

Thomas Murray Digital

Andrew Wright | Hugo Jack

Tel. +44 (0)20 8057 7100
Email: digital@thomasmurray.com
Web: thomasmurraydigital.com

Whilst reasonable care has been taken in the compilation of this information, neither Thomas Murray Network Management Limited, its affiliates or information contributors shall have any liability for any errors, omissions, delays or inadequacies in the information or for any loss or damage however occasioned (whether arising directly or indirectly), to any person or company relying on this information, or any decision made, action taken or inaction by any party in reliance upon this information (except to the extent permitted by law). Copyright © Thomas Murray Network Management Limited, company no. 03313014. All rights reserved. No reproduction without prior authorisation.

DeFi vs CeFi, ‘Regulation by Enforcement’, Emerging Market Opportunities, and Stablecoins vs CBDCs

Thomas Murray Digital Newsletter

Pantera Capital’s Dan Morehead (Photo by Steve Jennings/Getty Images for TechCrunch)

This issue’s stories cover the whole gamut of topics, from more regulatory debate and legislative progress, market opportunities, and questions over the best architecture for the future payment rails of global financial infrastructure:

  • Crypto hedge fund Pantera Capital asserts that recent crypto lender bankruptcies are down to old-fashioned over-leveraging and poor risk management, rather than symptomatic of risks specific to the digital asset sector, and a move to rigidly-applied smart contracts will provide increasing investor protections by taking out the human factor
  • Coinbase continues to bear the brunt of the SEC’s ‘regulation by enforcement’, in the words of the Commissioner of rival regulator the CFTC, as there continues to be disagreement on the definition of a security in the context of digital assets
  • Two reports highlight digital asset opportunities in emerging market regions including Latin America and Asia Pacific, with new revenue streams for exchanges identified and an estimate that there will be a billion crypto users worldwide by 2030
  • Stablecoin regulations are progressing in the EU, UK and US, while the debate continues over whether CDBCs or stablecoins should prevail for retail and wholesale payments use cases: can stablecoins function as ‘synthetic CBDCs’ in much the same way that commercial banks support fiat money supply under the existing system, and bypass issues with the potential for CBDCs to disintermediate commercial banks?

Digital Asset Developments

      


      		Crypto lender failures – is DeFi or CeFi to blame?
In the aftermath of the collapse of several lenders in the crypto-sphere – and the accompanying crash in cryptocurrency values – the CEO of crypto hedge fund Pantera Capital offers an interesting viewpoint countering the mainstream press narrative that this was a failure of the Decentralised Finance (DeFi) business model. In an investor newsletter, Dan Morehead points out that Celsius, BlockFi and Voyager Digital are not exemplars of the new financial world, despite operating in that sector, so much as traditional, centrally-managed and bank-like entities. These startups used VC funding to grow, but their fundamental business model was to take short-term deposits but to make long-term loans, all while massively over-leveraged, leading to the same results as experienced by Long Term Capital Management and Lehman Brothers, among other salutary tales from the world of traditional finance. This view corresponds with our previous article asserting that the bankruptcy of Three Arrows Capital was down to failures in governance and due diligence.
Conversely, the true DeFi protocols – including Aave, Compound, Uniswap and MakerDAO – continued to operate ‘flawlessly’ throughout the crisis. DeFi loan contracts are over-collateralised (typically in the 110-150% range, and as high as 300%) in much the same way as mortgages secured by real estate, providing effective risk management. The distributed operators of the infrastructure incentivised by yield on staked assets to use smart contracts to ensure the absolute consistency of the application of contract rules (removing the human factor) and the security of the protocols. The smart contracts forced Celsius and others to pay down their loans in order to avoid liquidation of their collateral, exactly as intended, and without introducing the complexities and potential for loss that a restructuring or breaking of contractual terms would entail. The newsletter highlights that the transparency of on-chain arrangements, such as DeFi smart contracts, allows open analysis of loan terms, leverage ratios, and performance, without having to take the representations of centralised finance (CeFi) players on trust.
Coinbase hits back at SEC over ‘regulation by enforcement’ in struggle to define digital securities
Reported by Bloomberg on Monday, the SEC has launched an investigation into Coinbase in an attempt to assess whether or not it let customers trade securities. The SEC published a list of crypto projects that it deems satisfy the Securities Act definition of an investment contract, seven out of the nine of which Coinbase supports on its platform. The digital asset provider vehemently refuted these claims in a blog post, stating the crypto exchange uses a thorough SEC-reviewed process for considering crypto projects for listing. Originally, the SEC’s interest in Coinbase stemmed from an investigation by the Department of Justice (DOJ) into insider trading which resulted in charges for a Coinbase product manager, his brother, and another party, with the SEC announcing its own civil case shortly after. The investigation coincidentally came hours after Coinbase filed a court petition calling upon the SEC to establish a clear regulatory framework for digital assets ‘guided by formal procedures and a public notice-and-comment process, rather than through arbitrary enforcement or guidance developed behind closed doors.’ The SEC’s approach has caught out a number of exchanges and crypto projects in the recent past, most notably Ripple Labs Inc., whom the SEC charged along with two executives with conducting an unregistered securities offering of its native token XRP. Adding the fuel of inter-agency rivalry to the fire, the Commissioner of the Commodity Futures Trading Commission (CFTC), Caroline Pham, echoed Coinbase’s indictment of the SEC and its behaviour, declaring on Twitter that the SEC’s broad classification of crypto projects as securities is a striking example of ‘regulation by enforcement’. The SEC has come under increasing pressure to issue a clear and concise framework that extends beyond the widely-used Howey Test, which was adopted in 1946, and not considered fit for purpose when considering digital assets.
The future of crypto exchanges: emerging market opportunities, revenue streams and institutional adoption
A recent report published by Boston Consulting Group (BCG), Bitget, and Foresight Ventures titled What Does the Future Hold for Crypto Exchanges? suggests that crypto as a technology and asset class is still in the early throes of adoption, and that it will really accelerate as it expands across the Latin America and Asia Pacific regions. These represent the greatest potential for growth due to under-developed traditional financial infrastructure, and offer opportunities for exchanges to offer crypto-backed services relevant to emerging markets such as loans, remittances, payment services, and tokenised stock trading. These services can supplement revenue streams that are also available to traditional exchanges but not as easily monetisable in the crypto world due to crypto’s more open nature, such as data, co-location services, market data feeds, and API high frequency trading connections.
The focus of the report looks at the role that exchanges play in the development of the digital asset ecosystem, which by the end of 2021 had accounted for approximately USD 54 trillion in crypto trading value. Emerging markets and ‘advanced APAC countries’ accounted for one third of global spot trading volumes and around 40% of global derivatives trading volumes in 2021.
The report also highlights that institutional adoption is continuing, with an expanding class of crypto-native funds leading the charge. The authors estimate that the number of crypto users will reach 1 billion by 2030.
A separate joint study by KPMG and HSBC on emerging corporate giants in the Asia Pacific region concluded that over a quarter of the 6,742 start-ups surveyed are blockchain related, with NFTs and DeFi proving the most popular themes. 32.8% of surveyed companies herald from China, 30.1% from India, 12.7% from Japan, and 8.7% from Australia, with a further 8 countries making up the remaining 5.2%.

Could stablecoins substitute CBDCs? Questions of adoption, privacy and bank disintermediation
The potential for Central Bank Digital Currencies (CBDCs) to facilitate domestic and international payments continues to receive significant attention. According to CBDCTracker.org, 86 central banks have recently researched, piloted or launched CBDCs, with increasing numbers of countries exploring their applications in both retail and wholesale sectors. Stablecoin projects and their adoption have also increased considerably in the past couple of years, supporting the role of settlement in digital asset markets globally by operating on the same digital rails as cryptocurrencies, utility tokens and asset-backed tokens such as NFTs.
While some including the Financial Stability Board, US Treasury and the Bank of England have warned of potential financial stability risks from stablecoins, there is growing recognition that properly backed stablecoins are highly effective tools for bridging the gap between traditional and crypto finance. A recent report by the Federal Reserve Bank of Richmond suggests that stablecoins may be better placed to serve the needs of growing crypto-based economies and can serve as ‘synthetic CBDCs’. Furthermore, the Chief of the Australian Central Bank has suggested that private, regulated tokens such as stablecoins could beat CBDCs to the punch due to their increasing acceptability and adoption in the market, their support for privacy (at front of mind for many given the intrusive nature of China’s digital yuan), their wholesale applicability, and their compatibility with commercial bank activities which is not as clear cut for some currently envisaged retail CBDCs. Stablecoins are also being brought into the scope of draft regulations such as the EU’s MiCA, the UK’s Financial Services and Markets Bill, and the US Stablecoin Bill.
Interestingly, as reported this week, China’s Digital Currency Electronic Payment project is witnessing a slowdown in adoption of the digital yuan. The report shows that users are struggling to differentiate between the benefits of the nascent e-CNY and existing digital payment applications such as the widely-used WeChat and Alipay. Furthermore, citizens are increasingly concerned with privacy, leading the Chinese Communist Party to announce an effort to increase personal data protections in the project, although without providing specifics.

News Links

U.S. Bipartisan Stablecoin Legislation Delayed (Ledger Insights)
Senators Toomey and Sinema Introduce Bill to Exempt Small Crypto Transactions from Capital Gains Taxes (The Block)
Putin Signs Law Banning Crypto-based Payments in Russia (Cryptoslate)
Binance Fined Over $3.3M by Dutch Central Bank (Coindesk)
South Korea Postpones 20% Tax on Crypto Gains to 2025 (Cointelegraph)
Paraguay’s New Bill May Turn the Country into Mining Heaven (Cryptoslate)
Strict Thai Crypto Regulation Causes Siam Commercial Bank Group to Delay Bitkub Acquisition (Cointelegraph)
SEC Hasn’t Subpoenaed Binance About BNB: FOIA Response (Coindesk)
Binance CEO Files Defamation Case Against Bloomberg (AMBCrypto)
Taiwan Set to Ban Crypto Purchases Using Credit Cards (Coindesk)
California Ends Ban on Crypto Campaign Donations (The Block)
Central Bank of Ireland Highlights Weaknesses in Virtual Asset Service Providers’ AML/CFT Frameworks (Central Bank of Ireland)
European Banking Regulator Sees ‘Major Concern’ in Retaining Staff to Handle Crypto: Report (Cointelegraph)
  Rio de Janeiro Forges Ahead with Bitcoin Integration Plans (Cryptoslate)
  Komainu, a Nomura-backed Crypto Custodian, Granted Initial Provisional Regulatory Approval to Operate in Dubai (PR Newswire)
  Gemini Becomes First Company to Be Registered as Virtual Asset Service Provider (VASP) in Ireland (Gemini)
  Coinbase Secures Regulatory Approval in Italy (Coindesk)
  Cryptocurrency Exchange Crypto.com Expands to Italy (Coindesk)
  Crypto.com Continues Expansion with Cyprus (Cryptoslate)
  Standard Chartered-backed Zodia Markets Secures FCA Registration (Finextra)
  Central African Republic Begins Public Sale of Sango Coin (The Block)
Schroders Buys Stake in Digital Assets Firm (Finextra)
Block by Block: Blockchain Technology is Transforming the Real Estate Market (Cointelegraph)
Barclays Snaps Up Stake in $2bn Cryptocurrency Firm Copper (Sky News)
Saxo Bank Founder: Blockchain Has the Biggest Potential Since the Internet (Cointelegraph)
FTX and Coinbase Invest in ‘Bloomberg for Crypto’ Coinfeeds (Finextra)
BNP Paribas Securities Services to Develop Digital Assets Custody Capabilities Through Partnerships with METACO and Fireblocks (BNPPSS)
BNP Paribas Issues Tokenized Bond for EDF on Public Blockchain (Ledger Insights)
  BME, BBVA and IDB Issue Spain’s First Blockchain-based Regulated Bonds (Inter-American Development Bank)

BCP Group to Launch First Bond Issue on Blockchain in Morocco (Morocco World News)
Russian Firm Claims Digital Token First (Finextra)
UK to Explore Blockchain-based Government Bond (Ledger Insights)
IMA Broker Issues Blockchain-based Certificates of Insurance (Ledger Insights)
UK Finance Association Labels Crypto a ‘Good Alternative’ to Traditional Payments (Finbold)

Key: Regulation             Technology            Ecosystem              Markets 

CBDC Corner

BIS and Bank Indonesia Shortlist 21 Teams for CBDC G20 TechSprint Challenge (Finextra)
Central Bank Digital Currencies and Regulatory Alternatives: the Case for Stablecoins (Richmond Federal Reserve)
Private but Regulated Tokens Could Beat CBDCs, Australian Central Bank Chief Says (Cryptoslate)
Reserve Bank of India Working on Phased Implementation of Digital Currency (The Print India)
Indonesia Plans Wholesale Digital Currency to Improve Transfers (Bloomberg)
IMF Wants M-Pesa Shielded in CBK Digital Shilling Plan (Nation Media)
Lenders Are Thwarting Digital Currency’s Adoption in Nigeria (Bloomberg)

Thomas Murray Digital

Andrew Wright | Hugo Jack

Tel. +44 (0)20 8057 7100
Email: digital@thomasmurray.com
Web: thomasmurraydigital.com

Whilst reasonable care has been taken in the compilation of this information, neither Thomas Murray Network Management Limited, its affiliates or information contributors shall have any liability for any errors, omissions, delays or inadequacies in the information or for any loss or damage however occasioned (whether arising directly or indirectly), to any person or company relying on this information, or any decision made, action taken or inaction by any party in reliance upon this information (except to the extent permitted by law). Copyright © Thomas Murray Network Management Limited, company no. 03313014. All rights reserved. No reproduction without prior authorisation.

Digital Custody Partnerships Abound Despite the Crypto Bear Market

Thomas Murray Digital Newsletter

Photo by Samson on Unsplash

The cryptocurrency market appears to have found a stable (if much reduced) footing, at least for the time being. The dwindling value of bitcoin and other cryptocurrencies has led some to short-sightedly conclude that investment would dry up and that infrastructural and market developments would grind to a halt. However, the course of digital assets has far wider scope than just cryptocurrencies, which merely serve as the first real examples of blockchain applications. It is therefore of little surprise that a number of high-profile partnerships between legacy custodian banks and digital asset technology firms have recently been announced.

CACEIS, the asset servicing arm of Crédit Agricole and Santander, has partnered with Taurus, a leading Swiss-based digital asset infrastructure and technology firm. Meanwhile, Citi announced a similar partnership with METACO, an equally established Swiss-based digital asset infrastructure and technology firm, to develop a platform to enable clients to store and settle digital assets seamlessly and securely. SG FORGE, the digital asset subsidiary of Société Générale, followed suit and announced its own partnership with METACO, to expand its institutional digital asset capabilities and aid the bank in its efforts to integrate security tokens into traditional finance. These partnerships will help incumbent providers to take advantage of the new and rapidly growing digital economy by giving them tools to securely and accurately support the trading, custody, issuance, and management of digital assets, which are taking tentative first steps to extend to securities tokens.

Archax, the U.K.’s first licensed digital asset exchange, has also partnered with METACO to be able to provide a segregated bank-grade custody solution, alongside IBM. While not the first to implement this model, it is representative of a growing trend, and a sign of increasing maturation, to formally segregate digital asset execution from custody, something that is standard practice across the traditional securities industry. In a related development, ING, which has been heavily involved in blockchain development and testing for many years, has decided to spin out its digital asset custody platform Pyctor to GMEX Group, a leading digital asset market infrastructure with a focus on post-trade solutions. The deal is expected to enable GMEX to scale Pyctor alongside its other digital asset services.

Digital Asset Developments

      

      		MiCA’s next milestone: The long awaited Markets in Crypto Assets (MiCA) regulation is one step closer to being finalised, having been provisionally agreed by the European Parliament (EP) and Council (EC). MiCA, which aims to create a regulatory framework for digital assets across Europe, has been through a number of iterations since it was first proposed in 2020 as part of the EU’s Digital Finance Package. The agreement now confirms a number of broad requirements for entities that interact with digital assets, including a robust licensing framework for crypto-asset service providers (CASPs) such as custodians, hosted wallet providers, and trading venues, which will all need authorisation to operate in the EU. Issuers of digital assets will be required to produce and publish a white paper outlining all relevant information on the specific crypto asset. MiCA regulation will capture all digital assets not currently covered under existing financial service legislation, including asset-reference tokens, e-money tokens, and other crypto assets. Stablecoins, which continue to receive significant attention by regulators globally, are firmly covered under MiCA, with strict conditions set for any stablecoin operators. These include being required to register an office in the EU, maintain significant reserves, guarantee 1:1 redemption in fiat, eliminate interest-bearing mechanisms for stablecoins, and supervision by the European Banking Association. NFTs will remain out of scope, unless they fall under existing categories of digital assets. The provisional agreement is subject to final approval by the EP and EC, whereupon the formal adoption procedures would then run their course. The regime would be expected to apply 18 months thereafter. Despite the progress made on MiCA, the European Central Bank has continued to sound the alarm bells by warning eurozone countries that national-level practices must be aligned in order to better manage digital asset risks, given that it will still be many months before MiCA comes into effect. This announcement comes two weeks after Lithuania introduced its own crypto licensing regime as a stop-gap measure.
UK regulation, stablecoin concerns, and DeFi: Given the EU’s progress with MiCA and the former UK Chancellor’s desire for the country to be a ‘cryptoassets technology hub‘, the UK Government and the Bank of England have been vocal in the past weeks in calling for greater clarity and regulatory oversight of the digital asset industry. The Bank of England, led by its Financial Policy Committee has stepped up efforts to address the financial stability threat, particularly in light of Terra LUNA/UST’s collapse in May of this year, the fallout from which is still reverberating. In its quarterly stability report, the BoE called for an ‘enhanced’ crypto regulatory framework that would be designed to mitigate potential risks emanating from digital assets, evidenced by recent vulnerabilities including bank-like runs, company bankruptcies, liquidity mismanagement, and likely criminal behaviour. Stablecoins, in the eyes of the BoE and most Central Banks continue to be the presiding threat to overall financial stability. Subsequently, the Bank this week recommended additional regulation be established to manage the systemic threat they may soon present. The Deputy Governor of the BoE announced last Wednesday (6 July) his expectation that a regulatory system for stablecoin legislation will be introduced prior to August. This announcement came a week before the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) announced their final guidance on stablecoin arrangements, which they confirm as now being subject to the Principles for Financial Market Infrastructures for systemically important tokens. Decentralised Finance (DeFi) and the tax treatment of events relating to the peer-to-peer economy continues to perplex governments and regulators alike. Last week, the UK Government launched a public consultation calling for members of the industry to opine on the DeFi economy, with a particular focus on the best ways to approach the taxation of cryptoasset loans, lending, and staking. The reported objective is to reduce the administrative burden and cost for taxpayers that engage in the activity. The consultation is set to close on 31 August 2022.

European support for digital asset funds: UK fund managers have been actively lobbying for the approval of blockchain-traded funds, arguing that the technology would lead to a number of worthwhile benefits including a reduction in general administration, greater transparency, near instant settlement, and reduction reduced customer costs. The message, delivered through the Investment Association – the trade body that represents the UK’s asset management industry – was that the industry is ready for blockchain-based funds and that all efforts should be made to approve them. Amongst the suggestions is a proposal to create a new task force that would investigate how to accelerate DLT adoption and explore ways to give customers greater customisation over their portfolios, which could include holdings in private companies as well as cryptocurrencies. Some jurisdictions have been much more proactive in developing frameworks to support digital asset-based funds, most notably Luxembourg, which permits Alternative Investment Funds (AIFs) to invest in digital assets, although Undertakings for the Collective Investment in Transferable Securities (UCITS) funds are still not permitted to do so. Ireland’s Central Bank has just introduced positive changes and updated its approval process for AIFs looking to allocate funds to digital assets, something it has reportedly been unwilling to consider until now. Last month, Germany introduced an update to its securities law by introducing the concept of Crypto Fund Units (Verordnung über Krypto­fonds­an­teile), so the law now recognises a fund’s ability to issue units in a common fund via a crypto securities register which may be decentralised and based on Distributed Ledger Technology.
Basel Committee’s Take 2 on Crypto Reserve Rules: In 2021, the Bank for International Settlements’ Basel Committee on Banking Supervision issued a proposal – largely viewed by the industry as unviable and even punitive – to require banks to reserve capital to cover the whole value of cryptocurrency holdings. Following stiff resistance, as we reported last November, the BIS withdrew that model and went back to the drawing board. The result, a new consultation document published on 30 June on the ‘prudential treatment of cryptoasset exposures’, takes a more refined and pragmatic stance. The latest suggestion is that banks may hold up to 1% of their reserves in cryptocurrencies. Digital assets may be classified as Group 1, broadly representing certain tokenised traditional assets (Group 1a) and some stablecoins with ‘effective stabilisation mechanisms’ (Group 1b). These would be treated in a similar way to the assets backing those tokens under the principle of ‘same risk, same activity, same treatment’. All other cryptoassets would fall into Group 2, which is also further divided into two classes. Group 2a has been defined in response to banks’ concerns that the original rules did not recognise that some assets are suitable for hedging, which can now be reflected when calculating banks’ net exposures. That leaves unbacked cryptoassets, and other tokens that do not meet the rules of Group 1 assets, in Group 2b, which remains subject to the 100% capital charge. It is these Group 2 assets of both sub-classes that will now be subject to a total exposure limit of 1% of Tier 1 capital, ‘including both direct holdings (cash and derivatives) and indirect holding (i.e. those via investment funds, ETF/ETN, special purpose vehicles)’. It remains to be seen how this may be reconciled to the SEC’s recent demand that client cryptoassets under custody should appear on banks’ own balance sheets, with industry groups, members of Congress and even the SEC’s own commissioners challenging that determination.

Lessons in due diligence from Three Arrows Capital: Three Arrows Capital (3AC), a crypto hedge fund that until recently had been viewed as a mature and reliable player, collapsed recently due to betting that the price of cryptocurrencies would rebound and to high exposures to the LUNA token that ‘backed’ the TerraUSD algorithmic stablecoin, both of which failed in May. Founded in 2012 by ex-Deutsche Bank and Credit Suisse traders Su Zhu and Kyle Davies, at one point the fund was managing USD 18 billion in assets, and was worth USD 10 billion as recently as March. Its rapid fall has led to further contagion risk to a surprisingly wide range of lenders including Voyager Digital, Babel Finance, Blockchain.com, Genesis, BlockFi, BitMEX and FTX, with Voyager also filing for Chapter 11 bankruptcy protection. These lenders relied primarily on 3AC’s founders’ reputation in setting their exposure levels to the fund. Research firm FSInsight has accused 3AC of running an old-fashioned Ponzi scheme, using new borrowings to service older loans in a repeat of the behaviour that sunk Long Term Capital Management back in 1998. This raises the spectacle that the industry – or at least, relative newcomers to it operating in the crypto sector – has failed to learn the lessons of the past. FSInsight’s report assesses that it is likely that the vast majority of 3AC’s assets were bought with borrowings, and that relatively little equity was made available as collateral for the loans. This leverage ratio turned sour due to bets on both LUNA and also the Grayscale Bitcoin Trust. To add to 3AC’s troubles, the Monetary Authority of Singapore (MAS) has accused the fund of providing false information and exceeding limits on assets under management (AUM) set by the regulator. 3AC, incorporated in the British Virgin Islands (BVI) but headquartered in Singapore, had told MAS that management of the fund had been transferred to an unrelated BVI entity in September 2021, without disclosing that Su was a shareholder of both 3AC and that entity. The AUM limit was allegedly breached between July and September 2020 and again between November 2020 and August 2021. A BVI court ordered the liquidation of the 3AC fund on 27 June. On 1 July 3AC filed for Chapter 15 bankruptcy protection in New York,  but despite that a New York court has frozen the fund’s assets in an attempt to protect them from unauthorised disposals, a possibility hinted at by the transfer of 3AC NFT holdings to a new address. Zhu and Davies have now gone missing and are allegedly failing to cooperate with court-appointed liquidator Teneo, which has been unable to obtain information regarding the fund’s wallets and their associated private keys. The lessons are clear: just as in traditional finance, reliance on reputation alone is insufficient. There are continuing needs to perform adequate due diligence, monitor overall credit exposures, and to ensure good governance practices such as the use of trustworthy, independent fund administrators and custodians who can keep records and assist stakeholders and administrators in the event that issues arise.
Challenging DLT’s Reputation for Decentralisation and Security: Research commissioned by the US’s Defense Advanced Research Projects Agency (DARPA) and conducted by Trail of Bits highlights several thought-provoking facts and possible attack vectors that could compromise blockchains. The paper’s insights add nuance to DLT concepts, such as decentralisation and immutability of transactions, that have almost become axiomatic. They have implications for the design and governance of blockchains before too much responsibility for running future financial infrastructure is placed on them. Although blockchain networks are ostensibly decentralised, centralisation (and therefore single or at least fewer points of failure/weakness) can creep in through: authoritative centrality, ‘the minimum number of entities necessary to disrupt the system’ (aka the Nakamoto coefficient); consensus centrality, the extent to which the source of consensus – such as mining power in proof-of-work blockchains – is concentrated; motivational centrality, the way in which network participants are disincentivised from acting maliciously and whether those levers are managed centrally; topological centrality, or the risk that a network could be disrupted because it relies on a specific subset of nodes; network centrality, in which nodes may be subject to similar connectivity risks due to their geographical location or ISP or cable connectivity; and software centrality, being the risk that bugs or back doors in the blockchain’s core software, or incompatibilities or differences between different clients, could break immutability or cause a fork in the chain. Taking the Bitcoin network as an example, they found that:
  • Every popular blockchain has privileged users or entities that can amend the system and potentially cause changes to past transactions
  • As few as two entities need to be compromised or act maliciously to disrupt the Bitcoin blockchain, four for Ethereum, and fewer than twelve for most proof-of-stake blockchains
  • Only a small and dense subset of the thousands of advertised Bitcoin nodes participates in mining, contributes to the health of the network, and coordinates mining activity (which, in addition to creating new bitcoins, is also responsible for validating transactions and voting on governance issues); furthermore, node operators are not penalised for any dishonesty
  • Unlike the transactions themselves, Bitcoin network traffic is unencrypted, and therefore vulnerable to man-in-the-middle observation and tampering with messages from ISPs, governments, WiFi providers or Tor network exit nodes (the latter host to traffic for about half of all Bitcoin nodes); similarly, the most common mining pool communication protocol, Stratum, is unencrypted and effectively unauthenticated
  • 60% of Bitcoin network traffic passes through just three ISPs
  • 21% of Bitcoin nodes still run an outdated version of the Bitcoin Core client software that was known to have code vulnerabilities as far back as June 2021, over a year ago

News Links

Bank for International Settlements to Allow Banks to Keep 1% of Reserves in Bitcoin (Finbold)
US Fed Evaluating SEC’s Position on Digital Assets Custody, Powell Says (CoinDesk)
Gensler Labels bitcoin a ‘Commodity’ as Crypto Prices Stabilize (Morningstar)
CPMI and IOSCO Publish Final Guidance on Stablecoin Arrangements
Confirming Application of Principles for Financial Market Infrastructures (CPMI and IOSCO)
Belgium Starts Consultation on Classification of Crypto as Securities and Investment Instruments (Cryptoslate)
Singapore Eyes More Regulation to Protect Retail Investors From Crypto Winter Fallout (Cryptoslate)
Russian Parliament Approves Tax Break for Issuers of Digital Assets (Reuters)
Bank of Russia Ready to Legalize Crypto Mining If Miners Sell Minted Coins Abroad (bitcoin.com)
Grayscale Files Suit Against SEC Following Rejection of GBTC Conversion Bid (The Block)
Poundtoken Launches as the First Fully Backed GBP Stablecoin Regulated in the British Isles (City A.M)
Tether To Launch GBP₮, Tether Tokens Pegged to the British Pound Sterling (Tether.io)
Colombia Integrates Ripple’s XRPL for Land Registry (Cryptoslate)
  Crypto Exchange Coinbase Seeks Licenses in Europe as it Looks to Ramp Up Growth Outside the U.S. (CNBC)
   Paxos Promises Monthly Disclosure of Reserve Assets Backing its Stablecoins (Finextra)
The Central African Republic Launches Crypto Initiative Post Bitcoin Adoption (Cointelegraph)
Swiss Post Office to Offer Crypto Trading and Custody Services by 2024 (Finbold)
Northern Trust Creates Digital Assets and Financial Markets Group (Finextra)
Blockchain Firm SETL Acquired by Turkish Fintech (Finextra)
Deloitte, NYDIG Partner to Help Institutions Adopt Bitcoin (Nasdaq)
Fintech Infrastructure Firm Prime Trust Raises $107m (Finextra)
Stablecoin Tether (USDT) To Undergo Full Audit From Top Firm in Bid for Transparency (Daily Hodl)
Tether Reducing Commercial Paper Holdings Down to $3.5 billion by End-July (Cryptoslate)
Delio Unveils South Korea’s First ‘Crypto Bank’ (Finextra)
Crypto Exchange Binance Launches New Platform Aimed at Institutional Investors (Decrypt)
  SIX Digital Exchange Launches SDX Web3 Services (Finextra)
ANZ Completes First A$DC Stablecoin Transaction (Finextra)
EU-regulated Firm Banking Circle Adopts USDC Stablecoin (Cointelegraph)
  Goldman Sachs Executes First Bitcoin Futures Trade in Asia (Finbold)
Binance Brings Bitcoin Trading Fees to Zero (The Paypers)
NIST Announces First Four Quantum-Resistant Cryptographic Algorithms (National Institute of Standards and Technology)
Key: Regulation             Technology            Ecosystem              Markets 

CBDC Corner

Report: Options for Access to and Interoperability of CBDCs for Cross-border Payments (Bank for International Settlements)
Ripple Introduces CBDC Competition to Encourage XRPL Innovation (U.Today)
Amsterdam to Launch its Own Digital Currency to Promote Local Economy (NL Times)
More African Central Banks Are Exploring Digital Currencies (IMFBlog)
ECCB Launches DCash in Anguilla (Eastern Caribbean Central Bank)
Bank of Russia Accelerates Schedule for Digital Ruble Project (Bitcoin.com)
Iran to Roll Out Pilot Version of Crypto-Rial Digital Currency Soon (IPFNews)
Taiwan Completes Trials of its Prototype CBDC for Retail Use (Forkast)
Taiwan Central Bank Governor Considers Interest-Free CBDC Design to Prevent Fiat Deposit Flight (Cointelegraph)
South Korea Ready to Test its CBDC with Commercial Banks (AJU)
Bank of England’s Vision for the Digital Pound Differs from China’s Model (Cryptoslate)
Banque de France Steps Up Wholesale CBDC Work (Finextra)

Thomas Murray Digital

Andrew Wright | Hugo Jack | Ben Ashley

Tel. +44 (0)20 8057 7100
Email: digital@thomasmurray.com
Web: thomasmurraydigital.com

Whilst reasonable care has been taken in the compilation of this information, neither Thomas Murray Network Management Limited, its affiliates or information contributors shall have any liability for any errors, omissions, delays or inadequacies in the information or for any loss or damage however occasioned (whether arising directly or indirectly), to any person or company relying on this information, or any decision made, action taken or inaction by any party in reliance upon this information (except to the extent permitted by law). Copyright © Thomas Murray Network Management Limited, company no. 03313014. All rights reserved. No reproduction without prior authorisation.

State of the Digital Asset Market, and Thomas Murray Digital at The Network Forum

Thomas Murray Digital Newsletter

Andrew Wright speaks at The Network Forum's 2022 Annual Meeting
TM Digital’s Andrew Wright speaks at The Network Forum’s 2022 Annual Meeting

For investors in digital assets, and cryptocurrencies in particular, the pain caused by the latest ‘crypto winter’ continues unabated. Although institutional investors have been engaged in the crypto market in large numbers since 2021 the digital asset sector is still reminiscent of the early days of the Internet, evidenced by ecosystem failures, the misallocation of capital, and poor investor protection. At the same time, financial institutions and FinTechs are continuing to invest and build new operational models and DLT-based infrastructure. Hugo Jack takes stock of what is happening in the crypto market today: where things are going wrong, but also the continuing positives driving the industry forward.

This newsletter comes out a week later than usual as Thomas Murray has been attending The Network Forum’s 2022 Annual Meeting. The Digital team was represented by Andrew Wright, who engaged in a lively debate with panellists from HSBC, Deutsche Bank, Euroclear and Digital Asset on DLT adoption in the financial services industry and the future of custody. Although it is relatively early days for institutional engagement with digital assets and their infrastructure, DLT has been deployed in some major applications for a few years already, with more projects – such as to replace the national clearing and settlement infrastructure for several major markets – in active development. The discussion centred on the speed at which digital forms of assets would become mainstream and the extent to which existing traditional securities may be converted to digital token form, if at all. Thomas Murray Digital’s house view is that it only requires a small pressure gradient, comprising convenience, transaction speed, enhanced functionality, and cost savings, to trigger a snowball effect in this tokenisation of existing assets. In the words of William Gibson, ‘The future is already here – it’s just not evenly distributed’; the example of SDX, Switzerland’s fully regulated end-to-end digital asset infrastructure, shows how the gap to a fully digital future can be bridged through the instantaneous tokenisation or conversion back into traditional form of securities, allowing the market to choose its preferred asset form at its own pace. Meanwhile, although members of the audience remained largely sceptical that digital assets would represent a majority of issuances any time soon, or ever, it seemed clear that the members of all three digital-themed panel discussions at the event accept DLT-based assets and infrastructure as an inevitability, given sufficient time.

Digital Asset Developments

      

      		Last week, Japan became the first country in the world to usher in comprehensive regulations governing stablecoins. Passed by the upper house, the bill takes aim at stablecoins and other fiat-pegged assets which in recent months have received significant attention from regulators globally amid concern for investor protection and financial stability. This comes on the back of the dramatic demise of Terra’s algorithmic stablecoin, UST, which collapsed in May, and the ongoing drama faced by lending platforms like Celsius which is currently facing solvency issues. The amendment to the Funds Settlement Law is expected to enter into force in 2023 and will limit the issuance of stablecoins to banks, licensed money transfer companies with custody capabilities, and trust companies. The law recognises stablecoins as electronic money and guarantees their redemption at face value to the Yen or other fiat currency of issue. In addition, a new licensing regime will apply for intermediaries including brokers and enhanced anti-money laundering provisions will be applied. This is a welcomed move by the industry as a group of 74 financial institutions is set to launch their own deposit-backed digital currency next year.
In a somewhat surprising move, Lithuania has pressed ahead and introduced its own crypto licensing regime, despite the European Union’s Markets in Crypto Assets Regulation (MiCA) being reportedly in the final stages of negotiation. The concern, articulated by the country’s vice minister of the Ministry of Finance, was that MiCA will take some time to come into effect, likely in 2024. In that time the industry will continue to go through immense changes, and yet it remains at the mercy of unscrupulous actors looking to game investors. The country has implemented these steps as an interim measure which the MiCA regime will supplant once ratified. That said, there is still much to cover in the pending European regulation, which for the most part does not yet cover how to govern non-fungible tokens (NFTs), decentralised finance (DeFi), and more systemically significant stablecoins proposed by the likes of Libra (later Diem and now purchased by Silvergate), which according to this article are likely to be rejected by EU member states due to their competition with the euro. The law will enter into force in Lithuania on November 1, 2022.
A copy of a U.S. draft bill entitled the Lummis-Gillibrand Responsible Financial Innovation Act has been leaked online and is making the rounds on social media. It reports to show that greater regulation is closing in on the digital asset ecosystem, with particular attention paid to Decentralised Finance (DeFi) and Decentralised Autonomous Organisations (DAOs) which are both soon to be subject to greater oversight. Within the 600 pages of the draft, investor protection appears to be the driving motivation. It proposes that crypto platforms or service providers, including DAOs that operate in the U.S., should be required to be legally registered in the country, although this would naturally compromise projects with anonymity at the core – such as the Bitcoin network itself. Encouragingly, the bill appears to offer long-awaited clarity on securities laws as they relate to tokens, DeFi and DAOs, offering an extended universe of tokens that would fall under the purview of the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) depending on their nature. Unsurprisingly, given the bill’s sponsors, the draft bill aims to limit the SEC’s remit to pure securities tokens due to what has been seen as an unhelpful and aggressive stance from the agency towards crypto, while the CFTC will oversee everything else including utility tokens, stablecoins and unbacked cryptocurrencies. The CFTC would be granted greater powers to police investor protection and anti-fraud/anti-manipulation issues, and would be funded from fees gathered from digital asset issuers. By that logic, man cryptocurrencies and stablecoins would be classed as commodities, while NFTs will be considered an entirely new asset class. The CFTC has already offered its working definition of securities tokens that will be under the SEC’s purview, stating that “if there is any debt, equity, profit revenue, or dividend of any variety, then it is now expressly not a digital asset commodity”. In light of the Terra debacle last month and the ongoing drama with crypto lender Celsius, investors will likely be pleased by one part of the draft bill which outlines the obligation of an exchange to return users’ funds rather than being able to liquidate them to cover operational losses. Some commentators have pointed out that the draft bill could increase the cost of compliance for these entities, which would most likely be passed on to the customers, however they may be willing to pay the price for increased protection.
 
In related news, the U.S. Treasury, in comments made by Deputy Secretary Wally Adeyemo, is taking actions to prevent the use of self-custody and unhosted crypto wallets. The argument presented by the Treasury is one that has been echoed by many policy makers globally as they grapple with the principle of anonymity against a rapidly evolving crypto financial ecosystem. Adeyemo argues that financial institutions need to be able to determine who they are dealing with, suggesting it is difficult to do so with unhosted wallets as they “are effectively just addresses on a blockchain”. Understandably, doing away with self-custodied wallets will increase the ease with which individuals can be identified as wallet providers are subject to KYC/AML rules, although it is accepted that there are numerous cryptographic techniques to prove one’s identity in a blockchain ecosystem that can still preserve anonymity. This policy, while intended to further mitigate money laundering and illegal activities, will likely impact heavily on decentralised finance models which are increasingly popular with digital asset businesses and some banking institutions. Counter to the above, the U.K. Treasury, in a response to its public consultation on Amendments to the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, Statutory Instrument 2022, has now backtracked on its intention to collect information on unhosted or private wallet data. Following feedback from industry, the Treasury suggests it does not make sense for every sender of funds to have to collect identification information of the beneficiary.

Acting on behalf of the recently hacked Lichtenstein-based digital asset exchange LCX, Lawyers Holland & Knight and Bluestone, P.C., achieved an historic first by issuing a temporary restraining order (TRO) via a non-fungible token (NFT). The token was sent to a hacker whose wallet addresses were discerned through blockchain tracking technology using algorithmic forensic analysis. The hacker managed to siphon approximately USD 8.0 million in digital assets from the exchange in January 2022. However, through coordinated court orders sought from the Supreme Court of New York and the courts of Liechtenstein, 500 eth and 1.3 million USDC have been frozen by Coinbase Europe and Centre Consortium, the operating entity of Circle, the issuer of the USDC stablecoin.

News Links

CFTC Sues Gemini Over ‘False Statements’ Relating Bitcoin Futures Plan (Finextra)
IRA Financial Trust to Sue Gemini Over $36M Crypto Assets Exploit Back in February (Cointelegraph)
New York Senate Votes for Bitcoin Mining Moratorium (Finextra)
SEC Investigates Binance Over ICO of BNB Token (Pymnts)
Bill to Ban Digital Assets as Payment Introduced in Russian Parliament (Cointelegraph)
Crypto Bank Custodia Sues Federal Reserve (CoinDesk)
The Republic of Serbia Securities Commission Approves Issuance of the First Digital Token (Republic of Serbia Securities Commission)
Britain Makes Crypto Technology a Priority for Streamlining Markets (Reuters)
Ugandan Central Bank U-turns on Crypto, Welcoming Firms to Regulatory Sandbox (Cointelegraph)
KBC launches Kate Coin (Finextra)
Indonesian Exchange Pintu Raises $113M to be ‘Coinbase of Southeast Asia’ (Decrypt)
Coinbase Extends Hiring Freeze, Rescinds Job Offers (Finextra)
FTX to Buy Canadian Crypto Player Bitvo (Finextra)
Goldman Sachs Begins Trading Ethereum-Linked Derivative Product (FinanceFeeds)
Russian Bank Sber to Complete its First Digital Currency Deal (Cointelegraph)
Central African Republic Announces Plan to Tokenize Country’s Minerals (The Block)
Two More Spot Crypto ETFs Launch on Australian Markets (Cointelegraph)
‘Bitcoin-Thematic’ ETF Lists on Italian Stock Exchange Borsa Italiana (Cointelegraph)
Osaka Digital Exchange Developing Secondary Market for Security Tokens (Osaka Digital Exchange)
Ripple and Stellar to Help Launch AUDC Stablecoin for Novatti Group (U.Today)
Tether Launches Stablecoin on Tezos to Unlock New DeFi Products (Decrypt)
Circle Launches Euro-Backed Stablecoin EUROC (Cointelegraph)
MoneyGram Launches Pioneering Global Crypto-to-Cash Service on the Stellar Network (PR Newswire)
UnionBank Raises ₱11B in PH’s First-Ever Digital Peso Bonds (CNN Philippines)
Deutsche Börse Introduces Comprehensive Crypto Data Feed (Finextra)
Bitcoin Uses 56 Times Less Energy Than Classical System (Cryptoslate)
BIS to Launch Market Intelligence Platform Amid Stablecoin, DeFi Collapse (Cointelegraph)
Key: Regulation             Technology            Ecosystem              Markets 

CBDC Corner

Bank of England Exec Says Digital Currencies Could Be ‘Important’ for Central Bank Balance Sheets (The Block)
No ‘Redline’ Argument Against CBDC, Says BoE Official (Beincrypto)
Bank of Russia Steps Up Efforts to Issue Digital Ruble Due to Sanctions (Bitcoin.com)
Bank of Ghana Tests CBDC Integration with Mobile Money Providers (The Papers)
Bank of Thailand Postpones CBDC Pilot (CoinDesk)
Digital Real Will Be Used by Banks in Brazil as Collateral to Issue Their Own Stablecoins (Bitcoin.com)
CBN to Introduce USSD Code to Improve eNaira (Premium Times)
Oman is Currently Working on its First Digital Currency (Beincrypto)
Central Bank Preparing Concept of Digital Manat (Azer News)
Philippines, Vietnam conducting CBDC Feasibility Studies with Soramitsu
Bank of Israel Investigates Anonymous Digital Shekel Payments (Finextra)

Thomas Murray Digital

Andrew Wright | Hugo Jack | Ben Ashley

Tel. +44 (0)20 8057 7100
Email: digital@thomasmurray.com
Web: thomasmurraydigital.com

Whilst reasonable care has been taken in the compilation of this information, neither Thomas Murray Network Management Limited, its affiliates or information contributors shall have any liability for any errors, omissions, delays or inadequacies in the information or for any loss or damage however occasioned (whether arising directly or indirectly), to any person or company relying on this information, or any decision made, action taken or inaction by any party in reliance upon this information (except to the extent permitted by law). Copyright © Thomas Murray Network Management Limited, company no. 03313014. All rights reserved. No reproduction without prior authorisation.

TerraUSD Fallout – Debating the Future of Stablecoins and CBDCs

Tether USD token

Thomas Murray Digital Newsletter

Following the recent failure of the TerraUSD algorithmic stablecoin, the fallout affecting the cryptocurrency markets and the policy questions that the incident raises have continued to dominate discussions. At issue are what – if any – role privately-operated stablecoins may have in the future of wholesale and cross-border settlements, the parameters and priority of stablecoin regulation, and the degree to which Central Bank Digital Currencies (CBDCs) – previously viewed by some major economies as more relevant to retail applications – could assume wholesale roles. We summarise those discussions and evaluate some of the other winners and losers in the stablecoin market.

Digital Asset Developments

      

      		Following the publication of the US Securities and Exchange Commission Staff Accounting Bulletin (SAB) 121 – which prompted Coinbase to present client assets as a liability on its balance sheet – the US government will reportedly urge Congress to legislate that crypto service providers segregate client and corporate funds. Coinbase’s disclosure that customers’ assets may potentially form part of any bankruptcy estate, and that the customers may be treated as general unsecured creditors, caused a stir within the crypto industry as the implication was that if Coinbase were to go bankrupt, many of the assets it holds for customers may go with it. Despite this move to mandate segregation of client funds  from proprietary funds, the government still believes providers should be able to pool customers’ assets, allowing them to internally manage trades instead of processing each individual trade on the blockchain.
The European Central Bank (ECB) says that the increasing interconnectedness between cryptoassets and traditional markets means that contagion from cryptoassets pose a considerable risk to financial stability. The report, published as part of the central bank’s biannual financial stability review, warned that “cryptoasset markets currently show all the signs of an emerging financial stability risk.” Although such contagion has so far remained sufficiently small to prevent any financial stability risks being incurred, the ECB is eager to highlight that a point will soon be reached where this is no longer the case. The central bank advocates for regulators to monitor developments, stating that “any further steps that allow the traditional financial sector to increase its interconnectedness with the crypto-asset market space should be carefully weighed up, and priority should be given to avoiding financial stability risks.” The report consequently argues that to prevent such risks it is paramount for regulatory measures to be globally coordinated: “The challenges faced in monitoring financial stability risks from cryptoasset developments and interconnectedness with the traditional financial sector will persist as long as there are no standardised reporting or disclosure requirements.”
JP Morgan has reportedly been trialling the use of its own private blockchain for collateral settlement, conducting a pilot transaction involving the transfer of tokenised BlackRock money market fund shares.  The investment bank, which founded Onyx Digital Assets (ODA) in 2020, has long been an advocate for the use of blockchain technology, despite its more recent Damascene conversion on the value of cryptocurrencies. ODA is described as a “blockchain-based network that enables the processing, recording and Delivery-versus-Payment (DVP) exchange of digital assets across asset classes.” BNP Paribas recently completed its first trade on the ODA platform, becoming the first European bank to join the network. JP Morgan is also involved in the Monetary Authority of Singapore’s Project Guardian, a tokenisation pilot for DeFi transactions involving borrowing and lending on a public blockchain, while the investment bank participated in the USD 60 million Series C fundraising round for blockchain analytics firm Elliptic, and recently evaluated bitcoin’s fair price at USD 38,000 while declaring crypto to be its preferred alternative asset in a note issued to clients.

News Links

Basel Committee to Issue Second Consultation on Crypto (The Block)
Regulate Ledgers and Not Individual Crypto Providers, BIS Study Says (CoinDesk)
Financial Regulator Cautions UK Against Rushing to Create ‘Crypto Hub’ (Financial Times)
Portugal’s Parliament Rejects Crypto Tax Proposals Amidst Budget Negotiations (The Block)
German BaFin Official Calls for ‘Innovative’ EU-Wide DeFi Regulation (Cointelegraph)
Russian Finance Ministry Calls on Crypto for International Settlements (Beincrypto)
Russian Central Bank Signals Agreement with Crypto Law Revisions: Report (Cointelegraph)
Paraguayan Bill Regulating Crypto Mining and Trading Moves Closer to Law (CoinDesk)
Thailand Excludes Crypto Transfers from VAT Payments Until 2024 (The Block)
South Korean Legislature Considering New Licensing System for Crypto (Cointelegraph)
Korean Police Move to Freeze Luna Foundation Guard Assets: Report (CoinDesk)
OCC’s Hsu Reiterates “Careful and Cautious” Approach after Terra Collapse (The Block)
US Senators Lummis and Gillibrand Set to Propose Crypto Oversight Bill Next Month (CoinDesk)
Draft Bill to Ban China’s Digital Yuan from US App Stores (Cointelegraph)
CFTC Roundtable on FTX Proposal Highlights Barriers in Clearing of Digital vs Physical Assets (The Block)
Central African Republic to Launch Bitcoin, Crypto Hub (Bitcoin Magazine)
Binance to Advise on Crypto Strategy as Kazakhstan Looks to Boost Industry (CoinDesk)
CBA Presses Pause on Crypto Pilot (Finextra)
China’s State-Backed BSN Pushes New Public Blockchain Network Unlinked to Cryptocurrencies for International Markets (South China Morning Post)
Investment Platform Achieves World-First with Asset Management Recorded on Blockchain (Cointelegraph)
Online Broker FlatexDegiro Moves into Crypto with Boerse Stuttgart (Finextra)
Swiss Asset Manager Julius Baer Eyes Crypto and DeFi Potential (Cointelegraph)
SBI Invests in Digital Asset for ‘Smart Yen’ Joint Venture Project (Finextra)
Protego Trust Bank Targets $2 Billion Valuation After Quietly Raising $70 Million (The Block)
Digital Securities Platform ADDX Raises $58 Million (The Block)
Tether Launches Stablecoin Pegged to Pesos on Ethereum, Tron and Polygon (Cointelegraph)
US SEC Rejects One River Spot Bitcoin ETF Application (Blockchain News)
ARK and 21Shares Make Another Attempt at a Bitcoin ETF Approval (The Block)
Terra to Restart Luna Blockchain, Abandon UST Stablecoin (Pymnts)
ISDA: Crypto-Asset Risks and Hedging Analysis (Markets Media)
Ethereum Liquidations Top $157M After Merge Upgrade Test Hits Snag (Decrypt)
Crypto Funds Under Management Drop to a Low Not Seen Since July 2021 (Cointelegraph)
Key: Regulation             Technology            Ecosystem              Markets 

CBDC Corner

As discussed in this week’s article, G7 Finance Ministers and Central Bank Governors have issued a statement that highlights the opportunities and implications of CBDCs and their potential role in future payment transactions. The statement encourages “jurisdictions exploring CBDCs to examine the international dimensions of CBDCs, in particular their cross-border use. CBDCs with cross-border functionality may have the potential to spur innovation and open up new ways to meet users’ demand for more efficient international payments, but continued international cooperation will be important to understanding and minimising any negative spillovers to the international monetary and financial system.”
Bank of Japan CBDC Experiments: Results and Findings from PoC Phase 1 (Bank of Japan)
ECB’s Lagarde Says While Crypto Has No Worth, She Would Back Digital Euro: Politico (The Block)
IMF, Bank of France Officials Believe More CBCDs Will Emerge in Next Three to Five Years (The Block)
Fed’s Brainard Sees Case for Central Bank Digital Currency (Reuters)
US Fed Vice Chair Says Digital Dollar Would Take 5 Years to Launch (CoinDesk)
Fed’s Vice Chair Tells Banks: Digital Dollar Won’t Cut You Out (Pymnts)
Nahmii Selected to Build Norges Bank CBDC Sandbox (Norges Bank)
Mercado Bitcoin Partners with Stellar to Create MVP for Brazilian CBDC (Cointelegraph)
SWIFT in Cross Border CBDC Interoperability Trial with Cap Gemini (Ledger Insights)
Circle Tells Federal Reserve a CBDC ‘Could Destabilize’ Banking (Pymnts)

Thomas Murray Digital

Andrew Wright | Hugo Jack | Ben Ashley

Tel. +44 (0)20 8057 7100
Email: digital@thomasmurray.com
Web: thomasmurraydigital.com

Whilst reasonable care has been taken in the compilation of this information, neither Thomas Murray Network Management Limited, its affiliates or information contributors shall have any liability for any errors, omissions, delays or inadequacies in the information or for any loss or damage however occasioned (whether arising directly or indirectly), to any person or company relying on this information, or any decision made, action taken or inaction by any party in reliance upon this information (except to the extent permitted by law). Copyright © Thomas Murray Network Management Limited, company no. 03313014. All rights reserved. No reproduction without prior authorisation.

TerraUSD Fallout – Debating the Future of Stablecoins and CBDCs

Tether USD token

Thomas Murray Digital team

Tether USD token
Photo by DrawKit Illustrations on Unsplash

Following the recent failure of the TerraUSD algorithmic stablecoin, the fallout affecting the cryptocurrency markets and the policy questions that the incident raises have continued to dominate discussions. At issue are what – if any – role privately-operated stablecoins may have in the future of wholesale and cross-border settlements, the parameters and priority of stablecoin regulation, and the degree to which Central Bank Digital Currencies (CBDCs) – previously viewed by some major economies as more relevant to retail applications – could assume wholesale roles.

Finance ministers from the G7 group of nations meeting in Germany this month with representatives from the International Monetary Fund, World Bank Group, Organisation for Economic Cooperation and Development, and the Financial Stability Board discussed the potential role that CBDCs could play in realising greater efficiencies, in the context of the G20 Roadmap for enhancing cross-border payments. They highlighted the potential international uses of CBDCs and the need to minimise negative effects on the international monetary system by introducing consistent and comprehensive regulation of digital asset issuers and service providers. They noted in particular the need to achieve widespread compliance with the Financial Action Task Force’s ‘travel rule’ and the need for greater reporting requirements of the assets backing stablecoins.

Policymakers at the Bank of England have previously been open about their view that any so-called ‘Britcoin’ would not be a priority for wholesale settlement, given the introduction in 2021 of omnibus accounts permitting regulated entities to commingle tokenised money in order to settle among themselves. The Bank’s governors also cited the ability of the private sector to manage such settlements, which have fewer complexities and policy implications than retail CBDC usage, without government involvement. However, the UK Treasury has this week published a consultation paper titled Managing the failure of systemic digital settlement asset (including stablecoin) firms that proposes that the Bank of England be designated as the regulator of stablecoins, giving it the power to appoint administrators should so-called Digital Settlement Assets encounter difficulties. Similarly, the Financial Conduct Authority would bring stablecoin activity under its existing electronic money and payments regulatory regime.

In South Korea, the government has reacted to Terra’s collapse – believed to have affected 280,000 Koreans – by proposing a new digital assets committee to oversee the imposition on the industry of investor protections equivalent to those for securities, uniting a currently fragmented regulatory environment under one roof.

The US and Japan commenced preparations for the regulation of stablecoin issuers last year. In November, the President’s Working Group on Financial Markets coordinated a report on stablecoins that proposed that issuers should be treated like banks. And in December, Japan’s Financial Services Agency proposed legislation to limit the number of stablecoin issuers by restricting their issuance to banks and wire transfer companies, positing that this would increase trust in them and help to avoid runs that could crash their value and potentially destabilise the wider financial markets.

While TerraUSD – a bold and unusual ‘algorithmic’ (rather than fully asset-backed) stablecoin – may not have enjoyed widespread institutional use, its collapse has put a sharp focus on its more traditionally structured erstwhile competitors.

The long-running controversy over Tether (USDT), the first and largest stablecoin, continues as the company behind it has still not produced an audited set of financial disclosures, despite past promises, to offer assurance that it has adequate asset backing for the USD-pegged tokens it has issued. Its CTO, Paolo Ardoini, has hinted at a reluctance to publish full details of the constitution of Tether’s reserves, or of its counterparties, calling the information its ‘secret sauce’. Senator Elizabeth Warren has called this lack of transparency a ‘gigantic red flag’. Tether’s accountant, MHA Cayman, introduced new language in its latest attestation report dated 18 May, covering Tether’s Consolidated Reserves Report as at 31 March, stating that there is significant uncertainty regarding the value of large parts of the reserves – for example, during a run on its tokens – and Tether’s exposure to risk resulting from potential issues with its unnamed custodians and counterparties:

“The valuation of the assets of the Group have been based upon normal trading conditions and do not reflect an unexpected large-scale sale of assets, or the case of any key custodians or counterparties defaulting or experiencing substantial illiquidity, which may result in materially different or delayed realisable values. No provision for expected credit losses was identified by management at the financial reporting date.”

MHA Cayman also states that Tether’s management makes no provision for the potential costs of two legal cases that it is currently defending nor for credit losses.

At the end of March, approximately 47% of the reserves were in less liquid and riskier forms such as digital tokens, commercial paper, corporate bonds, and money market funds. Just under 5% of its reserves were held as cash.

By contrast, Tether’s younger rival Circle – issuer of the USD Coin (USDC) stablecoin – is making hay from Tether’s misfortunes. Its CFO Jeremy Allaire published a blog post provocatively titled How to Be Stable asserting that USDC’s reserves are held entirely in cash and US Treasuries with maturities of 3 months or less, and that those assets are custodied by Bank of New York Mellon, US Bank and BlackRock. It has also recently stepped up publication of the full breakdown of its reserves from a monthly cadence to weekly, with monthly attestation reports from accountants Grant Thornton continuing.

 
USDT chart May 2022
Tether’s USDT market capitalisation, May 2022 (CoinMarketCap)
USDC chart May 2022
Circle’s USDC market capitalisation, May 2022 (CoinMarketCap)
 

As of writing, the market capitalisation of Tether’s USDT has fallen by approximately USD 11 billion since 7 May (when TerraUSD first showed signs of instability) while that of Circle’s USDC has risen by about USD 5.5 billion over the same period.

Cryptocurrency Market Crash, and SEC Moves Crypto Assets Under Custody Onto Balance Sheets

Coinbase logo on laptop

Thomas Murray Digital Newsletter

The past week saw another crash in the value of cryptocurrencies; bitcoin fell to USD 24,000, its lowest value since December 2020. Although bitcoin’s price has been slowly falling since the end of the last year – reflecting the current macroeconomic climate of increasing inflation and interest rates facilitating a risk-off environment – this latest capitulation was a result of the TerraUSD (UST) stablecoin catastrophically losing parity with its dollar peg and the fallout thereafter. Ben Ashley assesses the root causes of the incident and the impact on cryptocurrencies and stablecoins.

While causing fewer headlines, but perhaps of more significance to would-be digital asset custodians, the SEC has prompted Coinbase to disclose in its latest quarterly financial filing that customers’ assets may potentially form part of any bankruptcy estate, and that the customers may be treated as general unsecured creditors. It remains unclear whether this assessment stems from the way in which Coinbase structures its custody arrangements legally or more broadly reflects legal uncertainty surrounding liability for crypto assets given the lack of a clear legal, regulatory and accounting policy environment. In any case, the SEC appears to expect that customer crypto assets should appear on custodians’ balance sheets. Andrew Wright explores the SEC’s move and the reaction from policymakers to it.

Digital Asset Developments

      

      		The California state governor has signed an executive order for blockchain and Web 3.0 companies. The aim of the order is to integrate federal and state approaches to provide a regulatory environment that is clear, transparent, and easy to navigate. The order has seven key priorities – mainly focused on crypto assets and related technologies – and is designed to stimulate innovation while simultaneously protecting investors. The Governor commented that the state is aiming to get ahead of the curve in order to harness the potential of the technology. Further benefits the order cites are the ability to deploy blockchain technology for state and public institutions, and the construction of research and workforce development pathways.
A New York state assembly committee has advanced a bill blocking any new proof-of-work (PoW) mining facilities that use non-renewable energy. The bill, which would impose a two-year moratorium, will now go to a full vote of the legislative body. Although existing facilities will not be affected, a provision within the bill would ban permit renewals for carbon-based electric generating facilities if the renewal applicant supplies PoW mining facilities and seeks to grow their operation. On top of this, the bill calls for PoW miners to be subject to a full generic environmental impact statement review that evaluates their mining facilities within the state. The move is similar to efforts made by the European Parliament to introduce a provision to the Markets in Crypto Assets (MiCA) Regulation regarding the acceptability of PoW blockchains on environmental grounds. A controversial amendment had been added to the draft bill that would have limited PoW blockchains, but was subsequently removed due to fears that it could be interpreted as a de facto ban on bitcoin.

Following the news that Argentina’s two largest private banks will allow their customers to make crypto purchases, the Central Bank of the Argentine Republic has released a statement discouraging the supply of crypto assets through the financial system. The central bank cited the need to mitigate risks crypto assets pose to users of financial services and the financial system as a whole.

The Australian Securities Exchange (ASX) has confirmed further delays to its new blockchain-based post-trade platform. The project, which has already been delayed twice before, is designed to replace the existing CHESS post-trade settlement system with a new blockchain-based platform. The CHESS system has been running for more than 25 years and the project to replace a core, legacy platform with a new blockchain-based alternative has understandably garnered a lot of attention. Features of the new platform include instant settlement or non-batch bilateral delivery versus payment, as well as the potential for corporate actions such as dividend reinvestment plans and bonus share plans – although this has received some pushback regarding antitrust complaints against ASX. ASX has now confirmed the April 2023 go-live date is no longer achievable, citing application software delays from provider Digital Asset preventing ASX and CHESS users from completing the required testing.

News Links

New York Regulator Tells Crypto Firms to Use Blockchain Analytics (Finextra)
UK Treasury En Route to Legalizing Stablecoins Amid Terra’s UST Crash (Cointelegraph)
UK Court Recognizes NFTs as ‘Private Property’ — What Now? (Cointelegraph)
ECB’s Panetta Calls for Urgent Action to Curb Crypto Wild West (Finextra)
Portugal Considering Capital Gains Tax for Cryptocurrency (The Block)
Nigeria’s SEC Affirms All Digital Assets Are Securities in New Rulebook (CoinDesk)
Leaked Report: South Korea to Establish Crypto Framework by 2024 (Cointelegraph)
SEC Nearly Doubles Size of Enforcement’s Crypto Assets and Cyber Unit (SEC)
U.S. Treasury Issues First-Ever Sanctions on a Virtual Currency Mixer, Targets DPRK Cyber Threats (US Treasury)
Central African Republic Adopts Bitcoin as an Official Currency (Reuters)
Panama’s Legislature Approves Bill Regulating Crypto (Cointelegraph)
Cuban Central Bank Makes It Official: VASP Licensing Coming in May (Cointelegraph)
Uzbekistan President Issues Decree Regulating Cryptocurrencies, Mining and Trading (Bitcoin.com)
AIMA Releases Digital Asset Custody Guide (AIMA)
Latin America’s Largest Digital Bank Will Allocate 1% to BTC, Offer Crypto Investment Services (Cointelegraph)
LGT Bank Selects SEBA Bank to Provide Digital Asset Custody and Brokerage Services (SEBA)
BlackRock Launches Blockchain Industry ETF, Names Crypto as 1 of 3 Big Opportunities (Cointelegraph)
Goldman Offers Its First Bitcoin-Backed Loan in Crypto Push (Bloomberg)
Fidelity to Allow Clients to Invest in Bitcoin Through Their 401(k) Accounts (The Block)
Japan’s Largest Investment Bank Nomura Readies New Crypto Subsidiary (Cointelegraph)
Galaxy Digital Reports $112M Q1 Loss, Citing Crypto Price Volatility (Cointelegraph)
DeFi Investment Bank Ondo Raises $30m (Finextra)
Big Banks Invest in Institutional-Grade Crypto Trading Platform Talos (Finextra)
Barclays and Goldman Sachs Invest in Digital Asset Platform Elwood (Finextra)
Russia’s Central Bank Wants Stock Exchanges to Support Crypto Trading (Cryptopolitan)
Former regulators join $45 million round in crypto risk platform Solidus Labs (Finextra)
Grayscale Set to Roll Out First European ETF (The Block)
First crypto ETFs launch in Australia (Financial Times)
Samsung Asset to List Blockchain ETF on Hong Kong Exchange: Report (The Block)
Investment Management Firm VanEck Launches NFT Collection (The Block)
World’s First Combined Bitcoin, Gold Exchange-Traded Product Listed in Switzerland (CoinDesk)
Key: Regulation             Technology            Ecosystem              Markets 

CBDC Corner

Digital Euro Could Come as Soon As 2026 — ECB Official (Cointelegraph)
eNaira Upgrade: CBN to Include Bills Payment (Vanguard)
JAM-DEX Phased Rollout Underway (Bank of Jamaica)
The Bahamas’ ‘Sand Dollar’ Needs Improved Cybersecurity, IMF Says (CoinDesk)
The Philippines Will Launch Pilot Wholesale Central Bank Digital Currency Project (Cointelegraph)
Argentine Central Bank Explores Central Bank Digital Currency (The Central Bank of the Argentine Republic)
Bank of Israel Still Unsure on Digital Shekel but Garners Public Support (Reuters)
Chilean Digital Peso Would Need to Work Offline, Central Bank Governor Says (CoinDesk)
Wary of Crypto, Tanzania Shifts Closer to Own Digital Currency (Bloomberg)

Thomas Murray Digital

Andrew Wright | Hugo Jack | Ben Ashley

Tel. +44 (0)20 8057 7100
Email: digital@thomasmurray.com
Web: thomasmurraydigital.com

Whilst reasonable care has been taken in the compilation of this information, neither Thomas Murray Network Management Limited, its affiliates or information contributors shall have any liability for any errors, omissions, delays or inadequacies in the information or for any loss or damage however occasioned (whether arising directly or indirectly), to any person or company relying on this information, or any decision made, action taken or inaction by any party in reliance upon this information (except to the extent permitted by law). Copyright © Thomas Murray Network Management Limited, company no. 03313014. All rights reserved. No reproduction without prior authorisation.

SEC Prompts Crypto Custodians to Move Client Assets On-Balance Sheet

Coinbase logo on laptop

Andrew Wright

Coinbase logo on laptop
Photo by PiggyBank on Unsplash

Coinbase, one of the world’s largest crypto custodians, has disclosed that “in the event of bankruptcy, crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings.” The admission was part of a quarterly earnings report the company filed with the US Securities and Exchange Commission (SEC). Coinbase CEO Brian Armstrong revealed that this was because of the recent publication of SEC Staff Accounting Bulletin (SAB) 121 which requires any crypto asset custodian to ‘present a liability on its balance sheet to reflect its obligation to safe-guard the crypto-assets held for its platform users.’ The SEC expects such disclosures to be made by all businesses that ‘custody’ crypto assets no later than in financial statements covering the first interim or annual period after 15 June, so we will potentially see a wave of similar disclosures in the near future.

Coinbase’s declaration that customers’ assets may potentially form part of any bankruptcy estate, and that the customers may be treated as general unsecured creditors, has caused a stir within the crypto industry. Were Coinbase to go bankrupt, the implication is that many of the assets it holds for customers may go with it. Coinbase Custody, which has a New York state banking licence, points out that it has never had a security incident in over 7 years of operations. However, customers choosing from competing custody services will want the absolute minimum risk in exchange for their fees.

Coinbase’s custody business is standalone from the rest of the group and only provides cold storage, so it could rapidly end up being obsoleted and out-competed by traditional, larger bank custodians. This is a view shared by Nadine Chakar, the head of State Street Digital, as expressed at a recent Fund Forum panel discussion. Global Custodian reports Chakar as commenting, “unless you have larger custodians moving into the space and be the big kids at the table, it’s (digital assets) unlikely to see institutional adoption”. She called for more regulation to provide clarity.

SAB 121, published on 31 March, expresses the views of SEC staff but is not a formal rule. Despite this, it is very prescriptive regarding the detail and format of disclosure it expects to see. The financial statement impact is as simple – and dramatic – as moving the value of assets under custody onto the service provider’s balance sheet through a liability and matching asset at the fair value of those assets at the time of each filing (broken down into each significant crypto asset in notes to the accounts). The suggestion is that this should take place regardless of the entity’s assessment of the actual “legal ownership of the crypto-assets held for platform users, including whether they would be available to satisfy general creditor claims in the event of a bankruptcy”. As such, it would mark a sharp divergence in practice compared to the accounting treatment for assets under custody in traditional asset classes. Further, there should be a detailed discussion of the technological and legal risks and uncertainties facing the business in relation to safekeeping digital assets in other areas of filings outside the financial statements.

Coinbase’s lawyers will doubtless have considered the potential impact of this disclosure but, due to the lack of clear legislation and regulation cited by Chakar, and a desire to be seen as compliant with SEC expectations, have concluded that they should acknowledge that clients’ custodied assets “could be subject to bankruptcy proceedings”. It remains to be seen whether other crypto custodians will fall into line given the arguably optional nature of this guidance, pending the debate it is causing being worked through to a conclusion.

The new guidance overrides the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification 940, which states that broker-dealers holding client assets should keep them off-balance sheet – although the SEC is not yet licensing broker-dealers for crypto activity – and that otherwise custodians should assess whether they have a sufficient degree of control over those assets, as they would with traditional assets under custody. In other words, the FASB treats this as a judgment-based decision that may hinge on aspects such as the degree of customer control of their own assets through measures such as key sharing.

One of the five Commissioners of the SEC, Hester Peirce (a Trump appointee) has responded to the bulletin. Her view is that the SEC and the market have been aware of risks for a long time and already review custodians’ financial statements; that an interpretive Staff Accounting Bulletin is not the appropriate place to make rule changes; and that the SEC has itself been partially responsible for creating the legal and regulatory risks that have driven this accounting treatment by failing to provide adequate guidance on crypto assets. She also believes that some consultation with the FASB and with affected companies would have been helpful.

These are fair points, if politically motivated; the end result may be worthy, but Peirce is far from alone in denouncing the SEC’s methods. Around the same time, on 16 March, members of Congress from both parties wrote to Chair Gensler to criticise the SEC’s behaviour relating to crypto businesses, pointing out that its many requests for voluntary disclosures outside its remit amount to a jurisdictional land-grab by stealth, and also set it up in competition with the CFTC in some areas. These requests are accompanied by enforcement actions and fines despite clear guidance from the SEC; a reluctance to license broker-dealers and to authorise crypto-backed ETFs; and a determination that interest-bearing lending products are unlicensed securities. President Biden’s recent Executive Order may effect a change in attitude, particularly as one of its main goals is to ensure that the US is a competitive and attractive market for digital assets and related technologies.