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.

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.

Algorithmic Stablecoin Failure Crashes Cryptocurrency Markets

LUNA USD price chart
LUNA USD price chart

Ben Ashley

LUNA USD price chart
Photo by Alex jiang on Unsplash

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.

UST, an algorithmic stablecoin, works in conjunction with the Terra blockchain to maintain a 1:1 peg with the US dollar via a set of on-chain mint and burn mechanics. In theory, these mechanics ensure that one dollar of UST can always be swapped for one dollar of LUNA, the Terra blockchain’s native token, by allowing traders to take advantage of arbitrage opportunities. However, on 8 May this mechanism began to fail, and the value of UST fell below USD 0.8 the following day. Although the price managed to recover to USD 0.94, 11 May saw the sticking plaster ripped off and the price falling below USD 0.3 as trader sentiment around the stablecoin dropped. At the time of writing UST is now trading below USD 0.1, over 90% down on its supposed peg.

This de-pegging resulted in a significant knock-on effect for the price of the LUNA token used to help maintain the peg. The token opened May with a price of USD 80, down from its early April all-time-high of USD 120. However, at the time of writing the token’s price is a measly USD 0.0002, meaning the price has fallen over 99% in little over a week. Before the rout, LUNA was a top ten crypto asset with a market capitalisation in excess of USD 30 billion, while UST was the third largest stablecoin with a market capitalisation of USD 18 billion. The combined market capitalisation of the two tokens is now around USD 2 billion, meaning investors have lost over USD 45 billion.

The after-effects have rippled throughout the crypto market. The price of bitcoin fell over 20% in the three days following UST’s de-pegging, triggered by sell-offs of 80,000 bitcoin from the reserves of the firm behind LUNA and TerraUSD and a loss in sentiment, while the total market capitalisation of all cryptocurrencies fell over 30%. This – together with bitcoin’s value more recently falling in step with technology equities rather than ploughing its own furrow – suggests that the ‘bitcoin as an inflation hedge’ narrative is now well and truly dead. This is the first time since its creation that the cryptocurrency market is experiencing rising inflation and interest rates, and it is currently performing as badly as equity markets.

Tether (USDT) – the largest stablecoin with a market capitalisation of over USD 70 billion – also lost its dollar peg for a time. USDT differs from UST as it is supposedly backed 100% by a combination of cash, commercial paper, fiduciary deposits, reserve repo notes and treasury bills. Tether fell to USD 0.95 as fear and uncertainty spread throughout the market. Although the price recovered, it did not stop investors from redeeming USD 7 billion worth of the token.

The collapse of TerraUSD and the brief de-pegging of Tether have seen an outpouring of calls for the introduction of stablecoin regulations, including from the US Secretary of the Treasury Janet Yellen. With the rapidly increasing size of the stablecoin market, it is now obvious that regulation is needed to protect investors and address the risks posed to financial stability. The stablecoin debacle could lead to central banks rethinking the use cases for CBDCs and imposing themselves on the wholesale settlement markets after all, rather than prioritising exclusively retail-oriented applications. Indeed, as the European Central Bank’s Fabio Pannetta states: “Recent developments in the market for crypto assets illustrate that it is an illusion to believe that private instruments can act as money when they cannot be converted at par into public money at all times.”