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

Thomas Murray Digital Newsletter

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

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.

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.

Digital Custody Partnerships Abound Despite the Crypto Bear Market

Thomas Murray Digital Newsletter

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)

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: ‘Crypto Winter’ and Silver Linings

Hugo Jack

For investors in digital assets, and cryptocurrencies in particular, the last couple of months have been something of a nightmare. Ongoing macro and geopolitical pressures have continued to hit the digital asset ecosystem as investors – both retail and professional – have continued to exit the market as uncertainty around the regulatory and fiscal environment remains. While 2021 was officially the year in which institutional investors entered crypto in significant numbers, it is fair to say that 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.

That said, while a much-needed shakeout (mostly of irresponsible leverage trading) is taking place, a digital asset future is still very much on the cards. Just as the tech bubble in 2001 paved the way for the Internet success stories of today, now global banks, financial institutions and FinTechs are continuing to invest and build new operational models and DLT-based infrastructure. The scope for this new environment is not just cryptocurrencies, which constitute a meaningful but relatively small asset class, but all financial instruments including equities, bonds, funds and alternative assets that will in time all likely run on blockchain rails. That said, as cryptocurrencies currently comprise the largest part of today’s real use cases for digital assets, it is worth taking a look at what is happening today: where things are going wrong, but also the continuing positives driving the industry forward.

Digital assets continue to dive amid macro uncertainty and ecosystem failures

In the past couple of weeks the cryptocurrency sell-off has continued as bitcoin crashed to its lowest level in two years. The period from May to June has seen one of the largest month-on-month declines with over USD 416 billion wiped from the total market capitalisation, which now sits at USD 933.0 billion. Considered a key line of support, bitcoin crossed its 200-week moving average (200W MA) last week, which has reportedly only occurred three times in its 13-year history. Historically, this has usually correlated with a market bottom. That said, central bank tightening is likely applying greater pressure to markets globally, which in crypto is compounded by miners of bitcoin needing to sell their BTC rewards to cover their operational costs which currently stand at approximately USD 20,000 per bitcoin. Consequently, there may still be some way to go before any sign of a true turnaround can be found.

The crypto markets are still reeling from the collapse of the Terra/Luna ecosystem in May, which impacted tens of thousands of investors globally including a well-known Dubai-based crypto focused hedge fund, Three Arrows Capital (3AC). It was quickly reported that 3AC was facing insolvency after incurring at least $400 million in liquidations. It failed to meet margin calls and is now considering multiple options including an asset sale, or a bail out by another firm. Celsius, a crypto lending platform which at one point claimed more than USD 20 billion in assets under administration, has come under pressure by investors in an old-fashioned “bank run”, with depositors scrambling to pull assets from the platform. On Monday 13 June Celsius released a community memo announcing its decision to pause all withdrawals, swaps and transfers between accounts, an option which it reserved under its terms of use. According to reports, Celsius is similarly in the process of considering insolvency proceedings and has appointed a legal firm that specialises in business restructuring, as well as hiring Citigroup as an independent advisor to brainstorm possible financing options. Nexo, another lending platform, put forward an unsolicited offer to acquire “any remaining qualifying assets”, although following a swift initial rejection it is unlikely the offer will be accepted.

It is unclear where the market goes from here. A significant amount of speculative capital has been put into the crypto ecosystem over the last couple of years during a period of exceptionally loose monetary policy and government stimulus; however, a flight to safety is now well underway across all asset classes. In addition, well established and high profile firms have put their reputations on the line and acquired significant amounts of bitcoin; the poster child for this tactic is MicroStrategy (Nasdaq: MSTR) which has 130,000 bitcoin, acquired at a cost of circa USD 3.97 billion, on its balance sheet, bought with cash from sequential debt offerings totalling nearly USD 2.4 billion. As a significant holder of bitcoin, all eyes are on the institution which at current prices is facing an unrealised loss of over USD 1 billion. In May it was reported that if bitcoin fell to USD 21,000 then a margin call would be triggered on a USD 205 million loan it took with Silvergate Bank in March to purchase additional bitcoin. That number was reached last week and has in the following thereafter gone as low as USD 17,744 as of Saturday 17 June. There is an inevitable concern that further liquidations would panic the market even further, however, MicroStrategy CEO Michael Saylor confirmed last week that a margin call had not been made, and that the company has reserves to protect against bitcoin dropping much lower.

Re-evaluation of business needs triggers firing and hiring

The bear market and general downturn is causing concern across the industry, as companies grapple with the implications of a looming recession and even stagflation. Financial considerations are being made a priority amidst declining revenues. Consequently, some digital asset institutions have announced reductions in head count. Coinbase (Nasdaq: COIN), one of the leading digital asset custodians and exchanges, announced cuts to staff of 18%, or approximately 1,100 staff, and furthermore rescinded 300 new hire offers. Gemini, an equally established exchange, expects to lay off 10% of its employees, while BlockFi and Crypto.com, more retail focused entities, will reduce headcount by 20% and 5% respectively, citing a “dramatic shift in macroeconomic conditions worldwide” which are impacting growth. However, at odds with the trend is Citibank, which this week announced its intention to hire 4,000 tech workers in a $10 billion effort to enhance online customer experience. It is joined by Binance and Kraken, two of the largest and most well-known cryptocurrency exchanges, which have similarly advertised their on-going efforts to recruit for 2,000 and 500 new positions respectively.

Longer-term sentiment remains positive as adoption increases

Despite the obvious pain that is being felt by the market during the latest crypto winter, sentiment around the future of the ecosystem and about cryptoassets remains positive. This week, Bank of America carried out a survey in which 91% of US adults said they plan to buy more cryptoassets over the course of the next six months, with 30% of respondents confirming their intention to hold their assets for at least the next six months despite the uncertainty. Echoing this sentiment, PwC’s Global Crypto Hedge Fund Report showed that allocations by crypto-focused and traditional hedge funds have increased over the past year, with 38% of traditional hedge funds currently investing in digital assets, up 21% from a year ago. Furthermore, 27% of the traditional funds that had not yet invested in digital assets reported that if the main barriers to adoption were removed they would accelerate their investments in them. Capgemini, a leading technology consulting firm, also released its 2022 World Wealth Report last week. Of the 2,973 global High Net Worth Individuals (HNWI) polled, 71% of them have allocated capital to cryptocurrencies and other digital assets. Furthermore, in assessing the demographic of respondents, 91% of under 40s have invested in digital assets, with Capgemini observing that cryptocurrencies remain their favourite digital asset investments for now. Even J.P. Morgan – whose chairman and CEO Jamie Dimon has been famously anti-bitcoin – has declared cryptocurrencies its new favourite alternative asset in preference to real estate, and has set a ‘fair value’ for bitcoin of USD 38,000, nearly twice its current price. And a joint PayPal and Deloitte survey of 2,000 senior U.S. retail executives found that nearly 85% of them expect digital currency payments to be ‘ubiquitous’ within the next five years.

Continued growth in institutional products and services

In other news, Goldman Sachs (GS) has launched a derivatives product linked to ether (ETH). The non-deliverable forward will enable investors to speculate on the price of ether without having to hold it directly. It comes at a time when investor confidence is low in the short term, however the firm reinforced its belief that digital assets are still desirable, stating that “institutional demand continues to grow significantly in this space”, with this offering helping the firm to evolve its nascent cash-settled cryptocurrency capabilities. And despite the reputation of stablecoins taking a knock of late, demand for them remains high as Circle Internet Financial – creator of the popular USDC dollar-pegged token – launches a new regulated euro-pegged stablecoin, EUROC, fully backed by euros held in custody by US qualified custodians.

Digital infrastructure for the repo market is also having a good month. BNP Paribas recently joined J.P. Morgan’s Onyx Digital Assets system, a tokenisation platform whose Intraday Repo application has processed over USD 300 billion of US treasury-based transactions in the year since it launched and is now looking to tokenise money market funds and other traditional securities as collateral. Meanwhile, Finteum’s DLT-based intraday FX swap and repo trading platform – due to go live next year – has been successfully tested by 14 banks, including Citi, NatWest and Barclays.

In Japan, the country’s two largest banks are making further moves in the digital asset space. Nomura – already one of the backers of custodian Komainu – will launch a new wholly-owned subsidiary to offer a range of digital asset services to institutional clients, with an unnamed executive quoted as saying, ‘If we don’t do this, then it’s going to be more difficult down the line to be competitive’. Meanwhile, Tokyo cryptocurrency exchange Bitbank has partnered with Sumitomo Mitsui Trust to create a new institutional digital asset custodian to be named Japan Digital Asset Trust. And the country has just become the first to pass legislation to limit yen stablecoin issuance to licensed institutions and guarantee their redemption back into fiat currency at par, a move that come into effect next year as a consortium of 74 Japanese banks and corporations moves to launch a private sector yen stablecoin.

Growing pains belie a maturing sector

The current market shake-up is inflicting short-term pain on investors, and the drying up of the previous flood of cheap capital that led to poor investment choices is now consigning thousands of weaker tokens and their associated projects to the scrap-heap. Investors are being reminded of the need to focus on utility and fundamentals over speculation. The last crypto market crash occurred in early 2018 when cryptocurrencies were the preserve of retail investors and the bravest of hedge funds, and institutional-grade services and infrastructure were not yet established. Four years later, the build-out of the foundations of the future financial system has got off to a strong start and continues apace. At the same time, regulation is beginning to catch up with the exuberant growth of this sector. We are witnessing the latest shift in a free market that should lead us to a more robust digital asset economy. Perhaps this moment will be seen in retrospect as an inflection point in the march towards a future financial system that encapsulates the best aspects of both stability and innovation.

	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. Following closely behind, top UK asset manager Abrdn has become the largest external investor in British FCA-regulated digital asset custodian Archax (Ledger Insights). Archax custodies security tokens and cryptocurrencies, and will launch an exchange later this year. The Abrdn-Archax partnership will also work to tokenise funds. Earlier this month, Charles Schwab launched its Schwab Crypto Thematic Index of companies that ‘may benefit from the development or utilization of cryptocurrencies and other digital assets’, and trading in the associated Schwab Crypto Thematic ETF began on NYSE Arca funds exchange (Charles Schwab Investment Management).
	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.