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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.

Basel Committee Lags the Market in Digital Asset Regulation

Vlad Totia

The Basel Committee on Banking Supervision has announced it is to revert and revisit a set of rules on
capital adequacy requirements for cryptoassets held by banks that were viewed as punitive, resulting in
substantial pushback from a coalition of trade associations and a wide range of other market participants.
The controversial proposals were for banks to reserve capital to cover the value of cryptocurrency holdings
in full. This requirement would equate cryptocurrencies to the very riskiest assets, including those for which
banks lack the information to calculate exposures.
The coalition argued that this capital requirement would make it economically unviable for banks to
participate in this market, and put them at a competitive disadvantage while hindering progress towards a
digital future for the financial services industry.
The BIS has overshot in its attempt to create a legal framework for the market and push institutional
adoption and use of digital assets. While there clearly is an argument for the responsible management of
an inherently volatile asset by financial institutions, the strong market resistance shows that there is a lot
more appetite for innovation in the private sector.
The market is running ahead of regulators in this regard, but approaches vary between those banks that
are pushing ahead with digital asset engagement – potentially building competitive advantage but exposing
themselves to risk as regulation catches up – and those that are holding back pending regulatory clarity.
The longer it will take to have a functioning framework, the more difficult it will be for the ecosystem to
develop robust common standards. With the BIS scheduling its next consultation for next summer, banks
and other market participants are now facing the prospect of another year’s delay.
The Committee will now reassess its proposals and has stated: “Members reiterated the importance of
developing a conservative risk-based global minimum standard to mitigate prospective risks from
cryptoassets to the banking system, consistent with the general principles set out in the consultative
document. Accordingly, the Committee will further specify a proposed prudential treatment, with a view to
issuing a further consultative document by mid-2022.”

UK and US Take Differing Stances in Assessing the Financial Stability Risks of Cryptocurrencies

Recent statements by representatives of the Bank of England, the President’s Working Group on Financial Markets, and the Financial Stability Board (FSB) suggest that consensus on the potential of cryptocurrencies to put the stability of financial systems at risk is diverging, at least in emphasis.

In the US, the President’s Working Group on Financial Markets, together with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, released a report in which it claims an urgent need to regulate stablecoins and the entities that issue them. The potential risks raised by the group include payment system disruption, concentration of economic power, and destabilising runs. This is the next in a series of attempts by the US to regulate systemically important parts of the digital asset industry, and this approach particularly highlights a focus on regulating the environment in which digital assets function, rather than regulating the assets themselves.

In contrast, in a speech at SIBOS, Bank of England deputy governor for financial stability Sir Jon Cunliffe stressed that, while the risks that cryptoassets pose to the financial system are now ‘relatively limited’, that assessment may change rapidly. This marks a shift in attention from addressing stablecoins as a first priority towards a broad-brush approach to the digital asset class as a whole. Cunliffe’s key point was that the USD 2.3 trillion market value of cryptocurrencies today may comprise a relatively small part of the total USD 250 trillion global financial system, but it could more than suffice to cause issues given the lesson of the USD 1.2 trillion sub-prime mortgage sector in 2008. Crypto technologies could offer ‘radical improvements in financial services’ but are already a concern. Cunliffe underlined the fact that policymakers around the world have only just begun to develop a framework appropriate for digital assets but they should pursue it ‘as a matter of urgency’.

Cunliffe’s comments were echoed by Bank of England Deputy Governor Sam Woods, Chief Executive Officer of the Prudential Regulation Authority, who stated a willingness to ‘front-run’ regulation – i.e. to lead global regulatory efforts rather than wait for a consensus to emerge – in order to prevent UK banks from accumulating over-large exposure to cryptoassets without supporting capital. Referring to recent Basel Committee proposals to apply a risk weighting of 1,250% in setting the capital backing for cryptocurrency holdings, translating into requiring capital at least equal in value to them and disregarding banks’ ability to hedge exposures. Woods said that UK rules may not exactly match the Basel Committee approach, but that they would be ‘very conservative’.

The announcement is another example of a change in attitude by an important public entity, as only 5 months ago BoE governor Andrew Bailey stated, ‘If consumers invest in these types of product [cryptocurrencies], they should be prepared to lose all their money.’

In marked contrast, the Financial Stability Board’s Patrick Armstrong presented a view at September’s Global Digital Finance Summit that cryptoassets – while on the radar and growing in value – are still too small to cause concern for global financial stability. His view is predicated on the asset class remaining relatively insignificant in proportion to total financial assets, real assets, and household wealth. The FSB acknowledges the risk that investor confidence in cryptoassets could be damaged through volatility, fraud, theft, or operational failures, but believes this is unlikely to affect overall stability. Use cases for cryptocurrencies remain niche, although monitoring is warranted due to a lack of the systemic safeguards built into fiat currencies and other assets.

Regulatory Change Sweeps Through the Digital Asset Universe

Bringing tokens into the regulatory fold

Amid concerns about potential mis-selling and a lack of proper investor protections, regulators are now looking to bring in new rules to oversee digital assets. Nonetheless, they are conscious that digital assets are a diverse asset class, meaning a one-size-fits-all approach towards their supervision is not appropriate. Many regulators have made clear that there are significant differences between tokens such as cryptocurrencies and so-called stablecoins (tokens pegged to traditional securities, assets or fiat currencies) versus those that behave like securities. In the case of security tokens – digital assets that confer similar rights to the governance, value and income from an underlying enterprise as do an equity or a bond – regulators have generally said that these will be subject to prevailing securities laws. Conversely, cryptocurrencies are generally considered to be unregulated assets thus far.

“The EU’s proposed Markets in Crypto-assets Regulation (MiCA) states that crypto-assets such as security tokens fall outside the regulation’s remit, although it notes that they must comply with existing rules including the Markets in Financial Instruments Directive II (MiFID II). Security tokens are also subject to similar requirements in the US and UK. However, the EU’s proposals go further as they will create a pilot regime for market infrastructures to facilitate the trading and settlement of regulated crypto-assets (i.e. security tokens) using distributed ledger technology. This is an ambitious move, which could help accelerate more institutional inflows into security tokens,” said Hugo Jack of Datm.

Emerging regulation of securities tokens will be the subject of the next article in this series; in this first part, we focus on the more common cryptocurrency and payments use cases of today.

A delicate balancing act for cryptocurrencies

While global regulators look to be adopting a broadly similar – if less well-advanced – approach towards overseeing security tokens, the same does not ring true for currently non-regulated digital assets, particularly cryptocurrencies and stablecoins. The EU’s proposed MiCA rules are perhaps the most developed, as they introduce stringent regulation (including disclosure and transparency requirements) covering the issuance and trading of such crypto-assets. In addition, the proposals also demand that all manner of crypto-asset service providers, issuers of asset-referenced tokens and issuers of electronic money tokens be fully licensed. Accordingly, this will subject providers – including digital asset custodians – to minimum disclosure requirements, new governance arrangements; prudential requirements, market integrity measures such as compliance with the Market Abuse Regulation, and additional rules on safekeeping clients’ funds and complaint handling procedures.

“By imposing regulation on previously lightly supervised crypto-asset providers, safety and confidence in the asset class will improve and institutional investors may become more comfortable trading in digital assets – at least within the EU,” noted Jack.

In the UK and US, digital assets such as cryptocurrencies will remain unregulated for the time being, although this could change in the future if these countries choose to follow the EU’s lead. Global bodies including the Basel Committee for Banking Supervision are already talking about imposing tough risk-weighted capital obligations on financial institutions holding cryptocurrencies, stressing that their volatility could be destabilising for banks. It has suggested that a risk weighting of 1,250% be applied to banks holding bitcoin, meaning a USD 100 investment in bitcoin would correspond to USD 1,250 of risk-weighted capital. This would make it prohibitively expensive for most banks to trade cryptocurrencies.

Elsewhere, the UK government and the US Federal Reserve have made clear that they are taking a closer interest in stablecoins. According to reports, both governments are prioritising regulation of stablecoins over cryptocurrencies, as they believe the former has the potential to play a significant role in cross-border payments as well as retail and wholesale transactions. The rationale is that the pegging of stablecoins’ value to an underlying stable asset, such as the US dollar or euro, makes them less prone to violent price fluctuations and more suited for payment use cases than volatile non-backed cryptocurrencies like bitcoin.

Despite compelling uses cases, some lawmakers are adopting an uncompromising position toward cryptocurrencies. Having already outlawed cryptocurrency exchanges and initial coin offerings (ICOs) in 2019, the Chinese authorities have since banned financial institutions and payment companies from providing services related to cryptocurrency transactions. Reuters notes that banks and payment companies in China cannot provide clients with any services involving cryptocurrencies, including registration, trading, clearing and settlement. This comes amid Chinese concern about the volatility of cryptocurrencies and, likely, a desire to keep hold of the reins of means of payment. Other leading markets – including India – also have a track record of hostility towards cryptocurrencies. A 2018 circular issued by the Reserve Bank of India (RBI) prohibited banks from facilitating cryptocurrency transactions, although this was recently struck down in a Supreme Court ruling, meaning financial firms can now participate in the market. With the lack of joined-up regulation across different countries, crypto-assets may struggle to acquire broader momentum.

Getting the standards in place

In order for digital assets to thrive, there need to be sensible and proportionate regulations that are broadly aligned in terms of their objectives. Hugo Jack comments, “As of now, there is a plethora of different approaches and requirements across markets that risks persisting for years unless consensus can be reached. Although regulations overseeing security tokens – where they exist – may largely replicate pre-existing securities laws, the rules governing other digital assets like stablecoins and cryptocurrencies are highly divergent and frequently contradictory. Investors of all sizes appear keen to explore this new asset class, but they must first have a clear picture of what activities are permitted and to whom. The present playing field is uneven and its boundaries poorly defined. Equally, if trading in digital assets is to increase, regulators clearly need to bring in heightened checks on digital asset service providers. This will be vital in preserving market security, integrity and confidence.”

Datm will next examine the implications that regulations will have for security tokens, and the impact this could have on markets and service providers.

Snapshot of Global Progress Towards Acceptance of Cryptocurrencies

Vlad Totia

Last week El Salvador officially adopted bitcoin as legal tender, thus becoming the first country in history to start using a purely digital and decentralised form of currency. Salvadorans can now pay taxes, take loans, and use bitcoin for the exact same purposes as they use the US Dollar, the country’s only other official currency.

The adoption of bitcoin as a national currency is a monumental milestone for digital assets. For now, the experiment raises more questions than answers, with concerns such as initial protests against the measure and the disrupted launch of the government-issued wallets. However, this is not the only significant change to happen in the regulatory landscape regarding cryptocurrencies. These past few months have been filled to the brim with regulatory changes in every corner of the world.

Another sizeable leap forward for digital assets has been the US Senate’s vote on the Infrastructure Bill and its definition of the ways in which cryptocurrencies can be taxed and reported. It shows that the US Government is moving on from a previously sceptical and even adversarial attitude. There is now a legislative package to shape a more predictable and regulated environment in which these assets and services can grow. Moreover, it has recognised cryptocurrencies as an asset class that should eventually have the same legitimacy as fiat currency.

While some countries are optimistic and friendly towards cryptocurrency acceptance, others have outright banned its use. It is likely that we will continue to see differing attitudes and approaches to the regulation of digital assets more broadly. However, while all eyes are on El Salvador and its leap into cryptocurrency adoption, it is worth taking a step back to look at the larger picture with regard to crypto regulation worldwide.

The opposers

Although governments are becoming more comfortable with digital assets, there remain some areas of the world that continue to treat them with varying degrees of scepticism. China cracked down on crypto-exchanges and miners in the country in July, contributing to the 20% drop that bitcoin experienced – part of a trend down to a level less than half its April peak value. This move was the latest and most significant in a series of periodic shake-ups of the sector, with the declared purpose of guarding against financial risk. Where exactly cryptocurrency regulation is heading in China remains to be seen, but the shorter-term impact is that the country’s dominance over the Bitcoin network and other blockchains by means of controlling mining or ‘hashing’ power is dropping rapidly. The miner exodus and an increase in mining in other regions of the world have caused the Chinese share of Bitcoin mining to drop 55% since the beginning of the year. These events have led to a more even share of blockchain responsibility and have potentially thereby strengthened network governance.

Turkey is another example of a country that does not look kindly on widespread use of cryptocurrencies as it has banned paying for goods and services with them. The central bank cited concerns such as anonymity, protecting existing payment systems (a further step beyond its long-standing ban on PayPal), illegal activity, and the potential for retail investors to lose money. The ban does not extend to the ownership or purchase of cryptocurrencies via a personal bank account, potentially leaving the door open for regulated investment use cases in the future. This has interesting implications for a population that has already demonstrated its keenness to hedge against high inflation and the devaluation of the Turkish lira.

Similarly to Turkey and China, India is another country that has considered banning digital assets in one form or another. The latest digital currency bill proposal is under review. The legislative package mostly targets how exchanges operate and what the regulatory landscape they fall under should look like. This potentially presages a ban on the ownership of private cryptocurrencies while paving the way for an official Indian central bank digital currency (CBDC).

While these countries may not be seriously considering an outright ban of blockchain technology or cryptocurrencies, these regions are likely to see significant regulatory restrictions on digital assets for a long time.

The cautious

Despite pushback from some countries, most are not opposed to blockchain adoption, and maintain a cautiously positive outlook on the emerging digital asset ecosystem. The European Union is actively interested in blockchain technology and has set up and funded a variety of initiatives to encourage its advancement while working on its proposed Markets in Crypto-assets Regulation, or MiCA. Arguably the most encouraging development is its own push for a CBDC, also referred to as the digital euro. The initiative was initially announced with a planned rollout in 2025, but the European Central Bank has expedited the timeline and launched a two-year investigation phase in July. It is encouraging that even a massively bureaucratic organisation such as the European Union senses the urgency in moving forward with digital money.

Despite the positives, the aforementioned US Infrastructure Bill passed by the Senate last month caused the cryptocurrency community concern. The bill’s most controversial elements see legislators taking a tough stance by potentially classifying most entities that are involved with cryptocurrency-related transactions – even tangentially – as ‘brokers’ that must be tightly regulated. While its intentions have not yet been clarified, the United States has clearly begun to catch up when it comes to defining its stance towards digital assets. This is a key precursor to the clear regulatory environment demanded by investors. As a whole, regions such as the United States and the European Union are approaching digital assets at a more methodical pace but are certainly not opposed to them.

The optimists

While only official legal tender in one country thus far, cryptocurrencies like bitcoin are slowly starting to be legalised and accepted as a payment method in various parts of the world. One of the most recent countries to authorise a slew of cryptocurrencies for merchant payments is Cuba. The resolution, which came into force on 15 September, regulates "the use of certain virtual assets in commercial transactions" in "operations related to financial, exchange and collection or payment activities" in or from Cuban territory. Digital assets, and more specifically cryptocurrencies, are already quite popular in the Caribbean Island, with an estimated 10,000 Cubans using them to transfer money.

Germany is another example of a country moving forward positively in the regulatory space. Earlier this year, it passed legislation allowing investment funds to allocate up to 20% of their value to cryptocurrencies under a provision called ‘spezialfonds’ or special funds. On a similar note, France has also ramped up its regulatory programme, proposing EU-wide regulations for cryptocurrencies. The proposal’s language is positive as it recognises the potential benefits in terms of market efficiency and economies of scale enabled by digital assets. Countries such as Germany and Cuba are examples of an understanding of the benefits that blockchain technology can bring to help meet demand and solve inefficiencies specific to their own socio-economic landscapes.

The pioneers

There still remain few countries in the world that have taken the initiative when it comes to regulating such a new technology. Switzerland has a reputation as a pioneer in banking and financial services, and it has no intention of missing the digital asset boat. Just last month, payments via cryptocurrencies started to be offered within the country through a partnership between Worldline and Bitcoin Suisse, and several cantons accept payment of local taxes in cryptocurrency. Switzerland has also consistently allowed the many financial institutions that it harbours to experiment with digital assets through permissive legislation. This has cemented the country’s status as a hub for a variety of crypto-asset companies.

As of 7 September 2021, El Salvador became the first country to accept bitcoin as legal tender, putting it on par with the United States Dollar, the official fiat currency of the state. While there are many questions to be answered regarding how or if the central bank will be able to exert any form of monetary policy on a currency which it cannot control, El Salvador has started one of the most interesting economic experiments of the century. How international financial institutions, banks and corporations will support bitcoin use within the country is yet to be seen. Several other Latin American countries and Ukraine are observing closely as they consider their own plans to follow El Salvador’s lead.

Countries like Switzerland or El Salvador have taken the first bold steps in approaching a wide range of questions from regulation to the taxation of digital assets. They have secured their places in the history books by creating templates for other countries to follow when it comes to architecting the digital asset ecosystem. The potential to attract innovation and growth this early on in a strategically competitive new field is significant.

Bitcoin Adoption in El Salvador Raises Policy Questions for Cryptocurrencies

El Salvador has been everywhere in the news recently as the first country to adopt bitcoin as legal tender. This puts the cryptocurrency on par with the US dollar, which has held this status since the country abandoned its own currency, the colon, in 2001. The move marks the first time in history that a country has adopted a fully digital and decentralised currency for official national use. Salvadorans can now transact, take loans and pay tax with bitcoin, if they so choose. Slowly but surely, adoption of digital assets has moved on from something solely for retail users, or used in niche circumstances such as paying wages to sporting stars, towards the mainstream of public sector acceptance.

While the launch of the programme did not run perfectly smoothly, with the government’s official Chivo wallet experiencing a temporary blackout due to usage exceeding system capacity, the infrastructure is now in place for one of the most interesting economic experiments in recent history. With this adoption come many questions, particularly surrounding how central banks and other national and international financial institutions will deal with settling payments with the small Central American nation. Will the Central Reserve Bank (CRB) of El Salvador take bitcoin and exchange it for USD? Will it eventually issue its own central bank digital currency (CBDC)? Given the volatility of cryptocurrencies today, will the CRB take steps to hedge against massive price movements?

One solution that could offer more long-term stability to the national economy would be for the CRB to create a stablecoin – a token pegged to and backed by a reliable underlying asset – against its own reserve of bitcoin, and issue that same stablecoin for use as a form of payment. This solution would be similar to a CBDC, essentially a tokenised version of the national currency, but would give the government the possibility of amending the peg should circumstances such as major price swings require it to take action to protect its economy, giving it some degree of monetary control.

With many other potential challenges ahead for this first-of-its-kind experiment, it is clear that policymakers all over the world will pay close attention to how the Latin country goes about tackling them. El Salvador may be the first country to take this leap but, given the noises from several other nations, it may very well not be the last.