SEC

ASX Suspends CHESS Replacement; Fireblocks First CCSS Level 3 provider; Basel Committee Updates Bank Crypto Capital Exposure Proposal; SEC vs LBRY

Thomas Murray Digital Newsletter

Photo by Felix Mittermeier on Unsplash

As we head towards the year end, here is a final round-up of institutional digital asset-related news for 2022. We will be back in the new year with a review of developments over the course of this year and a look ahead to what the major themes of 2023 may be.

In the post-trade sector, ASX has suspended its challenged attempt to replace its ageing but still serviceable CHESS clearing and settlement system with a blockchain-based platform, and more digital asset custodians receive regulatory approvals.

In other news:

  • The Basel Committee has made a new proposal to limit banks’ Tier 1 capital exposure to cryptocurrencies.
  • Technology provider Fireblocks has become the first organisation to attain CryptoCurrency Security Standard Level 3 certification.
  • SEC prevails in court over LBRY, setting a potential precedent for treating more tokens as securities.

Custody and Post Trade Developments

ASX Will Reassess All Aspects of the CHESS Replacement Project and Derecognise Capitalised Software of $245-255 Million Pre-tax in 1H23 (ASX)
The Australian exchange and financial market infrastructure provider ASX has paused its efforts to replace its Clearing House Electronic Subregister System (CHESS) clearing and settlement platform with a blockchain-based system that was being built in conjunction with Digital Asset. This follows a review by Accenture that cast doubt on the project’s timelines and suitability to provide the speed and scale required to replace the legacy system, which continues to work satisfactorily. Blame is apportioned to an under-estimation of the complexity of the market and weak project management, and not to the technical implementation. A new Project Director will oversee the next phase of development, which may or may not incorporate blockchain technology and components already built using Digital Asset’s Daml smart contract language.
BitGo to Take Custody of FTX Assets in Bankruptcy Procedure (CryptoSlate)
LCH Explores Crypto Derivatives Clearing (Risk.net)
The central counterparty is in discussions with Global Futures and Options Exchange (GFO-X) with a view to partnering to clear cryptocurrency derivatives including crypto index-based futures and options.
DBS Completes Repo Transaction on JPMorgan’s Onyx (Finextra)
DBS has used JPM Coin for instant settlement and intraday maturity of a repo transaction, reducing the time requirement from the current standard of one to two working days. DBS is the first Asian bank to achieve this, following BNP Paribas as the first European bank to do so in May of this year (BNP Paribas).
Komainu Secures MVP Licence from Dubai’s Virtual Assets Regulatory Authority (Komainu)
Digital asset custodian Komainu has secured a licence from Dubai’s Virtual Assets Regulatory Authority (VARA) to provide digital asset custody and management services to institutional investors. Komainu is reportedly the first Digital Asset Service Provider (DASP) to receive such a licence.
Bitpanda Receives Crypto Custody and Proprietary Trading BaFin Licence (Finextra)
The Global Ambitions of Partior, the JP Morgan, DBS Blockchain Payment System (Ledger Insights)
Partior, the joint venture of JPMorgan, DBS and Temasek, is drawing the attention of more settlement banks as the network – only announced last year – now has more than 60 banks across 15 jurisdictions engaged. The interbank network is designed to support multi-currency payments, which initially started with USD and SGD and are now expanding to include GBP, EUR, AUD, JPY, CNH and HKD. As noted in the article, the network is very similar to SWIFT in that it is not a payment system but rather a blockchain that supports the execution of instructions communicated through it, which makes it agile and a potential competitor to SWIFT.
HSBC, Wells Fargo Extend FX DLT Settlement to Chinese Yuan (Ledger Insights)
Zodia Expands Digital Asset Support to WBTC, USDC and UNI (LinkedIn)
Digital asset custodian Zodia has expanded its support for digital assets, to include WBTC, an ERC20 (Ethereum blockchain-based) token that is backed 1:1 by bitcoin; USDC, the second largest stablecoin; and UNI, the utility token of the Uniswap network, a decentralised finance (DeFi) network that supports peer-to-peer trading, lending, and applications.
Zodia Custody Rolls Out Service to Protect Client Assets from Exchange Insolvency (The Block)
Zodia’s Interchange service will reduce counterparty risk by allowing clients to settle trades directly from custody, while ‘mirroring’ client balances to the exchange to facilitate trading.
Fnality and HQLAX Demonstrate the First Cross-Chain Repo Swap Pilot (Fnality)
The proof of concept, with Santander, Goldman Sachs and UBS, demonstrated a repo swap between the R3 Corda and Ethereum Enterprise blockchains, showing possibilities for intraday settlement and the provision of a cross-chain single pool of liquidity for payments, cross-currency payments (PvP) and delivery versus payment (DvP).

Other News and Links


Basel Committee Finalizes Policy Suggesting 2% Bitcoin Exposure Cap for Banks (Bitcoin Magazine)
The Basel Committee proposes a 2% limit on riskier ‘Group 2’ digital assets such as unbacked cryptocurrencies as part of banks’ Tier 1 capital, increased from 1%, and still comfortably in excess of total cryptocurrency market capitalisation.
Crypto Custody Tech Provider Fireblocks Receives First-of-Its-Kind Security Certificate (CoinDesk)
Fireblocks, the underlying digital asset technology provider to major clients including Bank of New York Mellon, has become the first digital asset service provider to achieve Level 3 certification under the CryptoCurrency Security Standard (CCSS), satisfying requirements for robust segregation of duties, controls, geographic and organisational distribution, and IT security, as audited by Confide. The certification joins others in its portfolio including SOC2 Type II, ISO 27001, ISO 27017, and ISO 27018.
Kenya Proposes Bill to Tax Crypto (CoinDesk)
Given approximately 8.5% of Kenya’s citizens own cryptocurrencies (fifth by adoption globally according to this UN Report), the country’s lawmakers have proposed an amendment to the Capital Markets Bill that would allow for the taxation of crypto exchanges, wallets, and transactions, as well as the reporting of holdings and capital gains tax when selling or using digital assets.
Italy to Impose 26% Crypto Gains Tax from 2023 (Crypto Slate)
UK Lawmakers Support Easy Seizure of Crypto Linked to Terrorist Activity (CoinDesk)
Lawmakers in the UK have approved new powers that will make it easier for law enforcement agencies to seize crypto assets. The Economic Crime and Corporate Transparency bill will be updated to give powers over crypto assets linked to terrorist activity that cannot readily be prosecuted under the criminal system, supplementing earlier amendments that do the same for assets linked to crime.
Bitcoin Cash Could Be Legal Tender in St Kitts by March, Prime Minister Says (CoinDesk)
Crypto Financial Services Firm Eqonex Files for Voluntary Debt Restructuring in Singapore (CoinDesk)
Nasdaq-listed Eqonex puts its HK-based Diginex and Singapore-based Eqonex Capital into voluntary liquidation, ending plans to offer custody, brokerage and asset management services through these entities, following the August closure of its crypto exchange. Its UK-based entities, FCA-registered crypto custodian Digivault and Bletchley Park Asset Management, are also to be voluntarily wound down.
Can Utility Tokens Be Securities? The Significance of SEC v. LBRY (Solidus Labs)
A recent US court ruling found in favour of the SEC’s argument that the LBRY Credit token is an unregistered security, based on LBRY’s own marketing that promoted the token’s potential to appreciate in value. This blog from Solidus Labs summarises the case and assesses its potential as a precedent that could tip the balance towards SEC Chair Gary Gensler’s argument that many utility tokens also, or exclusively, bear the characteristics of securities, and therefore would fall under his agency’s jurisdiction.
Gemini Secures Regulatory Approvals to Operate in Italy and Greece (Gemini)
Sygnum Awarded Abu Dhabi In-Principal Approval (Finextra)
Sygnum Expands its Offering into Luxembourg, Europe’s Largest Fund Market (Sygnum)
USDC Stablecoin Issuer Circle Says Businesses Can Accept Apple Pay (CoinDesk)
Business are now able to accept USDC, a USD pegged stablecoin, via Apple Pay.
Vanguard Australia Deploys Blockchain-based Back Office Tech (Finextra)
Vanguard’s Australian division has deployed a fund administration system based on the R3 Corda private blockchain. Use of a shared blockchain obviates the need for reconciliations between participants.
Binance Starts Recovery Fund for Crypto Projects Facing Liquidity Crisis (CoinDesk)
Accountant That Vetted Binance Reserves Halts Crypto Work (Bloomberg)
Audit firm Mazars suspends its work on crypto reserves attestations, concerned that their scope is not correctly understood by the public and at media scrutiny. BDO is understood to be reviewing the situation but is continuing its own similar work.
TP ICAP Wins Approval from FCA for Wholesale Spot Exchange for Digital Assets (Finextra)
Goldman Sachs on Hunt for Bargain Crypto Firms After FTX Fiasco (Reuters)
El Salvador Proposes Digital Securities Bill, Paves Way for Bitcoin Bonds (CoinDesk)
Delivered to the legislative arm of the government on November 17, El Salvador’s Minister of Economy has proposed a bill that seeks to establish a National Digital Assets Commission that would be tasked with the oversight of the digital asset industry in the country. The bill is designed to create a regulatory regime that supports administration, safeguarding and investments in public digital assets, a precursor to the country’s ambition to raise USD 1 billion via bitcoin-backed bonds.
Bitcoin Core 24, Bitcoin’s Controversial Upgrade is Now Live (Crypto Slate)
The Bitcoin protocol has once again received another update. Bitcoin Core 24 was activated on November 26, and fully implements Replace-by-Fee (RBF) logic, a way for nodes to prioritise conflicting transactions based on which pays the highest fee, instead of in chronological order. Some fear the update will encourage double-spend attacks, and it will also disincentivise zero-confirmation transactions, which are accepted by the blockchain prior to validation by miners, with the secondary outcome of increasing transaction fees paid to those miners.  

Key: Legal/Regulatory             Technology            Ecosystem              Markets 

CBDC Corner

The Atlantic Council’s CBDC Tracker has been updated to show that all G7 countries and 18 out of 20 G20 countries are actively developing CBDCs, with 7 pilot schemes running. 11 countries have launched CBDCs. China will expand its pilot to most of the country in 2023, and over 20 countries will move towards their own pilot schemes, including Australia, Thailand, Brazil, India, South Korea and Russia, and likely also the ECB.
Central Banks Consider Backing Stablecoins Instead of Launching CBDCs (FinanceFeeds)
Antoine Martin, a research advisor at the New York Fed, has posited that central banks, rather than commercial banks, could hold the reserves that back stablecoins to increase bankruptcy protections and decrease risks. This would be simpler than central banks supporting retail use cases for CBDCs directly themselves.
US Banks Launch Digital Asset Settlement Platform PoC (Finextra)
Several US Banks including Citi, Wells Fargo, BNY Mellon, HSBC and US Bank have partnered with the innovation arm of the New York Fed to explore the feasibility of an interoperable digital money platform called the regulated liability network (RLN). The 12-week proof-of-concept project is designed to test the settlement of simulated US dollars from commercial banks through simulated central bank reserves using a shared ledger. The test is supported by technology provided by SETL and Digital Asset, running on Amazon Web Services.
Several more CBDC proof of concept projects are in the works:
Bank of Japan to Run CBDC Experiments With Country’s Megabanks: Report (CoinDesk)
Bank of England issues RFP for a CBDC wallet (Bank of England) to support testing, including compatibility with the BIS Innovation Hub’s Project Rosalind (an API for retail CBDC distribution)
The Reserve Bank of Australia’s eAUD pilot programme (Reserve Bank of Australia) has attracted 140 proposals from around 80 entities, spanning retail and wholesale CBDC use cases
Banco de España has issued a call for expressions of interest in wholesale CBDC experiments (Banco de España) regarding fund transfers and settlement, and comparing CBDC advantages and disadvantages with traditional processes
Naira Redesign Policy – Revised Cash Withdrawal Limits (Central Bank of Nigeria)
The Central Bank of Nigeria is limiting cash withdrawals to 100,000 naira per week for individuals and 500,000 naira per week for corporations, with excesses subject to withdrawal fees of 5% and 10% respectively, in an effort to drive adoption of traceable electronic transactions and Nigeria’s CBDC, the eNaira.
Kazakhstan Central Bank Recommends a Phased CBDC Rollout Between 2023–25 (Cointelegraph)
India’s Digital Rupee Fails to Excite Interest, Bankers Say (Reuters)
EIB Innovates Further with Project Venus, the First Euro-denominated Digital Bond on a Private Blockchain (European Investment Bank)
The French and Luxembourg central banks have completed Project Venus in which they settled a EUR 100 million digital bond issued by the European Investment Bank (its second digital bond) using a synthetic CBDC on a jointly operated private blockchain on Goldman Sachs’ GS DAP tokenisation platform. Société Générale Securities Services acted as digital custodian.
National Bank of Ukraine Releases Draft Concept for Digital Hryvnia (Cointelegraph)
The paper considers three use cases: retail (including payments and smart contract usage), wholesale (for operations related to cryptocurrency exchanges and other digital asset service providers), and for cross-border payments.
Crypto To The Rescue: Why The UN Is Sending War-Torn People In Ukraine Aid In Stablecoins (Bitcoinist)
UNHCR is partnering with Stellar Development Foundation to send USD Coin to Vibrant digital wallets of eligible Ukrainians displaced by the Russian invasion. Withdrawals can be made at MoneyGram outlets in USD, EUR or UAH.

Wishing you a Merry Christmas and a Happy New Year!

Thomas Murray Digital

Andrew Wright | Hugo Jack

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Email: digital@thomasmurray.com
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SEC Guidance to Hold Client Cryptoassets on Balance Sheet Meets Resistance and Dampens Bank Plans; Staking Raises Prospect of Ether Being Classified as a Security

Thomas Murray Digital Newsletter

Securities and Exchange Commission Headquarters (SEC)

Reverberations from the SEC’s back-door attempt to move cryptoassets onto banks’ balance sheets – as we reported in May – continue as banks push back while their plans to offer digital asset services in the US falter. And the Ethereum Merge – a major and long-planned upgrade to the most widely used blockchain – passed uneventfully a week ago, shifting its operating model from Proof of Work to Proof of Stake and drastically reducing its energy consumption by an estimated 99.9%. While the change is welcome for environmental reasons, we examine whether the blockchain’s native ether token could be walking into a regulatory trap in which it could be reclassified from a commodity to a security.

Major Digital Asset Developments

      

      		SEC Accounting Guidance Issue Rumbles On
According to an article by Reuters, the US Securities and Exchange Commission’s (SEC) Staff Accounting Bulletin 121 (SEC), published in March earlier this year, is having a material dampening effect on banks looking to engage with digital assets. While ostensibly more of an expectation for organisations wishing to remain on good terms with the regulator than a rule, the accounting guidance requires public companies including banks to hold clients’ crypto assets as liabilities on their balance sheets, rather than off them as is customary for custodians of traditional client assets. This is problematic for banks which are subject to strict regulatory capital ratio rules.
Many of the largest banks in the US have announced intentions to support digital assets in one way or another, with some services already live, albeit primarily with select or private wealth clients. Nonetheless, the article makes clear that banks’ efforts in this space are undermined by the financial burden the capital requirements place on them, and some have had to ‘cease moving forward with [their] plans’. Both State Street and Bank of New York Mellon are reported to have been disrupted.
Nadine Shakar, head of State Street Digital, previously suggested at a recent Fund Forum panel discussion that this was no great imposition, and hinting that it could be an opportunity for large institutions like State Street to gain market share, saying ‘unless you have larger custodians moving into the space and be the big kids at the table, it’s [digital assets] unlikely to see institutional adoption’. It is now reported that she sees the SEC’s expectations as an issue for the bank, one that does not necessarily prevent them from custodying digital assets but that reduces its economic viability: ‘We do have an issue with the premise of doing that, because these are not our assets. This should not be on our balance sheet.’ (Reuters) U.S. Bancorp has paused onboarding new crypto custody clients, and anecdotally several European banks are pulling back from US advances until the issue is addressed.
Until there is clearer guidance, or changes to the capital impact faced by supporting crypto assets for banks – which seems unlikely in the short term – there may be a decline in ecosystem development, which is perhaps already being reflected in the value of the cryptocurrency market.
The Ethereum Merge and Securities Implications
The Ethereum blockchain successfully merged with the Beacon Chain on 15 September (CoinDesk), transforming it from a proof-of-work (PoW) to a proof-of-stake (PoS) protocol. The transition, which was many years in the making, has been welcomed as Ethereum is expected to consume 99.9% or so less energy as a result of the change (see previous newsletter). This, according to Bank of America (FXStreet), is an opportunity for greater institutional adoption of the blockchain’s native ether token, as those that were prohibited from investing in PoW systems due to ESG considerations may now acquire the cryptocurrency.
Ethereum and the thousands of tokens it supports have now removed themselves from potential moves by jurisdictions such as the EU and the US to ban or de-incentivise PoW: the EU has flip-flopped on including a ban in its pending Markets in Crypto-assets (MiCA) regulation, adding (The Block) then ultimately removing (CoinDesk) such clauses; the State of New York has implemented a moratorium on PoW mining using carbon-based energy sources (CoinDesk); and earlier this month one of the first responses to President Biden’s Executive Order on cryptoassets – from the White House Office of Science and Technology – asked the Environmental Protection Agency and the Department of Energy to consider a ban if the US cannot meet its climate goals through other means (Blockchain News).
However, by transitioning to PoS, with its reliance on the process of staking to secure and validate the network and its transactions, ether may have walked directly into the SEC’s securities oversight purview. In return for delegating ether to network validators (if they do not have enough tokens to qualify them to run staking nodes themselves), token-holders are rewarded in more ether tokens, which according to Chairperson Gensler of the SEC (Decrypt) and other regulatory agencies could constitute an investment contract under the US Howey test: ‘a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party’ (US Supreme Court).
While the SEC has not presented any formal analysis of the issue, it is assumed it does not consider ether to be a security, although the fundamentals are much harder to assess now and there is considerable scope for questions of consistency of approach to arise. Earlier this month, Gensler announced qualified support for Congress to hand more power to the Commodity Futures Trading Commission (CFTC) to regulate non-securities digital assets such as cryptocurrencies (Crypto Slate) so long as the move would not reduce the SEC’s power to regulate securities. He and the SEC have been the subject of notable dissatisfaction from the digital asset community and even the Commissioner of the CFTC due to the SEC’s failure to proactively shape a robust digital asset framework, receiving criticism for frequent cases of ‘regulation by enforcement’. Handing greater responsibility to the CFTC for such assets is seen by the community as a welcome development.
Bolstering the argument that ether and similar tokens should remain classed as commodities, Coin Center, a non-profit research and blockchain advocate, points out that the SEC looks at the economic realities underlying a project, rather than the terms and technologies used to create it, and given that the participation in the consensus mechanism is explicitly designed to be open to anyone, and not reliant solely on the efforts of others (Coin Center), staking, or mining for that matter, should not meet the criteria.

Other News and Links

White House Releases Inaugural Framework for Crypto Regulation (Crypto Slate)
Following President Biden’s Executive Order in March this year (described previously in our newsletter here), The White House has released a framework which offers a number of recommendations including how to approach the regulation of crypto assets, ways in which to mitigate fraud perpetrated using digital assets, and how to improve standards across the financial industry more broadly. The framework pays particular attention to fraud and fighting illicit finance, and suggests the President may call upon Congress to amend the Bank Secrecy Act so that digital asset exchanges and non-fungible token (NFT) platforms would explicitly fall subject to it.
US Banks Must Maintain Cautious Approach to Crypto, Says Acting OCC Head (Crypto Slate)
Michael Hsu, Acting Head of the Office of the Comptroller of the Currency (OCC), believes that US banks should remain caution when considering digital assets. The OCC was the first to green-light the provision of crypto custody services by national banks and federal savings associations when it issued its Interpretive Letter #1170 in July 2020, which in all likelihood contributed to the crypto bull market. That said, in his speech at the TCH + BPI Annual Conference Hsu made clear that he is much more cautious than the previous head of the OCC, and sees ‘red flags in crypto’s rapid growth’. As such, the agency has reportedly tightened its criteria for acceptance, indicating that these institutions can only engage in certain crypto activities so long as they can demonstrate the activities can be performed in a ‘safe, sound and fair manner.’
Crypto Oversight Should Resemble Traditional Bank Rules, Fed Official Says (CoinDesk)
In his first speech since taking office, Fed Vice Chair for Supervision, Michael Barr, articulated the need for greater regulatory oversight, particularly in how banks engage in crypto activities. He reiterated the need to regulate based on the “same activity, same risk” approach cited by multiple regulators and commentators over the preceding months.
UK Introduces Law to Seize, Freeze and Recover Crypto (CoinDesk)
The Economic Crime and Corporate Transparency bill supplements the Economic Crime (Transparency and Enforcement) Act used to impose sanctions against Russia and freeze UK-held assets – both traditional and digital – and is ostensibly designed to prevent sanctioned Russians from using crypto to evade those measures, as well as aid in combatting criminal activities.
Crypto Exchanges in UK Required to Report Sanction Breaches (Finextra)
The UK has updated its guidance towards sanctions reporting, which now brings crypto exchanges into scope for reporting violations and freezing assets. The guidelines were implemented by the Treasury’s Office of Financial Sanctions Implementation (OFSI) to combat potential breaches conducted with the use of cryptocurrencies.
New French Bill Could Give Authorities Powers to Seize Crypto Assets (CoinDesk)
In line with other countries around the world, such as the UK’s Economic Crime Bill, the French state is attempting to make it easier to freeze and seize the digital assets of suspected criminals. The proposal is due to be discussed next week by France’s Constitutional Law Committee.
Korea to Launch Security Token Guidelines, Pilots This Year (Ledger Insights)
SEC, CFTC Propose Amendments for Large Hedge Fund Crypto Reporting (Crypto Slate)
First announced earlier this month, the Securities and Exchange Commission (SEC) and the Commodities and Futures Trading Commission (CFTC) look set to introduce rules that will require hedge funds to report investments more accurately in digital assets. In particular, the Proposed Rule (Federal Register) will seek to distinguish between assets that have similar characteristics such as digital assets and cash and cash equivalents, and establish a new sub-asset class which will help regulators to more easily monitor systemic risks and economic stability.
Russia to Consider Possible Legalization of Cryptos for Cross-border Payments (AMBCrypto)
Due to the impact of financial sanctions on Russia, its Ministry of Finance is considering using cryptocurrencies as a means to support cross-border payments. This comes after Putin signed an order effectively banning the use of crypto-based assets for domestic payments in July earlier this year. Views are said to be softening in light of the ongoing financial situation, with Prime Minister Mikhail Mishustin suggesting the country needs to look to digital assets as a ‘safe alternative’ to support cross-border commerce. The Central Bank has tried to limit the use of crypto assets in the country as it looks to develop its own digital ruble, and once rolled out, may try to impose another ban on cryptocurrencies.
Australian Senator Releases Draft Bill to Push for Crypto Regulation (Crypto Slate)
Australian Senator Andrew Bragg has released a draft Digital Assets (Market Regulation) Bill 2022 (Andrew Bragg). It seeks to apply pressure to the Australian regulatory system in order to push forward with the regulation and oversight of the digital asset market and its constituent components. At a high level, the bill proposes to provide a framework for digital asset exchanges, digital asset custody, issuance of stablecoins, and the protection of consumers while promoting investment in Australia. Interestingly, another objective of the bill is to provide for the reporting of information from banks that facilitate the use or availability of China’s digital yuan in Australia. Consultation on the bill is being received until October 31, 2022.
Colorado Enables Crypto Payment for Taxes (Crypto Slate)
House Stablecoin Bill Would Put Two-Year Ban on Terra-Like Coins (Bloomberg)
Nigeria Plans to Create a Virtual Free Zone with Binance Crypto Exchange (CoinDesk)
Nigeria’s Export Processing Zones Authority (NEPZA) is looking to create a digital city to support the growing digital asset economy. It is reportedly looking to partner with Binance, the largest cryptocurrency exchange by volume, which signed an agreement to assist Dubai with the establishment of a similar industry hub for digital assets in December 2021.
Binance Secures Licence in Dubai to Offer More Crypto Services (CoinDesk)