State Street

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 a doption’. 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.

CBDC Corner

HKMA’s Policy Stance on e-HKD (Hong Kong Monetary Authority)
HKMA has concluded several consultations under its ‘Fintech 2025’ strategy and will take steps to prepare for a possible future retail CBDC based on broad support by working on technical and legal foundations while exploring application, implementation, and design issues.

IMF Says Crypto and Central Banks Could Set the Stage for Rich and Diverse Monetary Ecosystem – Here’s How (DailyHodl)

Crypto’s Adaptability, Openness Key to Ideal Monetary System, Say BIS Execs (Cointelegraph)

India’s Central Bank Plans CBDC Launch in 2022 with Help from Fintechs, Public Banks (Crypto Slate)

Digital Dollar Project Launches Sandbox Programme (Finextra)

Brazil, India Join CDBC Race: Will Start Pilot Projects in 2022 (The Tokenist)

Norwegian Central Bank Taps Ethereum for CBDC Work (Finextra)

ECB Taps CaixaBank and Amazon for Digital Euro Prototypes (Finextra)

China to Extend CBDC Trial to Most Populous Province, Guangdong, Three Others: Report (CoinDesk)

Iran to Start Testing a Digital Rial This Week (CoinDesk)

Thomas Murray Digital

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

Thomas Murray Digital Newsletter

In this issue:

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

Major Digital Asset Developments

Other News and Links

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

CBDC Corner

Fed Promotes FedNow as Alternative to CBDC and Updates Release Date to Mid-2023
US Federal Reserve Governor Michelle Bowman has claimed that a CBDC may not be necessary since many of the challenges that CBDCs are designed to solve, including 24×7 real-time payment and settlement, may be covered by the planned FedNow payment service (Federal Reserve). The Fed has also refined its 2023 target for the production rollout of FedNow to the May to July 2023 window, and has expanded its pilot test programme to over 120 organisations (Federal Reserve).

Tech Industry Consortium to Run CBDC Pilot with Sterling Stablecoin (Finextra)
The Digital Financial Market Infrastructure (DFMI) consortium has announced a test of retail CBDC use cases based on a live Sterling-denominated stablecoin under ‘Project New Era’ principles set out in a white paper (The Payments Association) authored by the Payments Association, Dutch payment infrastructure provider paywith.glass and Boston Consulting Group. With other DFMI members including IBM, Finastra, FinClusive, Ibanera, Mattereum, Trust Payments and Accomplish Financial on board, the pilot is also intended to expand to other jurisdictions.

Reserve Bank of Australia Says a Live CBDC Likely to be Wholesale (Ledger Insights)
Further to our coverage in our last edition of the Reserve Bank of Australia’s (RBA) initiation of a year-long CBDC research project that would cover both retail and institutional use cases (Thomas Murray Digital), the synopsis of a payment systems board meeting has revealed that there will be a particular focus on wholesale applications such as cross-border payments and securities settlement. These plans are in line with ASX’s ambitious but increasingly delayed plans for a DLT-based post-trade infrastructure (Finextra) and with Project Dunbar (Bank for International Settlements), a multi-CBDC cross-border payment project in conjunction with the Monetary Authority of Singapore and the central banks of Malaysia and South Africa overseen by the Bank for International Settlements.

Nigeria Cuts CBDC Fees and Enables USSD
The Governor of the Central Bank of Nigeria (CBN) has announced that Nigerians are able to transact with their eNaira wallets and open new wallets using Unstructured Supplementary Service Data (USSD) codes on their mobile telephones (Punch), enabling instant payments for merchants and consumers to any bank account. The Governor also announced in a speech that eNaira has been used for almost USD 10 million worth of transactions, and the app has been downloaded 840,000 times with 270,000 active wallets (CoinDesk) for the country’s population of about 200 million, about 40% of which is unbanked. However, in June – roughly 6 months on from eNaira’s launch – retailers remained slow to accept the CBDC and a survey revealed that only 4% of respondents had used it, with 67% not aware of it at all (Punch). As Quartz points out, this averages to just 1.35 transactions per active wallet (Quartz). Perhaps reacting to this, CBN’s Deputy Governor Dr Kingsley Obiora has now said that the bank is cutting merchant fees for using eNaira by 50% (Daily Trust) to increase adoption.

Colombia: Petro Government Will Seek “Creation of a Digital Currency” (Semana)
The Director of Colombia’s National Directorate of Taxes and Customs has announced plans to create a CBDC with the aims of making financial transactions easier and preventing tax evasion, which is estimated to be worth between 6% and 8% of GDP, by ensuring traceability of transactions over a certain value.

Brazil CBDC Trials: Farm Lending Explored by Digital Asset, Oliver Wyman, VERT (Ledger Insights)
This project is a participant in Banco Central do Brasil’s Real Digital Lift Challenge, a series of tests of CBDC. Initially using tokenised commercial bank money, it will test ensuring an ongoing role for commercial banks in processing loan applications while keeping their balance sheets free of current low-interest ‘directed’ lending, and will see the creation of a marketplace where the banks can bid to provide loans.

Russia to Start Digital Ruble Pilots in 2023 (Ledger Insights)

Reserve Bank of Zimbabwe ‘Developed a Roadmap for Adoption of CBDC,’ Says Governor (Bitcoin.com)

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

Andrew Wright

Photo by PiggyBank on Unsplash

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

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

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

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

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

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

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

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

	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)
	Coinbase Is Helping Sue the US Treasury Over Tornado Cash Sanctions (Bloomberg UK) Coinbase is challenging the authority of the US Treasury Department after it publicly declared its intention to pay the legal costs of a lawsuit brought by six individuals who are contesting the legality of the Treasury’s sanction of Tornado Cash. The plaintiffs argue that the move by the US Treasury’s Office of Foreign Assets Control (OFAC) to sanction wallets associated with the application, as well as the smart contract code itself, was unprecedented, as neutral technologies and tools are reportedly out of the scope of sanctions law. Brian Armstrong, CEO of Coinbase, stated that the Treasury issued a blanket-wide sanction rather than targeting the wallets of those known to have committed an offence, further suggesting that it was used by many law-abiding citizens looking for increased privacy, who now have funds trapped on the platform. Crypto Investment firm Paradigm strongly agrees with the action brought by the lawsuit, as it too stated in a legal argument (Paradigm) that blockchain infrastructures and the providers that support them should not be subject to US Treasury sanctions, as monitoring or censoring Specially Designated Nationals and Blocked Persons (SDN List) would jeopardise the neutrality of base blockchain layers and compromise their integrity and core functionality.
	Coinbase Gains Regulatory Approval in the Netherlands (Coinbase)
	Deutsche Börse to Issue Digital Securities on DLT-ready D7 Platform (Ledger Insights)
	Societe Generale Securities Services Extends Its Offer to Funds Investing in Digital Assets (Societe Generale) SGSS now offers asset managers to act as a fund custodian, valuator and liability manager, and has onboarded its first client, Arquant Capital.
	Hong Kong’s HashKey Receives Approval to Manage 100% Crypto Portfolio (CoinDesk) HashKey, a Hong Kong based asset manager, has received a Type 9 (Asset Management) Licence (Offshorelicense) from the Securities and Futures Commission (SFC) of Hong Kong, permitting it – alongside a growing number of virtual asset managers – to manage portfolios that are 100% invested in digital assets.
	Nasdaq Launches Crypto Custody Service (Nasdaq) Nasdaq is moving into the digital asset business, citing growing institutional demand from its financial institution clients. It is set to launch a digital asset custody offering which, following regulatory approval, will incorporate liquidity and execution services, effectively creating a full-service solution that may take a lead from Switzerland’s SDX.
	Royal Family of Dubai Company Seed Group Partners with Coincorner to Facilitate Bitcoin Transactions in the UAE (Bitcoin Magazine)
	Brazil Exceeds 1M Registered Crypto Users in July for First Time as Number Grows 68% in a Month (CoinDesk)
	Abra Launching First US Regulated Crypto Bank (Blockworks) Abra, a crypto exchange and lending platform, has successfully acquired a licence to become the first US regulated crypto bank. With the licence comes an ability to offer clients regulated interest-bearing crypto accounts, an activity that some providers have had to discontinue. For example, BlockFi was sued successfully by the SEC for USD 100 million (The Verge) as its offering was considered an unregistered security and the firm was not registered as an investment company. Abra is due to launch in the US in Q1/2 2023.
	Tokenization of Illiquid Assets to Reach $16T by 2030: Report (Cointelegraph) A report by Boston Consulting Group (BCG) and ADDX, a digital asset exchange, estimates that illiquid assets such as pre-IPO stock, real estate, art, and private debt will become a USD 16.1 trillion tokenised market by 2030.
	Singapore’s Financial Authority Grants License to SBI’s Digital Asset Arm (Cointelegraph) The Monetary Authority of Singapore (MAS) has granted Japan-based SBI Holdings a Capital Markets Services licence for its digital subsidiary SBI Digital Markets. In-principal approval was granted in May this year, however the full licence will now permit the firm to offer digital asset custody, capital markets products, and financial advisory services in Singapore as a regulated business.
	Singapore’s Largest Bank DBS to Offer Crypto Services to 300,000 Investors (Crypto Slate)
	Fidelity to Launch Bitcoin Retail Trading in November (Crypto Slate)
	ErisX Introduces Settlement Service for OTC Crypto Transactions (Finextra) ErisX, a leading digital asset exchange, has launched a new settlement service for OTC transactions that is designed to eliminate counterparty risk by routing orders through a US-licensed crypto spot exchange, thus reducing the risk and operational burden associated with OTC transactions.
	Broadridge Integrates with Coinbase (Finextra) Broadridge, a leading provider of shareholder services, has partnered with Coinbase’s Prime offering, enabling enhanced liquidity and the ability for Broadridge’s clients to route orders to Coinbase Prime via its NYFIX order-routing network.
	Crypto Custody Specialist Anchorage Digital Offers Japanese Yen Stablecoin (CoinDesk)
	Gunvor, Total Execute First Physical Oil Trade Confirmation using VAKT Blockchain (Ledger Insights) VAKT, a post-trade blockchain startup backed by oil majors including BP, Saudi Aramco, Shell, Total and Chevron, has launched an electronic trade confirmation solution which is designed to replace manual processing of oil contracts, which according to VAKT’s own analysis is responsible for a 15% error rate.
	Major Fund Administrator Apex Offers Blockchain-based Valuation Data for Private Assets (Ledger Insights)
	SWIFT Runs Blockchain Pilot for Corporate Actions Data (Finextra) The banking infrastructure provider is trialling a new blockchain system for corporate actions with the aid of Symbiont, a private technology platform, as well as seven securities market participants. Corporate actions are seen as one of a number of key areas in which post-trade can be better served by blockchain technology, with SWIFT estimating as much as 30% of the costs associated with processing corporate actions are related to manual processing.
	CME Group Launches Ether Options (Finextra)

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