Thomas Murray Digital Newsletter
For investors in digital assets, and cryptocurrencies in particular, the pain caused by the latest ‘crypto winter’ continues unabated. Although institutional investors have been engaged in the crypto market in large numbers since 2021 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. At the same time, financial institutions and FinTechs are continuing to invest and build new operational models and DLT-based infrastructure. Hugo Jack takes stock of what is happening in the crypto market today: where things are going wrong, but also the continuing positives driving the industry forward.
This newsletter comes out a week later than usual as Thomas Murray has been attending The Network Forum’s 2022 Annual Meeting. The Digital team was represented by Andrew Wright, who engaged in a lively debate with panellists from HSBC, Deutsche Bank, Euroclear and Digital Asset on DLT adoption in the financial services industry and the future of custody. Although it is relatively early days for institutional engagement with digital assets and their infrastructure, DLT has been deployed in some major applications for a few years already, with more projects – such as to replace the national clearing and settlement infrastructure for several major markets – in active development. The discussion centred on the speed at which digital forms of assets would become mainstream and the extent to which existing traditional securities may be converted to digital token form, if at all. Thomas Murray Digital’s house view is that it only requires a small pressure gradient, comprising convenience, transaction speed, enhanced functionality, and cost savings, to trigger a snowball effect in this tokenisation of existing assets. In the words of William Gibson, ‘The future is already here – it’s just not evenly distributed’; the example of SDX, Switzerland’s fully regulated end-to-end digital asset infrastructure, shows how the gap to a fully digital future can be bridged through the instantaneous tokenisation or conversion back into traditional form of securities, allowing the market to choose its preferred asset form at its own pace. Meanwhile, although members of the audience remained largely sceptical that digital assets would represent a majority of issuances any time soon, or ever, it seemed clear that the members of all three digital-themed panel discussions at the event accept DLT-based assets and infrastructure as an inevitability, given sufficient time.
Digital Asset Developments
 | Last week, Japan became the first country in the world to usher in comprehensive regulations governing stablecoins. Passed by the upper house, the bill takes aim at stablecoins and other fiat-pegged assets which in recent months have received significant attention from regulators globally amid concern for investor protection and financial stability. This comes on the back of the dramatic demise of Terra’s algorithmic stablecoin, UST, which collapsed in May, and the ongoing drama faced by lending platforms like Celsius which is currently facing solvency issues. The amendment to the Funds Settlement Law is expected to enter into force in 2023 and will limit the issuance of stablecoins to banks, licensed money transfer companies with custody capabilities, and trust companies. The law recognises stablecoins as electronic money and guarantees their redemption at face value to the Yen or other fiat currency of issue. In addition, a new licensing regime will apply for intermediaries including brokers and enhanced anti-money laundering provisions will be applied. This is a welcomed move by the industry as a group of 74 financial institutions is set to launch their own deposit-backed digital currency next year. |
| In a somewhat surprising move, Lithuania has pressed ahead and introduced its own crypto licensing regime, despite the European Union’s Markets in Crypto Assets Regulation (MiCA) being reportedly in the final stages of negotiation. The concern, articulated by the country’s vice minister of the Ministry of Finance, was that MiCA will take some time to come into effect, likely in 2024. In that time the industry will continue to go through immense changes, and yet it remains at the mercy of unscrupulous actors looking to game investors. The country has implemented these steps as an interim measure which the MiCA regime will supplant once ratified. That said, there is still much to cover in the pending European regulation, which for the most part does not yet cover how to govern non-fungible tokens (NFTs), decentralised finance (DeFi), and more systemically significant stablecoins proposed by the likes of Libra (later Diem and now purchased by Silvergate), which according to this article are likely to be rejected by EU member states due to their competition with the euro. The law will enter into force in Lithuania on November 1, 2022. |
| A copy of a U.S. draft bill entitled the Lummis-Gillibrand Responsible Financial Innovation Act has been leaked online and is making the rounds on social media. It reports to show that greater regulation is closing in on the digital asset ecosystem, with particular attention paid to Decentralised Finance (DeFi) and Decentralised Autonomous Organisations (DAOs) which are both soon to be subject to greater oversight. Within the 600 pages of the draft, investor protection appears to be the driving motivation. It proposes that crypto platforms or service providers, including DAOs that operate in the U.S., should be required to be legally registered in the country, although this would naturally compromise projects with anonymity at the core – such as the Bitcoin network itself. Encouragingly, the bill appears to offer long-awaited clarity on securities laws as they relate to tokens, DeFi and DAOs, offering an extended universe of tokens that would fall under the purview of the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) depending on their nature. Unsurprisingly, given the bill’s sponsors, the draft bill aims to limit the SEC’s remit to pure securities tokens due to what has been seen as an unhelpful and aggressive stance from the agency towards crypto, while the CFTC will oversee everything else including utility tokens, stablecoins and unbacked cryptocurrencies. The CFTC would be granted greater powers to police investor protection and anti-fraud/anti-manipulation issues, and would be funded from fees gathered from digital asset issuers. By that logic, man cryptocurrencies and stablecoins would be classed as commodities, while NFTs will be considered an entirely new asset class. The CFTC has already offered its working definition of securities tokens that will be under the SEC’s purview, stating that “if there is any debt, equity, profit revenue, or dividend of any variety, then it is now expressly not a digital asset commodity”. In light of the Terra debacle last month and the ongoing drama with crypto lender Celsius, investors will likely be pleased by one part of the draft bill which outlines the obligation of an exchange to return users’ funds rather than being able to liquidate them to cover operational losses. Some commentators have pointed out that the draft bill could increase the cost of compliance for these entities, which would most likely be passed on to the customers, however they may be willing to pay the price for increased protection. In related news, the U.S. Treasury, in comments made by Deputy Secretary Wally Adeyemo, is taking actions to prevent the use of self-custody and unhosted crypto wallets. The argument presented by the Treasury is one that has been echoed by many policy makers globally as they grapple with the principle of anonymity against a rapidly evolving crypto financial ecosystem. Adeyemo argues that financial institutions need to be able to determine who they are dealing with, suggesting it is difficult to do so with unhosted wallets as they “are effectively just addresses on a blockchain”. Understandably, doing away with self-custodied wallets will increase the ease with which individuals can be identified as wallet providers are subject to KYC/AML rules, although it is accepted that there are numerous cryptographic techniques to prove one’s identity in a blockchain ecosystem that can still preserve anonymity. This policy, while intended to further mitigate money laundering and illegal activities, will likely impact heavily on decentralised finance models which are increasingly popular with digital asset businesses and some banking institutions. Counter to the above, the U.K. Treasury, in a response to its public consultation on Amendments to the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, Statutory Instrument 2022, has now backtracked on its intention to collect information on unhosted or private wallet data. Following feedback from industry, the Treasury suggests it does not make sense for every sender of funds to have to collect identification information of the beneficiary. |
 | Acting on behalf of the recently hacked Lichtenstein-based digital asset exchange LCX, Lawyers Holland & Knight and Bluestone, P.C., achieved an historic first by issuing a temporary restraining order (TRO) via a non-fungible token (NFT). The token was sent to a hacker whose wallet addresses were discerned through blockchain tracking technology using algorithmic forensic analysis. The hacker managed to siphon approximately USD 8.0 million in digital assets from the exchange in January 2022. However, through coordinated court orders sought from the Supreme Court of New York and the courts of Liechtenstein, 500 eth and 1.3 million USDC have been frozen by Coinbase Europe and Centre Consortium, the operating entity of Circle, the issuer of the USDC stablecoin. |
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