CryptoLaw Newsletter #22
US on stablecoins, Bloomberg on Tether (and why do traders use it?), financialisation of NFTs, what is decentralisation in DeFi, EU report on blockchain energy; who’s behind the $1.6bn BTC tx?
"No matter what anyone thinks about it, government is going to regulate it. They are going to regulate it for (anti-money laundering) purposes, for (Bank Secrecy Act) purposes, for tax," said JPMorgan’s Jamie Dimon. Of course – but does that mean the end of crypto? No.
UK – Cryptoassets pose limited risks to UK financial stability, according to the Bank of England. “Regulation needs to develop quickly enough, both domestically and at a global level, to address the risks they could pose in the future.”
US – SEC Chair Gary Gensler testified last week before the US House Financial Services Committee. He talked about various things, including dark pools and payment for order flow, but also talked about crypto-assets, stablecoins and DeFi. For a summary , see our blog post here.
US - The Securities & Exchange Commission approved a crypto ETF that will not hold crypto directly. Instead, investors can gain exposure to publicly listed companies that hold bitcoin. No bitcoin ETFs have been approved yet by the SEC, although hopes are rising that this may finally happen soon, perhaps as early as this month. (Coindesk)
US – Crypto investment giant a16z proposed 4 changes on US law to the Banking Committee (including on consumer protection, DAOs and tax).
Brazil – A bill is going to the Chamber of Deputies that would give statutory footing to bitcoin and cryptocurrencies in Brazil for the first time. Brazilian lawmakers have already approved a draft version of Bill 2.303 / 15, but a proposed amendment would go further: it would make bitcoin a “payment currency” (although not proposing to make it legal tender). (Decrypt)
Colombia – A Colombian senator said his country should follow in the footsteps of El Salvador and use renewable energy such as hydropower for bitcoin mining. (Decrypt)
South Korea – Opposition lawmakers are pushing for a one-year extension to a crypto tax law that would impose a flat tax of 20% cryptocurrency gains exceeding 2.5 million Korean won ($2,100) in 2022. Instead, the opposition wants a tiered tax regime, in line with the Financial Investment Income Tax, to come into effect in 2023. (Cointelegraph)
China - The judiciary is reportedly investigating how to convict and sentence activity related to cryptocurrency and judicial interpretations are a likely tool to that end, writes Coindesk.
China – Is China’s crypto crackdown pushing Chinese crypto owners into the arms of foreign exchanges? Bitcoin and other crypto prices edged higher again – although one massive buy of $1.6 billion within minutes pushed up bitcoin prices with 5% and may not have been about being bullish on bitcoin. “It’s an eerie coincidence a trade of this magnitude happened on exchanges with ties to Chinese customers in the middle of a week beset by capital market woes in that country,” writes Coindesk.
El Salvador - Ethereum founder Vitalik Buterin said El Salvador’s approach to bicoin is contrary to the ideals of crypto. "This tactic of pushing BTC to millions of people in El Salvador at the same time with almost no attempt at prior education is reckless, and risks a large number of innocent people getting hacked or scammed,” he wrote. (Decrypt)
Ukraine – Just a few weeks ago, the Ukrainian parliament adopted the “On Virtual Assets” law that would have formally recognized digital assets, offering definitions, assigning supervisory powers among state bodies and establish a new crypto-dedicated regulator. Now, President Zelensky is saying: not so fast. He sent the text back to the Verkhovna Rada, the legislative body, with his own suggestions. The President thinks the planned crypto-specific body will require significant state funding. Instead, he proposed that the country’s securities regulator (National Securities and Stock Market Commission) be the regulatory body for crypto markets. (Bitcoin.com)
Portugal – The first licensed crypto exchange in the country launched online trading. (Coindesk)
Japan – Creditors and other claimants of the now defunct Mt. Gox crypto-exchange had until last Friday to vote for a distribution proposal. The proposal required more than 50% of those with the right to vote to vote in favour of the proposal. If fewer than 50% of claimants voted, or if more than 50% voted against it, the rehabilitation plan would be rejected, meaning no claimants would receive the compensation proposed in the plan. (Cointelegraph)
Global – “Regulatory uncertainty kept coming up at London’s Token2049 conference” last week, writes Coindesk.
Global – Another week, another insider trading allegation. This time, analysts noticed price spikes for tokens on layer-1 blockchains Celo, Avalanche and Algorand shortly before they announced major incentive programs. Were those price spikes caused by insiders trading coins before the announcements were made? "The most logical conclusion is that those closest to the deals or partnerships front-ran the announcements," said a senior analyst at OKEx Insights, although others (including some of the companies behind the layer-1 blockchains) gave alternative potential explanations for the price spikes, such as major developments on those blockchains in the preceding weeks. (Coindesk) Legally speaking, there can only be insider trading if the tokens are securities/financial instruments, but the concern is more fundamental. Crypto has seen several allegations of insider trading-like behaviour. Regardless of the legal qualification, this undermines trust and goes counter to the promise of building fairer markets. It’s good the issue is getting more attention at all levels of the blockchain stack (from layer-1 blockchains to the application and aggregation level), yet it’s not good that these allegations keep popping up. Not all allegations may be true, of course. Yet companies and teams issuing tokens (whether NFTs or layer-1 blockchain incentive tokens) should set clear rules-of-the-game for their team members preventing this type of behaviour. OpenSea only implemented policies preventing their employees from buying NFTs that were yet to list on the platform after such behaviour already occurred. This cannot be an afterthought and should be standard practice for all token-issuing companies and teams.
US – SEC Chair Gary Gensler testified before the House House Financial Services Committee. On stablecoins, or ‘stable value coins’, as he calls them, Gensler wants Congress to clarify how to regulate them. He also compared current stablecoins to poker chips at a casino, although things might be different for future stablecoins with “clear and clean reserves”.
US – The Federal Deposit Insurance Corporation (FDIC) reportedly is considering deposit insurance for stablecoins. So-called pass-through coverage could insure stablecoin-holders “for against losses up to $250,000 if the bank holding the collateral were to fail”. That presumes, of course, that we can identify the stablecoin-holders and how many stablecoins they hold. (Coindesk)
US - Stablecoins are now part of the US Financial Stability Oversight Council (Bloomberg). The FSOC will review “an update on the report on stablecoins being developed by the President’s Working Group on Financial Markets” during its next meeting on 18 October. That part of the discussion will take place behind closed doors, according to the FSOC agenda.
Supranational – Stablecoins should face the same regulation as traditional payments, according to the International Organization of Securities Commissions (IOSCO) and the Bank for International Settlements (BIS). The BIS said its consultative report does not intend to impose new rules, only to clarify the application of the Principles for financial market infrastructures (PFMI) to systemically important stablecoin arrangements. A public consultation on the proposed guidance closes on 1 December. The updated guidance will be finalized in early 2022. (Reuters)
Tether fired back against a Bloomberg story raising questions about Tether’s reserves. The report raised the question whether Tether may be exposed to bad Chinese debt. Although Tether denies holding any commercial paper of Chinese company Evergrande, the Bloomberg story says Tether refused to say whether it held commercial paper from other China-based companies vulnerable to an Evergrande bankruptcy.(Cointelegraph)
Why do traders keep using Tether, regardless of the red flags around its reserves? Here’s one trader’s explanation:
4/ The problem with the mainstream perspective is that it deals in absolutes: "Tether lied/isn't 100% cash-backed" implies "you shouldn't hold Tether" according to this view. Perhaps this is how regular people think about risk, but it's not how traders think.
US - SEC Chair Gary Gensler testified in the US House Committee (see above). On DeFi, Gensler seemed to assume that most DeFi protocols are still centralised enough to impose rules on: “even in the decentralized platforms, or so-called DeFi platforms, there is a centralized protocol. And though they don’t take custody in the same way, those are the places where we can get the maximum amount of public policy.” He didn’t clarify how policies could be imposed on DeFi protocols that don’t custody user assets at all.
What is ‘decentralisation’? When is something truly decentralised? Crypto-lawyer g4brielShapir0 last year proposed a flexible decentralisation test, which is worth a read. He proposes a number rebuttable presumptions in combination with a safe harbour. For example, a rebuttable presumption is “that a person or group owning or controlling more than 20% of the native token” while the safe harbour would apply if no single person or group of affiliated persons beneficially owns more than 10% of the network tokens, directly or indirectly. He suggests a test flexible enough to allow certain aspects of centralisation in an otherwise decentralised network. Although the decentralisation test proposed is difficult to meet, he argues “it should be a difficult test to meet. The purpose of finding that a blockchain system is sufficiently decentralized as a matter of law is to declare that since no person controls the system, no person is legally responsible for it and it is not subject to regulations, such as securities laws, that would ordinarily apply in similar circumstances. For this, the blockchain system must essentially be an un-owned, public commons. To qualify as such, it should truly exist for the benefit of and under the control of the public, rather than predominantly serving the interests of any specific person or group.” Decentralisation should be assessed on several layers:
Validation power (who can read and validate transactions/blocks?)
Consensus power (who can write data on-chain?)
Power over the protocol/client (who can change the rulebook embedded in the blockchain code?)
Economic power (who can affect token price through R&D or trading activity?)
User power (can small tokenholders influence/resist power of large tokenholders?)
US – Acting Comptroller of the Currency Michael Hsu said DeFi and crypto may be another fool’s gold rush: “I have seen one fool’s gold rush from up close in the lead up to the 2008 financial crisis. It feels like we may be on the cusp of another with cryptocurrencies (crypto) and decentralized finance (DeFi).”
DeFi has a governance problem, according to Synthetix’ founder, who called DeFi’s current governance infrastructure “pretty terrible”. Synthetix plans to publish an open-source improved governance module that can be used by other DeFi protocols. (Decrypt)
EU – The EU Blockchain Forum and Observatory published a report on energy efficiency of blockchains, as we mentioned last week. Some key takeaways:
“In recent years, the term ‘blockchain’ has often been used synonymously with inefficiency and disproportionate energy consumption. These claims often point to a single component of the technology, the consensus mechanism. However, blockchain technology is not homogenous, and the amount of energy consumed by different consensus mechanisms varies by several orders of magnitude. Moreover, contrary to often heard statements, energy consumption does not necessarily grow with the number of transactions executed.”
The energy consumption of various types of blockchains can differ significantly: blockchains that rely on a Proof-of-Stake (PoS) consensus consumes “orders of magnitude less energy” than Proof-of-Work (PoW) consensus mechanisms, as used on the Bitcoin and Ethereum blockchain, typically “99.95%” or more. PoS-based blockchains still consume energy, of course, most of which comes from nodes’ idle consumption and redundant processing of transactions (as all nodes keep a full copy of the blockchain history or a significant part of it). PoS systems also risk concentration of tokens, depending on the initial distribution of tokens and the particular type of PoS mechanism. For example, the report argues that the proposed transition of Ethereum to a PoS mechanism could enable “rich users to accumulate more wealth over time”. The report proposed, among other things, that “a blockchain energy consumption index should be developed and agreed upon between the Member States”.
Sri Lanka- Sri Lanka’s government approved a committee to implement crypto mining and blockchain activities to attract investors. The committee will “study the regulations and initiatives of other countries such as Dubai, Malaysia, Philippines, EU, and Singapore etc, and propose a suitable framework for Sri Lanka”, according to a press release. (Cointelegraph)
NFTs are no longer just about crypto collectibles (if they ever were): companies are starting to offer a slew of new services around the booming NFT industry. Republic is offering users ‘Security NFTs’, which allow people to invest in albums and songs of artists. (The Block) Other companies are offering NFT-based lending, using an NFT as collateral for a loan or rent-an-NFT services.
Can NFTs be securities? They might, if they offer royalties not to the original artist but to the NFT holders. FTX and OpenSea both restrict such NFTs from trading on their platforms. (The Block)
Thanks for reading!