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Main blockchain and crypto trends in 2022: unexpected expectations

18-01-2022 | Carlo de Meijer | treasuryXL | LinkedIn |

For me it is becoming a sort of tradition. Writing a blog about the upcoming trends in the Blockchain and crypto arena for the next year and beyond.

 

A year ago I concluded with the sentence: “always expect the unexpected”.

 

And unexpected was the upcoming of the DeFi market, as well that of NFT. But also a growing number of traditional banks entering the crypto scene, increasingly believing crypto is here to stay. What may bring this year? This will be described in the following 15 trends.

 

1. New third and fourth generation blockchain solutions

A first trend we will observe is de-acceleration in the development of new third and fourth-generation solutions aimed at removing the speed and scalability challenges. Third-generation blockchain platforms like Aion, Cardano, and EOS, introduced technology such as sharding to tackle scaling issues in order to cut down on cost and speed of transactions. These platforms also matured the distributed application capabilities of blockchain.

And there are fourth-generation blockchains aimed to resolve prior challenges and enable trust in easy-to-consume ways, accelerating the formation, operation, and reconfiguration of business networks. In addition to greater ease of onboarding, these lower cost, and highly scalable platforms are built to make pragmatic trade-offs such as recognizing that not all transactions are created equal using variable consensus mechanisms. Interesting fourth-generation blockchain platforms like Insolar and Aergo, are enabling business networks to be easier to use through business-oriented interfaces that hide the complexity of the underlying blockchain technology.

2. Towards more blockchain standardisation and interoperability

Another trend we will see in 2022 is an acceleration in the creation of standards and interoperability possibilities. These should enable multiple blockchains to communicate. The number of blockchain and distributed ledger networks are firmly growing. Most blockchain networks operate on isolated ecosystems as they try to resolve a unique set of needs. Interconnecting these new chains is becoming a necessity as more people continue to take note of the emerging technology and its capabilities.

Standards are an important key to success for any developing technology, and blockchain is no exception. The right standards, set at the right time in a technology’s development, can ensure interoperability, generate trust in and help ensure ease of use of the technology. In this way, they support its development and create a pathway to mass adoption.

The rapid development of blockchain is set to give rise to many different kinds of chains. One such technology that is becoming increasingly evident is cross-chain technology, an emerging technology that seeks to allow the transmission of value and information between different blockchain networks. This technology is increasingly becoming a hot topic of discussion seen as the ultimate solution for enhancing interoperability between blockchains.

3. Blockchain-as-a-service (BaaS) solutions

BaaS has emerged as a boosting adoption across business companies due to many developments in this atmosphere of blockchain. The demand for Blockchain-as-a-service (BaaS), a third-party creation and management of cloud-based networks for companies in the business of creating blockchain applications, among companies is firmly growing and that will continue in 2022. Main players in this space include Microsoft, Amazon and R3.

BaaS facilitates its clients to leverage the solutions to build hosts, based on the cloud and enable them to operate related functions on the blockchain and their applications, without having to overcome technical difficulties or operational overhead and without the need to invest in more infrastructure developments as well as lack of skills. BaaS operators help the clients to focus only on their core job and blockchain functions

4. Great demand for blockchain and crypto skills

The year 2022 will see a greater demand for blockchain and crypto skills. The potential for growth in the blockchain industry and the increasing dominance of blockchain across various sectors serve as a prominent reason for the increased demand for these skills. The promises of blockchain technology for enterprises in terms of cost efficiency and performance improvement and the booming development of the crypto markets translate directly into the rise in demand for blockchain professionals.

A report by LinkedIn has placed blockchain as one of the most in-demand skills for 2021 and beyond. Enterprises therefore need blockchain professionals with the skills to help them leverage most of blockchain technology for driving their business objectives. 

5. Blockchain-IOT-G5 integration 

This year we experienced a growing trend of blockchain being integrated with other technologies such as Big Data and Artificial Intelligence amongst others. There is also growing attention of corporates to use blockchain for IoT or Internet of Things applications.

The IoT market is increasing drastically and this is expected to continue in 2022 in an accelerated way triggered by the recent uptake of the 5G network. The expected potential of the 5G IoT market today is however limited by an extremely fragmented IoT ecosystem.

Blockchain technology appears as potentially the most suitable and efficient way to the various 5G IoT challenges. It can potentially help to solve many problems around security as well as scalability due to the automated encrypted and immutable nature of blockchain. It is expected to hear about more pilot projects and initial use cases in this field during 2022.

6. Blockchain and the Metaverse

Blockchain applications in Metaverse are another top blockchain trend in 2002. Metaverse is the emerging universe of the formerly known Facebook where there will be ‘immersive’ experiences with new technologies like blockchain, augmented reality, virtual reality etc. Without blockchain technology the Metaverse would be incomplete because everything would be stored in the centralised network.

Blockchain will enable the upcoming of a new wave of social networks that could be bigger and even better than the existing ones such as the former Facebook, Instagram, Twitter, and YouTube that are now synonymous with the word social media.

Blockchain in 2022 is expected to run multiple platforms on Metaverse with NFTs and cryptocurrencies. Digital assets like NFTs will thereby define ownership on the Metaverse and cryptocurrencies will power the new digital economy. Moreover, also Twitter, with its vast user base of 192 million daily active users, is now planning to integrate cryptocurrencies into the platform with things like Bitcoin tipping for creators.

7. Blockchain and governments

Governments are also starting to enter the blockchain market. Blockchain provides new ways for governments to organize processes and handle information in a more efficient way. Over the past few years, governments in several countries have been experimenting with the application of this novel technology to a wide variety of functions and services, including land registration, educational credentialing, health care, procurement, food supply chains, and identity management.

What is holding back various governments up till now is the factor of trust. The World Bank therefore proposes a “Three Layer” design and implementation framework, to prevent potential glitches between the technology and its intended application. Their framework comprises the social layer, data layer, and technical layer. The social layer constitutes human actors and social aspects such as incentives and motivation among others.

The data layer is the ledger itself and what it provides in terms of usability, security, authenticity, and reliability. The technical layer comprises DLT protocols, data storage, and consensus mechanisms among others.

8. More projects on CBDCs

With 80% of the world’s central banks now exploring Central Bank Digital Currency (CBDC) projects during 2021, according to the Bank of International Settlement, the year 2022 will see a further breakthrough. Governments worldwide realise that cryptocurrencies are here to stay and the majority of CBDCs are being introduced to ensure their monetary system stays relevant to consumer demands and not necessarily to eradicate the use of Bitcoin and other private cryptocurrencies.

Despite most central banks are still planning their frameworks for what a CBDC might look like, there are already CBDCs that have gone live. These however are limited to a few small countries including the Bahamas, Cambodia, the Eastern Caribbean States and most recently followed by Nigeria.

In terms of developed nations, China and Sweden (e-krona) are the most advanced with extensive pilots having already taken place. China is expecting to further test its CBDC – digital yuan – during the Winter Olympics in early 2022. This will certainly trigger other central banks including those of the UK, the US, Russia, Japan and the European Central Bank, to follow suit.

9. The DeFi market will further boom ….

DeFi, or decentralised finance is quickly emerging as a transparent and permissionless way for users to interact directly with each other. This year the value of assets in DeFi reached more than $180 bn and expectations are that this will further rise in 2022. As there is an increasing need to replicate physical items properties like uniqueness, ownership proof, we will see further uptake of the DeFi market as well as the arrival of more dedicated DeFi applications. Upcoming regulation, as well as the growing acceptance that crypto is here to stay, may in the longer term lead to more convergence between traditional or centralised finance (CeFi) and decentralised finance (DeFi).

10. ….. as well as NFTs

The remarkable growth of the NFT market in 2021 is expected to continue in 2022. As almost everything is becoming digital, there is an increasing need to replicate physical items properties like more uniqueness, ownership proof and scarcity. The Metaverse concept that was earlier described will bring plenty of new opportunities for innovative NFT use cases.

Various new use cases including gaming, music, ticketing, post on social media etc. are entering the NFT market attracted by the various benefits and the profits that can be made.

But the risks and challenges this market is confronted with will ask for regulatory intervention. This raises the importance of having an international regulatory body of non-fungible tokens for its better regulation and legalization. The outcome could have a great impact and will be decisive for the future of NTFs. It is however still uncertain how that will proceed.

11. Large banks are entering the DeFi market

The attitude of traditional banks, especially the larger ones towards crypto and DeFi is changing. . With central banks around the world beginning to embrace the concept of CDBCs and stablecoins, the principles underlying the DeFi industry will gain more and more acceptance amongst traditional firms. The banking industry is beginning to see DeFi’s potential to overhaul the inflexibility of present processes and are reacting. More and more established banks, pushed by the demands of their clients and shareholders, are now exploring how they might engage with DeFi and the crypto markets. While this year some big names entered the DeFi space in order to meet their customers’ demand for crypto thereby delivering a number of DeFi based applications, this number will further increase in 2022 thereby seeking greater exposure to the DeFi space.

12. We will see more DAOs

To meet the upcoming governance issues at DeFi organisations we will see the arrival of more decentralised autonomous organisations or DAOs in 2022 and beyond.

The decision-making, or governance, at DeFi organizations (from the fees they charge users to the products they offer) is often meant to be decentralized. In the initial stage of DeFi a single person or a small group of people might be driving a decentralized application at inception. But as the DeFi project gains momentum they often seek to step away, thereby handing over control to the community that uses it.

That transition is expected to be increasingly in the form of a decentralized autonomous organization (DAO). They have their rules and regulations embedded in programming code via smart contracts and may issue governance tokens, which give holders of those coins a say in decisions.

13. The number of challenger banks and crypto banks will further grow

A new trend we will see in the years to come is the rising number of challenger and crypto banks, aimed at meeting the needs of millennials and the Gen Z generation. Both are increasingly looking to new ways money is being managed. This has led to the emergence of challenger banks that are making finance fully digital. But even this is not enough for the 25-year-olds and under, Gen Z. Saving, making money work, and being in control of finances is a key difference between millennials and Gen Z and this is where cryptocurrency starts to enter the discussion. This will intensify the upcoming of crypto banks.

14. Crypto currency rates to more realistic levels

Notwithstanding there is a growing demand for cryptocurrencies not only from consumers but also from institutional investors as well as large financial institutions, 2022 will see the end of the cryptocurrency hype, a further correction in crypto rates and the return to more realistic levels, triggered by the upcoming regulations worldwide (see trend 15).

Notwithstanding the growing importance of the DeFi and NFT markets, the year 2022 may see crypto currencies lose some of their magic. Investors are greatly overestimating the speed with which the related blockchain technology will see a broad-based adoption. This may retrace trading euphoria in a bigger way in the cryptocurrency space.

15. Regulators are making up their mind

And finally, but most important, a growing number of regulators around the world – long-time struggling how to deal with the various crypto issues – will intensify their work and come up with regulatory measures, both individually and collectively. Aim is to meet the various risks and challenges of the crypto industry, including cryptocurrencies, crypto assets, stable coins, DeFi, NFT etc. on one hand, but without frustrating or harming technology developments.

While some countries have banned cryptocurrency entirely, there is a growing trend that regulators believe cryptocurrencies are here to stay and try to partially control their flow in the economy. International institutions like BIS, IMF, World Bank and others however are messaging that international regulatory collaboration and a cohesive regulatory framework is urgently needed.



Promising 2022

Dear followers. All these trends are based on a number of premisses. Thereby older trends play an important role in making these forecasts. If all these predictions come through, 2022 will be a great year for blockchain and the crypto industry. But as I also concluded in my blog on the trends of 2021: always expect the unexpected. Curious to experience.

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

What is holding back blockchain adoption and what should be done?

08-12-2021 | Carlo de Meijer | treasuryXL | LinkedIn

Early this year I wrote a blog about the existing technology challenges that were holding back a more massive adoption of blockchain technology and of possible solutions that may tackle these. Though blockchain has many advantages this technology still has a lot of growing pains to go through before it could unlock its full potential.

So I was wondering where we are now. Gartner showed several times, any new technology – and that is blockchain too – has to go through various stages.

“According to recent surveys, almost 90% of blockchain-based projects still failed.”

 

And that is not strange. For new technologies, it takes a lot of time to get rid of all the challenges and use it to power the modern world. And these challenges are not only technical. What is the way forward?


Challenges

Blockchain technology has been surrounded by plenty of hypes, which makes many business leaders keenly interested in adopting it. Blockchain however faces different blockchain adoption challenges that make them reluctant. These are not only related to technological inefficiencies, but also to the lack of regulation and limited knowledge/awareness. Most of these challenges still need to be addressed and overcome in order for the technology to reach omnipresence and make blockchain a more acceptable technology for all.

 

Technological challenges

Although blockchain technology has a lot of benefits, it still has a number of shortcomings in technological ways, that are preventing a much higher adoption. Bitcoin but also other blockchains are well known for their inefficient technological design, leading to low scalability, lack of speed of the network, high energy consumption and as a result high costs of transactions. Besides, there is a lack of standardisation and interoperability, limiting the chance for different blockchains to communicate with each other. Ethereum tried to cover up a number of these defects, but it is still not enough.

Low scalability
First of all there is the scalability issue. Their limited capacity to scale in order to handle large transaction volumes. This so-called ‘scalability trilemma’ is the main reason why many doubt that blockchain systems would ever be capable of operating at scale. It essentially revolves around the difficulties current blockchain platforms experience when trying to find the right balance between scalability, decentralization and security. In reality, blockchains work fine for a small number of users. But what happens when a mass integration will take place? Ethereum and Bitcoin nowadays have the highest number of users on the network, but they are having a hard time dealing with the situation.

Lack of speed
Another important challenge that should be addressed is the need to increase the processing speeds. When the number of users increases, the network tends to slow down taking more time to process any transactions. This may result in huge transaction fees, making the technology less and less attractive. Also, the encryption of the system could make it even slower. Completing a transaction can take up to several hours or sometimes even days. It is thus most suited for making large transactions where time is not a vital element. This blockchain adoption challenge can become a hurdle soon.

High energy consumption
High energy consumption is a blockchain adoption challenge, especially now with the worldwide climate discussion. Most of the blockchain technologies follow Bitcoins infrastructure and use Proof of Work (PoW) as a consensus algorithm, thereby needing massive computational power, which is very energy-intensive.

This not only limits the opportunities for ordinary people to join PoW networks and hinders decentralization by encouraging the formation of large mining pools, but it also raises environmental concerns. At present, miners are using 0.2% of the total electricity. If it keeps increasing, then miners will take more power than the world can provide. Many organizations are trying to avoid blockchain altogether just for this challenge.

Lack of standardization
A fourth issue that is limiting a more massive blockchain adoption is the lack of standardization. Standards are required for any technology to have a scalable adoption across the globe. All networks which will be using blockchain technology need to speak the same language in order to be understood and to complete the transaction. All new technologies however suffer from this at the beginning till the standards slowly build up from experience.

Lack of interoperability
As more organizations begin adopting blockchain, there is a tendency for many to develop their own systems with varying characteristics (governance rules, blockchain technology versions, consensus models, etc.). These separate blockchains mostly do not work together, and there is currently no universal standard to enable different networks to communicate with each other. Blockchain interoperability includes the ability to share, see and access information across different blockchain networks without the need for an intermediary or central authority. This lack of interoperability can make mass adoption an almost impossible task.

Regulatory challenges

Next to these technological challenges, another big obstacle to blockchain adoption is the lack of regulatory clarity. Existing regulatory regimes are unable to keep up with the rapid development happening in blockchain and crypto. There aren’t any specific regulations about it. So, no one follows any specific rules when it comes to the blockchain.

Initial coin offerings, stablecoins and DeFi protocols have in recent years demonstrated the limitations of current rules and regulations when it comes to handling the sector. There are various challenges caused by this lack of regulation, including criminal activities, lack of privacy, and, although blockchain guarantees visibility as one of its benefits, there is still no security.

Criminal connection/activities
There is the anonymous feature of the blockchain technology that may become a great threat. The nature of the blockchain network is decentralized so that no one can know your true identity. Being anonymous is however quite convenient for illegal transactions. This has attracted criminals leading to various cybercrimes/illegal transactions such as crypto exchange hacks, scam projects, market manipulation asking cryptos in exchange as a ransom or using Bitcoin as a currency in the black market and on the dark web.

Lack of privacy
Privacy is another challenge as far as the blockchain is concerned. One of the greatest strengths of blockchain technology, public blockchain networks in particular, is the transparency that comes from having a record of a network’s transaction history that is public and easy to verify. This is however not always seen as a positive, as it also poses threat to privacy of organisations or the public using it. Many companies that work with privacy need to have defined boundaries. Enterprises, which want to protect their trade secrets and other sensitive information, are therefore reluctant to embrace some of the most prominent blockchain protocols.

Security and trust problems
Security is another crucial topic here that may limit blockchain adoption. Every blockchain technology talks about its security as the main advantage. But like any other technology, blockchain also comes with a number of security risks including coding flaws or loopholes. Ethereum allows developers to implement dApps based on their system. And there have been many dApps based on them. However, most of them seem to have a matter of false coding and loopholes. Users can utilize these loopholes and hack into the system quickly. The resulting lack of trust among blockchain users is another major obstacle to widespread implementation.

 

Educational challenges

Blockchain is still very much an emerging technology, and the skills needed to develop and use it are scarce, while the lack of awareness amongst the large public are challenging the adoption of this technology.

Lack of Adequate Skill Sets
This skills gap is a top challenge. The marketplace for blockchain skills and qualified people to manage blockchain technology is highly competitive. The demand for this qualified staff is enormous but few people have the adequate skills to support such technology, so one has to pay up high salaries.

The expense and difficulty of talent acquisition in this area only adds to the concerns that organizations have about adopting blockchain and integrating it with legacy systems.

Lack of awareness
Though broader awareness of the technology is growing, the majority of organizations are still in the early stages of adoption. Only 12% of participants in a recent survey reported that they are live with either blockchain or blockchain as a service, while 34% of respondents are not even exploring the use of it. But also the majority of the public is still not aware of the existence and potential use of blockchain, while there is lack of proper marketing of this technology.

Blockchain = Bitcoin?
Blockchain is an emerging technology and the distributed ledger technology (DLT)  space is still relatively young. And with crypto price volatility dominating the headlines of mainstream media, it is not surprising that the immense utility the technology has is not well understood by the public. Currently, blockchain technology is almost the same meaning as Bitcoin and remains associated with the dark transactions of money laundering, black trade, and other illegal activities. Before a general adoption is possible, the large public must understand the difference between Bitcoins, other cryptocurrencies, and blockchain.

Ways to accelerate blockchain adoption

As I described in my earlier blog, there are a number of ways to solve the various challenges. Challenges such as inefficient technological design, lack of scalability, low speed, lack of standards and interoperability as well as high energy consumption should be tackled by technology innovations.

The privacy, trust and security issues ask for proper regulation without endangering technology innovations. Lack of skills and poor public perception and awareness should be increased by education and broad information and communication.

Technological improvements

The list of blockchain adoption challenges clearly underlines the need for technological improvements. The sector needs to find ways to address the biggest challenges it is currently facing. In my blog of 28 February 2021 “Blockchain Technology Challenges: new third-generation Solutions” I already explained the various solutions in a more detailed way. So, I am not going to repeat that.

The good news is that, as we saw above, the blockchain community is actively working on solving these technological challenges such as speed and power consumption thereby using improved technology.

Refining consensus algorithms
Proof of Work (PoW) has played a crucial role in bringing the blockchain revolution to the world, but its drawbacks in important areas such as scalability, speed and energy consumption suggest that PoW can no longer support the further growth and evolution of blockchain. Blockchain can utilize other more refined consensus methods to validate the transitions. This has forced Ethereum to start a transition to a Proof of Stake (PoS) consensus algorithm that requires fewer energy to process.

Layer 2 solutions
The scalability problem can also be tackled by building so-called Layer 2 or off-chain scaling solutions that refer to approaches that allow transactions to be executed, taking some of the load of the main chain, without overcharging the blockchain. There are a number of interesting off-chain solutions ranging from state channels, accelerated chips, side chains to sharding.

State channels
State channels refer to the process in which users transact with one another directly outside of the blockchain, or ‘off-chain,’ and greatly minimize their use of ‘on-chain’ operations, while accelerated chips could be used to speed up confirmation and transaction time.

Sidechains
Another tool to speed up scalability are so-called side chains. These are aimed to reduce the load on a given blockchain by sending transactions via these connected side chains and putting the end state of the transaction on the main blockchain.

Sharding
And there is sharding, a scaling solution of spreading out the computing and storage workload from a blockchain into single nodes. This technology divides a blockchain into many separate areas, called shards, with each shard assigned a small group of nodes to maintain, thereby limiting the transactional lode. Polkadot is one of those examples built around the idea of sharding.

Multi-layered structure
Another solution to upgrade scale is the use of multi-layered structures, which is the isolation of transaction processing and data storage. Main projects are Cardano and CPCChain.

 

Zero-knowledge proofs
To solve the privacy challenge several protocols have been developed as alternatives to Bitcoin’s pseudo-anonymity, such as CoinJoin and Ring Signature.  An interesting tool is a zero-knowledge proof. This is a class of mathematical instruments that can be used to show that something is true without disclosing the actual data that proves it. The Baseline Protocol, for example, utilizes Zero-Knowledge proofs and other cryptographic techniques and instruments to synchronize private business processes via the Ethereum Mainnet while preserving privacy, confidentiality and data security.

 

Private blockchains
The privacy issues, especially for enterprises, that come with the transparent nature of public blockchains can also be avoided by using private networks such as Corda, Hyperledger and Quorum. These networks are designed to support a relatively small number of network participants with known identity, thereby providing the capability of executing private transactions between two or more participating nodes. Since participation in such networks requires permission, they are also called permissioned blockchain networks.

Private blockchain protocols can be used to create practical enterprise-grade solutions capable of connecting multiple companies or separate departments within a company. Participants would get limited access, and all sensitive information would stay private as it should. As an example, to build trust among users, TradeLens (a global logistics network created by Maersk and IBM using the IBM Blockchain Platform) uses a permissioned blockchain to offer immutability, privacy and traceability of shipping documents. 

Hybrid approach
The power of private and public blockchains can also be combined to achieve optimal results. This so-called hybrid blockchain approach involves using a public blockchain to store encrypted proof for all the work that has been done on a private network thereby connecting a small number of known stakeholders.


Standards and interoperability
Over the past few years we have seen an increasing number of interoperability projects meant to bridge the gap between different blockchains. Many of them are aimed at connecting private networks to each other or to public blockchains. These systems will ultimately be more useful to business leaders than prior approaches that focused on public blockchains and cryptocurrency-related tools.

Next to the more well-known examples of cross-chain communications that are most first- or second-generation, like the Bitcoin Lightning Network, the Ethereum Raid Network and the Ripple Interledger Protocol, there is a growing number of interoperability projects that are exploring third-generation solutions, including Cosmos, Neox and Polkadot.  And there is a growing number of projects teaming up in order to allow their blockchains to communicate with each other, aiming at solving the blockchain isolation problem. Main example is the Blockchain Industrial Alliance formed by ICON, AION and Wanchain.

 

Regulatory frameworks
The rapid evolution of blockchain technology has caught regulators around the world by surprise, leaving them scrambling to react to a rapidly growing and changing industry. Though regulators are now taking more and more steps in a growing number of countries to deal with this situation, there is still a lack of a unified approach when it comes to the regulation of the blockchain sector. This has resulted in a regulatory patchwork, with various jurisdictions across the world and sometimes even different regulatory bodies in a single region coming up with their own rules and regulations for the sector.

This problem could be countered by drawing up regulatory frameworks that afford regulatory consistency across larger regions. An example of such a framework is the European Commission’s propose Markets in Crypto Assets Regulation (MICA), which will introduce an EU-wide regime for crypto tokens. Thereby they are taking a pragmatic approach of regulating the market without harming the technology.

Raising skills quality and awareness
A closer examination of this barrier shows that it is very much connected to an underlying lack of organizational awareness, lack of adequate skills and lack of knowledge and understanding of blockchain technology. As awareness of blockchain technology becomes more widespread, the ability to effectively make a business case for their adoption, might contribute to more massive adoption.

Raising awareness
Considering that distributed ledger technologies are still largely unknown to the public, it is on the blockchain community to inform people about the technology’s design, strengths and utility. Building educational resources, holding webinars and other educational events are some of the ways that blockchain companies can utilize to raise awareness. Initiatives like Coinbase Learn are examples of how some of the world’s leading blockchain companies are working to raise awareness about blockchain technology.

Blockchain-as-a-service
And there is blockchain-as-a-service (BaaS) that has the potential to mitigate the blockchain skills barrier. The use of BaaS enables organizations to reap the benefits of blockchain, without having to invest significantly in the expensive blockchain skills. Users only need to know the basics of the technology (not the technological insides) to take advantage. They will for instance need to understand how to execute smart contracts, but they won’t need specialized knowledge about the complexities of distributed ledgers.

Forward-looking
Blockchains are ecosystems that require broad adoption to work effectively. Without widespread adoption, the effectiveness and scalability of blockchains will remain limited. As described in this blog the adoption of blockchain and DLTs depends on solving the various challenges and will require active support from governments and other public organizations. Organizations are increasingly coming together and forming collaborative blockchain working groups to address common pain points and develop solutions that can benefit everyone without revealing proprietary information. There is already a lot of applications and projects live that is working perfectly. Like any technological innovation, the blockchain will continue to evolve. Yes, there may be challenges, but they should not be seen as obstacles. So, as I have shown, all the problems with blockchain will come with solutions and opportunities. There are this good reasons to be optimistic that the adoption of blockchain will grow.

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

Non-fungible Tokens: bubble or future?

| 29-11-2021 | Carlo de Meijer | treasuryXL | LinkedIn

A new phenomenon in the blockchain world are so-called NFTs or non-fungible tokens. Although NFTs have been around for some years, the market for digital art pieces, commemorative items, and other assets that now reside in blockchain ecosystems has exploded this year.

The NFT market got an enormous boost after Christie’s auction house sold a digital artwork last March titled “Everydays: The First 5,000 Days” made by digital artist Beeple for an astronomic $69,4 million. And there have been more of these exorbitant transactions. This triggered the NFTs market to grow exponentially, thereby gaining profound attention from various players from mainstream companies to retail and institutional investors.

Many are still struggling with the NFT phenomenon. While some see NFTs as a bubble, comparing it with the tulip mania in the 17th century,  thereby debating over how long the NFT trend would last, others believe NFTs are here to stay and see it as the next investment theme.

In this blog, I will go into more detail related to the world of NFTs, what they are, where they could be used and what they may bring. But above all what are the risks and challenges associated with this new phenomenon.


What are NFTs?

NFTs, which stands for non-fungible token, are unique or distinct digital assets that cannot be replaced. Broadly speaking, they’re a one-of-a-kind digital asset. They have distinct properties, and can’t be changed with other assets. They are digital files that can carry any form of digital content (and can even contain access to physical content) from art to video to music.

NFTs rely on blockchain and cryptocurrencies to keep track of digital ownership and create scarcity to ensure they cannot be identically reproduced. NFTs enable to verify the authenticity of a digital artwork.

NFTs are not cryptocurrencies

NFTs are a type of asset which can be bought with cryptocurrencies. Both are tokens that are key elements in the world of blockchain. While both NFTs and cryptocurrencies use the same blockchain technology, they however differ in their attributes.

Cryptocurrencies use fungible tokens, meaning they can be traded or exchanged for one another. They are accessible in various forms and are utilized for various reasons. Every token is exactly the same and equal (represent the same amount of value). Crypto’s fungibility makes it a trusted means of conducting transactions on the blockchain.

A non-fungible token is different from notable cryptocurrencies in terms of fungibility. With NFTs, every token is different and unique. Each has a digital signature that makes it impossible for NFTs to be exchanged for or equal to one another (hence, non-fungible). If a person were to receive two NFTs, they would not represent the same piece of digital content, even if they were both exact copies of the same digital file.

What Are NFTs Used For?

NFTs are considered beneficial in a wide variety of blockchain use cases  They can be literally anything digital such as art, fashion, licenses and certifications, collectibles, sports, etc.

NFTs are nowadays increasingly used in contemporary art auctions, including images, animation or even tweets. Non-fungible tokens also have made their way into real life applications beyond digital art and collectibles, such as music clips, videos, games, or even a ticket to an event, such as a movie or a sport game, that took place at a specific time. But also for domain names, virtual land and real estate.

An upcoming use case for NTFs recently is photography. Photography and prints have been particularly successful in this new online environment. Photographers are increasingly finding a new market for their work with NFTs.

An interesting new use case are political NFTs.  In the US a Democrat-backed group, named Front Row, is planning the launch of a political NFT marketplace, that will be exclusively used for Democratic party campaigns and causes.

How does the NFT market work?

But how does the NTF market work? How can they be created and traded?

Creation of NFTs

Artists who want to create an NFT of one of their digital artworks will have to use one of the NFT platforms or NFT marketplaces. An NFT is created by ‘minting’ a digital asset (whatever it may be) on a blockchain. For that a digital wallet is needed with cryptocurrencies that allows you to store NFTs and cryptocurrencies.

Though there are more blockchains supporting different cryptocurrencies that can host NFTs, most major digital transactions are taking place on Ethereum.  Ethereum’s MetaMask is such a wallet that is mostly used in the NFT market. This wallet can be downloaded from the App Store or via chrome extension.

Artists will need to purchase at least a fractional amount of Ether for so-called ‘gas fees’. This will enable them to cover the costs associated with minting your NFT, which places it on the Ethereum blockchain, and listing it for sale.

When adding an NFT to the Ethereum blockchain, a smart contract is added to the blockchain containing a set of actions and certain conditions to meet. They can be coded to detail the limitations on the use of an NFT. Once the conditions are met, the action takes place (such as providing a digital file to a buyer), and the blockchain is updated with this transaction.

Subsequently, the NFT creator has the privilege of putting up the NFT for sale on a marketplace. At the same time, NFT creators could associate the NFTs with a royalty agreement to receive added compensation with every sale.

NFTs can be sold or bought in the digital market via NFT market places.

NFT selling

In order to connect with NFT marketplaces and authenticate their identity, to access these market, they are required to have a digital wallet to streamline this process. If one wants to sell it or trade NFTs, it depends on the platform and whether he can send it to other platforms or only keep it on that platform. Even if one is just selling an NFT, one still needs to pay a transaction fee in ETH gas, which is a denomination of the token called Gwei (one billionth of ETH).

The new owner of an NFT would receive possession of the NFT through a smart contract. NFT sellers will thereby need to ensure that smart contracts clearly outline the rights that are being assigned as part of the NFT. In most cases, the NFT holder is simply obtaining a non-exclusive license to the underlying intellectual property rights of an asset and only for non-commercial purposes.

NFT buying

How you buy an NFT depends on the type of NFT you want to buy and the platform you are using. Most NFTs are purchased with a cryptocurrency and some with fiat currency. For buying NFTs, you must have a crypto wallet that allows you to store NFTs and cryptocurrencies.

Before purchasing any NFT, one first needs to purchase some cryptocurrency. This depends on what currencies your NFT provider accepts. Most likely this will be ETH, Ethereum’s native token. They can be purchased by using a credit card on almost any digital exchange from Coinbase, Binance, eToro to Coinbase and even Paypal now. Most exchanges charge at least a percentage of your transaction when you buy crypto.

After this one will be able to move it from the exchange to their crypto wallet of choice. From that on it is simple on most platforms to connect the wallet. Once the wallet had been connected, users can begin browsing the market and placing bids.

Each user’s wallet address thereby acts as a passport and lets users interact with certain NFT platforms. And if one later decide to use NFT marketplaces outside of Ethereum, one will still be able to swap ETH tokens for alternative blockchain tokens.

NFT Market places

NFTs allow digital works to at least be traded via NFT marketplaces. On these marketplaces NFTs can be created, bought or sold. Most marketplaces hold auctions where users can submit a bid for an NFT they wish to purchase. Buying an NFT from the primary marketplace increases potential resale value directly after the product goes on sale. That especially goes for a high demand NFT immediately after their release. On the other hand, one of the main issues with buying an NFT from a primary marketplace is it is hard to estimate the demand for the art. On the secondary marketplace, however, users are able compare purchases to previous sales.


Most popular NFT marketplaces

Currently there are several NFT marketplaces and each marketplace sell different types of NFT. The most popular and largest ones include: OpenSea, Rarible and Foundation NFT. Other interesting platforms have names like CryptoSlam, AtomicAssets, SuperRare, Nifty Gateway and NBA Top Shot. Most of these marketplaces are still hosted on Ethereum’s blockchain, thereby acting as Ethereum’s dApps.

OpenSea is a marketplace for NFTs which operates on Ethereum trading rare digital items and collectibles. It hosts a variety of digital collectibles, from video game items to digital artwork. Using OpenSea, users can interact with the network to browse NFT collections to exchange NFTs for cryptocurrency. One can also sort pieces by sales volume to discover new artists.

Rarible s a  so-called ‘democratic’, open marketplace that allows artists and creators to issue and sell NFTs. RARI tokens issued on the platform enable holders to weigh in on features like fees and community rules.

On the Foundation NFT marketplace artists must receive “upvotes” or an invitation from fellow creators to post their art. The community’s exclusivity and cost of entry – artists must also purchase “gas” to mint NFTs – means it may boast higher-calibre artwork.

An interesting newcomer on the NFT market is Coinbase. The cryptocurrency exchange, aims to launch a marketplace that lets users mint, collect and trade NFTs. Users can sign up to a waitlist for early access to the feature. Its marketplace, to be named Coinbase NFT, would include ‘social features’ and tap into the so-called creator economy (a term used to describe the world of people who make money posting videos and other content online).

What may NFTs bring?

NFTs provide a number of  advantages to both content creators, sellers and buyers, depending on the platform they are created on. With NFTs in Ethereum, the smart contract is automatic: The code in the smart contract cannot be changed once it’s added to the blockchain, and the transaction cannot be changed once the criteria have been met and verified. This provides security to both creators and buyers.

For the creator 

Blockchain technology and NFTs afford artists and content creators a unique opportunity to monetize their wares. For example, artists no longer have to rely on galleries or auction houses to sell their art. They can sell it directly to the consumer as an NFT, which also lets them keep more of the profits.

Typically, most art pieces are physically sorted, which exposes them to the risk of being stolen or duplicated. NFTs may eliminate these shortcomings to certain extent by allowing artists to keep the records of the actual copy on the blockchain network. On top NFTs create an ecosystem where artists can authenticate the actual ownership of their work by recording the metadata on-chain.

Most websites where NFTs are sold also allow content creators to add a royalty system to the subsequent selling of their content. Doing this they may receive a percentage of sales whenever their art is sold to a new owner. Importantly, the artist benefits every single time their NFT changes hands. This is seen as an attractive feature as artists generally do not receive future proceeds after their art is first sold.

For the collector

NFTs allow for proof of ownership in the digital world for the collector. Before the invention of NFTs, there was no way to prove the ownership or authenticity of digital artworks or collectibles. With NFTs the investor has true ownership of the non-fungible token they purchase. When a digital asset is tokenized this creates value as it is possible to prove its authenticity and ownership, which also means it can be bought and sold many times over.

With NFTs, a copy can be verified with the use of a unique identifier included in the NFT, and the history of ownership for that copy can be maintained. Because it has a unique identifier, and there’s a record of the work on the blockchain, it’s easy to track.

Next to that due to blockchain technology and NFTs, the principle of ‘scarcity’ now also exists
in the digital world. This because each NFT is rare, unique and indivisible. For a collector, the intrinsic value associated with the purchase of an NFT is supporting an artist whose work they admire.

It also give access to decentralised finance (DeFi) NFT services. Some NFT projects such as Hoard marketplace are providing DeFi services which allows users to buy, sell, loan or rent NFTs. The platform empowers developers with tools to integrate digital art, in-game items and domain names with the Ethereum blockchain.

Other potential benefits of this NFT eco system are growth prospects and value preservation where artist can preserve their art and yield income. The growth prospects of NFTs are significant and present more opportunities for creatives and investors to join the market. The NFT market is firmly growing, which means most NFTs could only become more valuable and innovative as time goes on.

And there are the utility benefits. NFTs enable businesses and individuals to acquire and protect value in real-world and virtual objects. When one owns an NFT on the blockchain, one has the ability to flip it, or sell it on the secondary market, for profit.

The downside of NFTs

While the advantages/benefits of NFTs clearly paint a promising  picture for their future, these markets are also confronted with various challenges and risks that one should consider before deciding to enter the space.

First of all there is the market risk. The market for NFTs such as digital art and collectibles is booming — but that doesn’t mean they are a safe investment. Investing in NFTs comes with its own unique set of risks. Their future is uncertain, and we don’t yet have a lot of history to judge their performance. When investing in NFTs one should be aware of volatility, illiquidity, and fraud in the nascent market.

Though investing in art is often a subjective act, there is the risk of losing its value. The NFT market suffers from massive volatility,  in part because there aren’t any mechanisms in place yet to help people price these digital assets.

When it comes to liquidity of NFTs every seller needs to find a buyer who’s willing to pay a certain price for a particular, one-of-a-kind item. That can put collectors in a difficult position if they have spent a lot of money on a ‘Top Shot‘ moment and the market begins to tank.

Another risk refers to the uncertainty in determining the value of NFTs. The valuation of NFTs depends considerably on the authenticity, creativity, and the perception of owners and buyers. An NFT’s value is based largely on what someone else is willing to pay for it, thereby leading to fluctuations. Therefore, demand will drive the price rather than fundamental, technical or economic indicators.

And there is the risk related to intellectual property issues. Someone who buys an NFT, only gets the right to use the NFT rather than intellectual property rights. It is therefore important to consider the ownership rights of an individual to a particular NFT in the metadata of the underlying smart contract, such as copyrights, trademarks, patents, moral rights, and the right to publicity.

The growing  NFT market is also attracting cybercriminals resulting in various risks of fraud, cybersecurity and hacks. There have been a few instances of fake websites, where NFTs hosted on the platform have disappeared and faced copyright and trade infringements.

Some artists have also fallen victim to impersonators who have listed and sold their work without their permission. And those who own an NFT do not necessarily own the original version of the digital content.

Another risk related to cybersecurity and fraud include copyright theft, replication of popular NFTs or fake airdrops, and NFT giveaways. And there is the risk of smart contracts being attacked by hackers and the challenges of NFT maintenance. This is seen as a main concern in the NFT landscape presently. As a result people can end up buying the fake NFT tokens, which practically do not have any value as an asset.

In addition, NFTs are also associated with jurisdictional challenges as there is no specific precedent for regulating NFTs. Decentralized peer-to-peer transactions on blockchain-based  NFT platforms without any monitoring authority can lead to AML and CFT challenges. As NFT can challenge the conventional FATF standard, regulations and intermediate supervision become necessary for these platforms.

Challenges

An there are the various challenges NFTs may be confronted, that could limit their adoption. Some of these challenges are more fundamental.

One of the most fundamental challenge for this NTF market is how these tokens will have to be fused into an ill-suited legal framework. The lack of regulation creates a lot of pitfalls in NFT adoption. There is the confusion of how NTFs should be classified and thus regulatory treated. As a security or something else. NFT does not have a specific definition and can describe a wide variety of assets. They are unique, not interchangeable, and not fungible. With the increasing variety and number of NFTs, it is difficult to find a solid ground for compliance in NFTs. As of now, many of the existing laws pertaining to NFT are stuck on finding the ideal definition for NFTs. Various countries like Japan, UK, US and the EU have different approaches for the classification of NFTs.

Next to regulatory challenges there is the lack of uniform, universal infrastructure for NFTs that may limit their adoption. For instance the verification processes for creators and NFT listings aren’t consistent across platforms – some are more stringent than others.

Accessibility to NFTs can be a significant barrier for new entrants to the NFT market. While NFT marketplaces are user-friendly, content creators must pay fees for the creation and upkeep of the NFT. These fees are usually required to be paid with a cryptocurrency in a digital wallet. The NFT marketplaces are also only popular for certain types of digital content; currently, for example, there are very few writers who sell their work as NFTs.

Environmental effect

Another pain point of using NFTs is the effect the cryptocurrency industry has on the environment. The current mining practices for the most popular cryptocurrencies use proof-of work techniques, which require a vast amount of energy from powerful computers.

The way forward: bubble or future

The NFT markets are booming. And every day new use case are entering the NFT market attracted by the various benefits and the incredible profits that can be made.

But the risks and challenges this market is confronted with will ask for regulatory intervention. The importance of reflecting on the legal and regulatory NFT risks is clearly evident. As this NTF market continues to grow and expand into different use cases, this raises the importance of having an international regulatory body of Non-fungible tokens for its better regulation and legalization. The outcome could have a great impact and will be decisive for the future of NTFs.

It is however still uncertain how that will proceed.

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

Binance and regulatory scrutiny: changing times for the crypto market

28-09-2021 | Carlo de Meijer | treasuryXL

Long-time regulators were not sure on if at all or how to handle the crypto ecosystem. But that has changed fundamentally with the crypto industry witnessing massive growth and interest from traditional institutions and major investors.


This year has been a year of increased regulatory focus of the booming crypto market. The potential for crypto exchanges to launder money has worried regulators all over the world, with US Treasury Secretary Janet Yellen and ECB President Christine Lagarde among those to voice concerns. As a result regulators and law enforcement agencies worldwide have begun to scrutinise suspect players and started to write regulations to bring those players within the blockchain arena to take control of them.

Recently the world’s largest crypto platform, Binance has come under regulatory fire. Regulators across the world are concerned over the potential for crypto to be used to launder money as well as the risks to consumers from volatile crypto trading. Most recently also DNB, the Dutch Central Bank, joined forces, saying Binance was not compliant with anti-terrorism financial law. It is unclear if this is a coordinated effort by regulators or something closer to a domino effect.

Regulatory scrutiny

Financial regulators across the world have now targeted major cryptocurrency exchange Binance. The platform has come under increased scrutiny from a growing number of regulators worldwide, including regulatory authorities from the UK, US, the Netherlands, Canada, Japan, Malaysia, Thailand, Germany, Cayman Islands, Lithuania, Hong Kong. And this group is growing.

The platform has faced warnings and business curbs from financial watchdogs who are concerned over the use of crypto in money laundering and the high risks of their products to consumers. Binance has also been accused of accepting ‘gigantic tips’ from creators of                  ‘questionable’ cryptocurrencies in exchange of receiving a privileged place on their platform.  Several countries have announced investigations in Binance and its products. While a number of countries have banned the platform from certain activities, quite a few countries have started banning it completely.

Banks are delisting Binance

Not just countries, but also a growing number of banks are cutting ties with the crypto exchange as well. Several banks or payment processors, primarily in Europe and the UK, have subsequently cut off the exchange, potentially freezing its customers’ accounts. Major banks began to ‘delist’ Binance in June and July of 2021, leading the exchange to suspend withdrawals and/or limit withdrawals dramatically on most accounts.

A number of banks, including Barclays, Nationwide, HSBC and Santander pulled Binance’s access or announced reviews of their approach to crypto at large. HSBC banned its UK customers from making any further payments to Binance, while Barclays suspended UK card payments to Binance, citing the FCA warning to customers. Also the European Union’s Single Euro Payments Area appears to have (temporarily) cut off Binance. SEPA payments to Binance were halted.

Regulators and Binance: some approaches

US
The largest of investigations is perhaps be through the US Commodity Futures Trading Commission  (CFTC), with the regulator seeking to determine whether cryptocurrency derivatives were bought and sold by US citizens on the Binance platform.  Binance is also reportedly under investigation by the US Justice Department and Internal Revenue Service (IRS). 

Cayman Islands
The Cayman Islands also challenged the lack of authorization of the exchange. Cayman Islands Monetary Authority (CIMA) said that all the entities associated with Binance are not registered, licensed, or regulated and thus not authorised to operate a crypto exchange from or within the Cayman Islands“.

UK
Last week UK’s Financial Conduct Authority (FCA) stated that it is ‘not capable’ of effectively supervising the world’s largest crypto currency exchange, Binance. They also reiterated the risk its products could pose to customers. The FCA decided to ban the exchange from conducting all regulated activity in the UK for failing to report in line with its ant-money laundering (AML) regulation. The FCA also stated that Binance has refused to answer questions about its wider global business model, and ‘refused or was unable’ to provide (high-risk financial) products offered on Binance, such as their Binance Stock token.

DNB
De Nederlandsche Bank (DNB), the Dutch Central Bank, announced that Binance is providing crypto services in the Netherlands without the required legal registration. As a result the platform was not in compliance with the Dutch anti-money laundering and anti-terrorist financing Act. And thus Binance is illegally offering services for the exchange between virtual and fiduciary currencies as well as illegally offering custodian wallets. This may increase the risk of customers becoming involved in money laundering or terrorist financing.

Japan
Considered to be among the most crypto-forward countries, Japan’s Financial Services Agency (FSA) also warned Binance. It mentioned that the crypto exchange is not registered to accept business from Japanese residents, within the country, ordering to suspend operations.

Hong Kong
Hong Kong’s Securities and Futures Commission (SFC) notified that Binance’s offering of investing in Stock Tokens is not a regulated activity. Binance has not taken any license to offer the services to HK residents.

Malaysia
In June Binance was subject to enforcement actions by the Securities Commission Malaysia for alleged illegal operations. It was ordered specifically to disable Binance.com and mobile applications in the country from June 26 onwards. It was also told to stop media and marketing targeting Malaysian consumers and to restrict access to Binance Telegram group.

Thailand
Thailand’s Securities and Exchange Commission (SEC) notified that it has filed a criminal complaint against Binance. It stated that an investigation has been launched against the exchange for operating its business without a license.

What is Binance?

Binance is the world’s largest cryptocurrency exchange platform by trading volume according to data from CryptoCompare. Notwithstanding the various measures taken it still boasts a daily trading volume of more than $25 billion, which is significantly more than its nearest competitor Coinbase ($3,5 billion). Binance also leads crypto derivatives trading, in large part by allowing people to trade crypto derivatives using high levels of leverage, or borrowed money.
Crypto exchange Binance was established in 2017 by Chinese-Canadian entrepreneur Changpeng Zhao. Binance offers trading in over 500 cryptocurrencies and virtual tokens. Thanks to its own cryptocurrency BNB the Binance platform has a large group of loyal customers. They get a discount when trading/using BNBs.The crypto exchange offers a wide range of services to users across the globe, from cryptocurrency spot and derivatives trading to loans and non-fungible tokens. It also offers services around trading, listing, fundraising and de-listing or withdrawal of cryptocurrencies. Binance’s corporate structure is ‘opaque’ (non-transparent), though its holding company is registered in the Cayman Islands, according to British court documents and Malaysia’s watchdog. This might have contributed to today’s massive regulatory scrutiny.

Measures taken/announced

Binance is undergoing big changes to appease regulators, who are unhappy with some of the exchange’s products and their compliance with local rules. Therefore they have made regulatory compliance its top priority. In the wake of the regulatory pressure from various countries

Binance announced that they will be taking drastic steps to better meet financial regulations, improve user protection and manage risks, including strengthening their compliance and legal teams, banning or scaling back products, demand stricter background checks, change the business model and improve relations with regulators.

Focus on regulatory compliance

Binance is focusing on regulatory compliance as ‘the exchange pivots from a technology start-up into a financial services company’ CEO Zhao explained.

For that they unveiled a series of measures it is going to take to become what it says is a fully compliant and licensed institution in all countries it operates in, as fully licensed competitors continue to appear.

“Compliance is a journey – especially in new sectors like crypto. The industry still has a lot of uncertainty. We also recognize that with the growth comes more complexity and more responsibility”. CEO Zhao

Strengthening compliance and legal teams

Binance is strengthening their compliance and legal teams, by hiring more staff who have relevant regulatory compliance experience as well as very senior people ‘that can bring teams in’.  Binance highlighted that the exchange has increased its international compliance team and advisory board by 500% since 2020.  Binance declared that they are planning to double the size of their compliance team within this year.

Recent appointments

Binance recently announced it was hiring a number of former regulators to its compliance and executive teams. They recently announced the appointment of Richard Teng – former chief executive officer (CEO) of Financial Services Regulatory Authority at Abu Dhabi Global Market (ADGM) – as its new CEO, Singapore.

This announcement comes barely a week after the hire of former US treasury criminal investor, Greg Monahan, as its global money laundering reporting officer (GMLRO) – a move that seeks to clear up Binance’s ongoing money laundering issues. Binance also appointed Samuel Lim, who has over 10 years of experience in compliance in investment banking, as chief compliance officer and Jonathan Farnell, with over 20 years of experience in the UK financial and payments sector, as director of compliance.

Banning or scaling back products

Binance is shifting its commercial focus to other product offerings that will better serve its users for the long term. Binance has scaled back some of its range of crypto products that regulators may oversee. To make sure that all their products are fully compliant, Binance has been limiting their futures, derivatives products in most of Europe,  with users in Germany, Italy and the Netherlands among those first affected. It has also restricted the trading of derivatives in some parts of Asia as well such as by Hong Kong users. Binance also would stop offering crypto margin trading involving the Australian dollar, euro and sterling.  

“We need to make sure that all of our products are fully compliant … This is why we’ve been limiting our futures, derivatives products in most of Europe and some parts of Asia as well.” CEO Zhao

In July, Binance also stopped offering/selling digital tokens linked to shares like Apple Inc. and Tesla Inc. after regulators raised concerns about the products for appearing to violate local securities regulations. Hong Kong’s markets regulator became the latest regulatory body to warn investors about Binance’s stock tokens. These crypto products will be unavailable for purchase on Binance effective immediately. Customers who own the tokens may sell them over the next 90 days, and Binance will cease to support the products on Oct. 14, the exchange said.

Reduce withdrawal limits

Orders from regulatory authorities in different nations have caused Binance to reduce its non-KYC withdrawal limits. In an official announcement, Binance notified customers that the withdrawal limit for users with basic verification will drop to 0.6 Bitcoin in mid-August. This is in an effort to prevent money laundering and curb broader criminal activities happening through the platform.

Stricter background checks

Pressure from regulators globally also forces Binance to demand stricter background checks on customers to bolster efforts against money laundering, with immediate effect. This should further enhance user protection and combat financial crime. Until now, document-based ID checks at Binance were only required for users seeking higher limits on trading.

Steps taken by crypto exchanges to make identity and background checks remain varied, with some demanding full documentation and others allowing users to sign up for accounts with as little as an email address. Many large platforms also require users to submit ID documents, while others only require personal information for limited access to trades.

From now on, Binance users will have to complete a verification process to access its products and services. Users will now have to upload an ID card, driver’s license or passport to prove their identity. Those who have not done so will only be able to withdraw funds, cancel orders and close positions. The move represents a major shift by Binance.

Changed business model

Binance also plans to make a series of fundamental changes in its corporate structure to ‘get back into the good books’ of the regulators in the various regions to handling increased scrutiny from regulators. The company is going to have to totally overhaul its business model by institutionalising and centralising its digital asset operations. The crypto exchange has until now had decentralized operations, meaning it doesn’t have headquarters of any sort. Instead, they will now add headquarters around the world and work towards being licensed everywhere and become compliant as much as it can in every region where it plans to operate. Each of these headquarters would have regional CEOs as well leading to a centralized authority controlling all these subsidiaries. While this goes against what cryptocurrencies stand for, it is necessary for Binance to stay relevant in many countries.

Improve relations with regulators

Binance CEO Zhao also wanted to improve relations with regulators. Zhao’s focus on regulation is seen as a sign of the changing times in the crypto world. The CEO asserted that new laws are necessary for the crypto ecosystem to support its further development.

The firm is willing to work and communicate with regulators to bring compliance into the crypto ecosystem. For that Binance will expand the team dedicated to working with authorities to ensure services are compliant with local regulations. Binance is also willing to meet regularly with regulators to proactively update them on what the firm is doing. To start, Binance would share some user data with local regulators.

“We aim to work more collaboratively with policy-makers to improve global standards and discourage bad actors,” Binance CEO Changpeng Zhao

Is this enough?

Notwithstanding the various measures announced or taken by Binance there is still a lot of sceptics around Binance real intentions. In the crypto world it is still like the Wild West with many ‘ cowboys’ operating that are averse to rules. Some argue ‘the exchange is playing smart by trying to be compliant, having multiple entities, making influential hires, and more’. Others say ‘It is a nice marketing statement, but from the regulators’ perspective, this is not enough”. For them ‘it is a questionable approach to reportedly evading rather than complying with jurisdictional regulations’.

Still, some lawyers are skeptical over whether Binance move to tighten checks would convince regulators. Regulators would need to know which of Binance’s local entities run the know-your-customer process to audit and check if it complies with local laws. “Since they are doing it on a voluntary basis, regulators do not know whether they have the authority to supervise the identity check, and no one can look whether they are doing it properly.”

It is questionable if Binance is able to face the regulatory actions from so many countries and financial watchdogs at the same time. While Binance says it is intent on cleaning up its compliance image, it will take more than a few give-ins to the regulators to resolve the numerous bans and restrictions that it currently faces.

What may we further expect?

It is tough to say whether it is a coordinated attack on Binance with all the regulatory bodies are coming together against the exchange. Considering it is the biggest crypto exchange in the world and due to its sheer size, it may be expected that many more crypto platforms will come under intensified regulatory scrutiny.

Is this the beginning of a worldwide approach to regulate the whole crypto market? As one of the oldest and largest crypto platforms Binance symbolizes for the whole crypto ecosystem. What is sure,  what happens to Binance may signal how regulators will approach crypto, with enforcement actions against the exchange hinting at what other platforms should expect.

In my mind, this is not a step-change in regulation of the ‘crypto world’. It is part of a growing trend of worldwide and collaborated regulatory intervention in crypto markets. As a consequence regulations are quickly becoming the most important aspect of any company in the cryptocurrency industry. As governments around the world continue to work towards developing regulatory frameworks for crypto, companies are constantly needing to adapt to continue operating.

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

Stablecoins are not that stable: what regulatory approach?

09-08-2021 | Carlo de Meijer | treasuryXL

Stablecoins are one of the newest hot spots on the crypto market. They  have the potential to enhance the efficiency of the provision of financial services including payments, and to promote financial inclusion. They might offer a new way to transact and retain value, starting to redefine modern finance. We all have seen their incredible growth in 2020 and 2021 under the DeFi market influence as I described in my former blog. Stablecoins however bear a number of risks that could harm. They are not that stable as is suggested. And think of the systemic risks when stable coins are being used all over the world. Disruptions in the value of a stablecoin could not only have damaging impact on the broader crypto market, but also on the real financial world, unless regulators step in. Main question is: what kind of regulatory oversight would work best without harming innovation?


What are stable coins?

Stablecoins are a type of cryptocurrencies that are pegged to and/or backed by the underlying real-world assets what can be anything from fiat money, commodities or even another cryptocurrency. Like their name suggests, stablecoins are designed to have value that stays (rather) stable with traditional currencies or the underlying commodities. Many stablecoins are collateralized at a 1:1 ratio with their peg, which can be traded on exchanges across the world.

Stablecoins have been created to overcome the price volatility of crypto currencies such as Bitcoin or Tether, which stems from the fact that there is no robust mechanism to determine their real-world value. Given high levels of distrust in those cryptocurrencies, investors tend to resort to safer options like stablecoins. These may leverage the benefits of cryptocurrencies and blockchain without losing the guarantees of trust and stability that come with using fiat currencies. Currently, there are more than 200 stablecoins. At the time of writing of this blog the total value of stablecoins issued on public blockchain networks has surpassed $110 billion, compared to $28 bn at the start of 2021, which reflects the high institutional and retail demand in unstable times.

Types of stable coins

Based on design, we can split stablecoins into a number of major types: fiat-collateralized, crypto-collateralized, commodity-collateralized, and algorithmic or non-collateralized.

Fiat-collateralized

Fiat-collateralized stablecoins are the simplest and most common type. They are pegged to fiat currencies like the US dollar or the Euro, and usually backed at a 1:1 ratio, by holding a basket of dollar- or euro-denominated assets. This means that for each of such stablecoin in existence, there is a fiat currency in a bank account. Traders can exchange their stable coins and redeem their dollars directly from the exchange at any time. The most popular fiat-collateralised stablecoins are Tether (USDT) (market cap $62 bn) and USD Coin (USDC0 (market cap $ 27,3 bn).

Commodity-collateralized

These are stablecoins that are backed by commodity assets, like precious metals, gold, silver, real estate, or oil. This theoretically indicates to investors that these stablecoins have the potential to appreciate in value in parallel with the increase in value of their underlying assets, thereby providing an increased incentive to hold and use these coins. One example of these stablecoins is PAX Gold (PAXG) (market cap $330 mio), that relies on a gold reserve.

Crypto-collateralized

Another type are crypto collateralized stablecoins. These are pegged to other cryptocurrencies as collateral. Because the crypto values themselves are not stable, these stablecoins need to use a set of protocols to ensure that the price of the stablecoin issued remains at $1. They are often collateralized by a diversified reserve of cryptocurrencies that can sustain shocks and yet remain stable. Another mechanism involves over-collateralization, which means for a crypto-backed stablecoin that is pegged 1:2, for each stablecoin, cryptocurrency worth twice the value of stablecoins will be held in reserve. Since everything occurs on the blockchain, these crypto-backed stablecoins are much more transparent, have open source codes, and can be operated in a decentralized manner, unlike their fiat-backed counterparts. However, they are also more complex to understand, and therefore lack popularity. The most popular crypto-backed stablecoin is Dai (market cap $56.8 mio), created by MakerDAO, whose face value is pegged to the US dollar, but is collateralized by Ethereum.

Algorithmic or non-collateralized Stablecoins

A fourth class are so-called algorithmic stablecoins, also known as non-collateralized stablecoins. This is a very different design as it is not backed by any collateral. It operates in the way fiat currencies work, in that it is governed by a sovereign such as a country’s Central Bank. Given the evident difficulties these stablecoins have at maintaining value stability their usefulness is limited.

Algorithmic stablecoins use total supply manipulations to maintain a peg. The basic mechanism is creating a new coin, setting a peg, and then monitoring the price on the exchange. This can be done algorithmically, in a decentralized way, with open source code that is visible and auditable by everyone. This so-called rebasing is a speculative investment asset where the probability of gain and the probability of loss are both greater than zero. A second category of algorithmic stablecoins are coupon-based coins. The difference from rebasing coins is that holders don’t see their number of tokens change unless they do specific actions. The downside, however, is that coupon-based coins seem to be much more unstable. Some of the more known ones include Ampleforth (AMPL), Based, Empty Set Dollar (ESD) and Dynamic Set Dollar (DSD).

How do stablecoins work?

Some central stablecoins, such as Tether, require a custodian to regulate the currency and then reserve a certain amount of collateral. Tether holds the US dollar in a bank account. The amount held must be equal to what they issue to maintain the order of the system. In this way, price fluctuations should be prevented. However, there are other stable decentralized cryptocurrencies, such as the crypto-backed stablecoin Dai that achieve this goal without a central authority figure. They use smart contracts on the Ethereum blockchain to manage the collateral and maintain order. Stablecoins automatically adjust the number of tokens in circulation to keep the price stable. This means that the value of stable coins should (in theory) not fluctuate frequently, as in normal crypto assets.

Why are stablecoins used?

Stablecoins are used in the crypto market for a number of reasons. Crypto currency owners may turn profits into stablecoins in the short term with the intention of investing in other cryptocurrencies when opportunities arise, rather than turning profits into fiat money and transferring them to their bank account.

Stablecoins are also invested in cryptocurrency exchanges or decentralised finance (DEFI) applications to return interest and yield. Investing in crypto currency exchanges in particular offers a safe and attractive alternative to traditional savings methods offered by legacy finance. They empower more people to harness the benefits of the blockchain without the risk of large market fluctuations. In the event of a local fiat currency crashing, people can easily exchange their savings with US dollar backed or Euro-backed or even gold-backed stablecoins, thereby preventing the further depreciation of their savings.

Where are stablecoins used?

With the growing number of stablecoins the use cases keep growing.

Switch between volatile cryptocurrencies and stablecoins

Stablecoins are most popularly used to quickly switch between a volatile cryptocurrency and a stablecoin, while trading, to protect the value of holdings. They provide traders with a ‘safe harbor’, which allows them to reduce their risk to crypto-assets without the need to leave the crypto ecosystem.

Allow the use of smart contracts

Stablecoins allow for the use of smart financial contracts that are enforceable over time. These are self-executing contracts that exist on a blockchain network, and do not require any third party or central authority’s involvement. These automatic transactions are traceable, transparent, and irreversible, making them an ideal tool for salary/loan payments, rent payments, and subscriptions.

Mainstream commerce

Because these stablecoins are seen as relatively less volatile compared to other cryptocurrencies like Bitcoin and Ether, the idea is that stablecoins might be more widely accepted in mainstream commerce. Consumers, businesses and merchants would therefore be more comfortable with using stablecoins as true units of exchange.

Payments

Stablecoins allow payers to get as close to the benefits of cash as possible. Stablecoins are freely transferable just like cash; anyone on the blockchain network can receive and send coins. The coins are structured as bearer instruments, giving the holder the rights to redeem the coins for US dollars at any time. This is especially relevant in the decentralized finance (DeFi) segment, where stablecoins play an important role to enable the ecosystem. Mainstream applications with stablecoins are also picking up in cross-border payments, where they are being used to facilitate cross-border trade and remittances.

Risks of stable coins

While stablecoins have the potential to enhance the efficiency of the provision of financial services, they may also generate risks to financial stability, particularly if they are adopted at a significant scale. Some stablecoins are actually riskier than they may seem. Stablecoins may bear risks in terms of asset contagion, collateral and accountability. We also shouldn’t ignore the risks that stablecoins potentially pose to the financial system in terms of systemic risks thereby undermining sovereign currencies.

Not all stablecoins are stable

Notwithstanding their name and the suggestion that their value is quite stable,  not all stablecoins are really 100 percent price-stable. Their values are dependent on their underlying assets. Stable coins can only be truly stable if they are 100% backed by cash. The reason for that is that the issuers of fiat-collateralized stablecoins need to manage the supply of their coins through issuing and redeeming to ensure the value of their coins maintains roughly 1-to-1 with the fiat currency. This stands true for commodity-backed and crypto-backed stablecoins as well. The promise can only work if the stablecoin issuer properly manages the reserves. Since cryptocurrency prices can fluctuate violently, crypto-backed stablecoins are more susceptible to price instability than other collateralized stablecoins.

Asset contagion risk

The rapid growth of stablecoin issuance could, in time, have implications for the functioning of short-term credit markets. Certain stablecoins are today’s economic equivalent of money-market funds, and in some cases their practices could lead to lower values, creating significant damage in the broader crypto market. There are potential asset contagion risks linked to the liquidation of stablecoin reserve holdings. These risks are primarily associated with collateralised stablecoins, varying based on the size, liquidity and riskiness of their asset holdings, as well as the transparency and governance of the operator.
Fewer risks are posed by coins that are fully backed by safe, highly liquid assets.
One of the most known and most widely traded stablecoin is Tether. Each Tether token is pegged 1-to-1 to the dollar. But the true value of those tokens depends on the market value of its reserves. Tether has disclosed that as of 31 March  it held only 26.2% of its reserves in cash, fiduciary deposits, reverse repo notes and government securities, with a further 49.6% in commercial paper (CP).

Collateral consequences

Also further collateral consequences, particularly because the recent rise in crypto prices, has been fuelled in significant part by debt. It is questionable whether stablecoins could liquidate sufficient investments quickly to satisfy the demand if needed. The consequences of such an inability to meet a sudden wave of withdrawals could be significant in the larger crypto ecosystem.

Lack of accountability

The drawback of fiat-collateralized stablecoins is that they are not transparent or auditable by everyone. They are operated just like non-bank financial intermediaries that provide services similar to traditional commercial banks, but outside normal banking regulation. They therefor may escape accountability. In the case of fiat-backed stablecoins traders need to blindly trust the exchange or operator to trade in these currencies or try to find and examine out its financial disclosers by themselves to ensure that the stablecoins are fully backed by fiat, even if they do not release audit results.

Financial stability and systemic risk

Stablecoins may also generate risks to financial stability. Some of these fiat currency-pegged tokens are not backed by actual fiat currencies, but by a combination of riskier assets. This puts not only stablecoin holders at risk but could potentially threaten financial stability in general, if a run on a stablecoin causes the asset and other cryptocurrency prices to collapse. And there is the systemic risk issue. A widely adopted stablecoin with a potential reach and use across multiple jurisdictions (so-called “global stablecoin” or GSC) like Facebook’s Libra, now called Diem, could become systemically important in and across one or many jurisdictions, including as a means of making payments.

Why is regulation needed?

These issues underline there is a large regulation gap concerning stablecoins that contributes to weak investor protection and fraudulent activities. There is no legal framework for regulating stable coins, so no requirements on how reserves must be invested, nor any requirements for audits or reporting. This lack of regulatory clarity also creates confusion when new products related to stablecoins are brought to market.

The activities associated with “global stablecoins” and the risks they may pose can span across banking, payments and securities/investment regulatory regimes both within jurisdictions and across borders. Especially if stable coins would become a significant part of the payments and finance universe there is urging need for a regulatory framework. Ensuring the appropriate regulatory approach within jurisdictions across sectors and borders will be important.

Regulatory scrutiny of stablecoins

A range of regulatory bodies, from the G7, the Federal Stability Board (FSB) to the BIS, have started publishing guidelines. They mostly highlighted risks and challenges, including issues such as financial stability, consumer and investor protection, anti-money laundering, combating financing of terrorism, data protection, market integrity and monetary sovereignty, as well as issues of competition, monetary policy, cybersecurity, operational resilience and regulatory uncertainties.

G7 Summit

At the recently held 2021 G7 Summit in Cornwall (UK) delegations concluded that common standards would be maintained through international cooperation, as well as, standards from the Financial Standards Board. They concluded that no global stablecoin project should begin operation until it adequately addresses relevant legal, regulatory, and oversight requirements through appropriate design and by adhering to applicable standards.

Basel Committee on Banking Supervision

Also released recently was a consultation paper from the Basel Committee on Banking Supervision on prudential treatment of stablecoin exposures. While the paper notes that bank exposure is currently limited the continued growth and innovation in crypto assets and related services, coupled with the heightened interest of some banks, could increase global financial stability concerns and risks to the banking system in the absence of a specified prudential treatment.

BIS

The BIS’ Basel Committee ‘posited’ in a recent announcement that the crypto classes would be divided between offerings such as stablecoins and tokenized assets that would be eligible for treatment under the Basel Framework, which provides standards for banking supervision. The proposed roadmap hints at more regulation such as stablecoins being governed by stricter capital reserve policies.

FSB recommendations

The Financial Stability Board (FSB) has agreed on 10 high-level recommendations to address the regulatory, supervisory and oversight challenges raised by “global stablecoin” arrangements. They thereby respond  o a call by the G20 to examine regulatory issues raised by “global stablecoin” arrangements and to advise on multilateral responses as appropriate, taking into account the perspective of emerging market and developing economies.

According to the FSB, the emergence of global stable coins (GSCs) may challenge the comprehensiveness and effectiveness of existing regulatory and supervisory oversight. They therefor proposed some principles for regulating stablecoins, including restrictions on reserves, limits on risk and transparency requirements. That should promote coordinated and effective regulation, supervision and oversight of GSC arrangements These arrangements should address the financial stability risks posed by GSCs, both at the domestic and international level. The recommendations call for regulation, supervision and oversight that is proportionate to the risks. They thereby  support responsible innovation and provide sufficient flexibility for jurisdictions.

The final recommendations., including the feedback from the public consultation, will be published in October 2021, while the completion of international standard-setting work is planned by December this year.

Regulatory approaches

Notwithstanding the active work of the various international regulatory and oversight bodies it is still far from sure what regulatory approach would be chosen. There still remains uncertainty as to how they will regulate, either by proposing a bespoke regime for stable coins, banning it outright or assimilating the asset class into their existing regulatory frameworks. There is a number of regulatory approaches starting to shape how stablecoins might be governed and to more narrowly define their use. Most advanced are the EU where the EU Commission came up with their MICA proposal, though the timetable and details of planned changes remain unclear or subject to change. But now also in countries like the US and the UK regulatory activities are accelerating.

EU Market in Crypto-Asset Regulation (MICA)

Europe is currently assessing the large number of comments received during the consultation period on its proposed Market in Crypto-Assets regulation (MICA) that was issued last year September. MICA especially focuses on rules that regulate stablecoins, particularly those that have the potential to become widely accepted and systemic and crypto asset providers such as exchanges. Aim is to provide a comprehensive and transparent regulatory framework and establish a uniform set of rules that should provide investor protection, transparency and governance standard, while allowing the digital asset ecosystem to flourish.

The regulation thereby separates stablecoins into categories such as e-money tokens (stablecoins whose value is pegged to a single fiat currency) and significant asset referenced tokens’, which purport to maintain a stable value by referring to the worth of fiat currencies. These significant asset-referenced tokens are subject to strict regulatory standards of transparency, operation, and governance. Unlike other cryptocurrencies, stablecoins need to be authorised by regulatory institutions to be traded within the EU. The authorisation requirement applies also to stablecoins already in circulation. Except for existing credit institutions, everyone else that wishes to engage in stablecoin activities will also have to gain prior permission from their national supervisory authority.

MICA regulation makes it a legal obligation for stable coin projects to issue a white paper and submit it to their national financial supervisory authority. That supervisory body has the power to prohibit the issuer from releasing their planned stable coins. Most importantly, the regulation prohibits the issuance of interest to e-money tokens. With the interest ban, the EU legislator is arguably aiming to disincentivise the investment of crypto profits in stablecoins, and consequently to protect the interests of the European banking sector.

UK Bank of England

Though the UK is well behind with its regulatory activities around stablecoins compared to the EU, regulators in the UK are now also speeding up their steps to regulate stablecoins. Earlier this year the UK HM Treasury issued a general consultation and a call for evidence on crypto assets and stablecoins generally. The UK’s proposals however are narrower than the UK MICA proposals, reflecting an intention to take a ‘staged and proportionate approach’. In particular, the UK proposes to regulate only ‘stable tokens used as a means of payment’ initially.

The Bank of England Discussion Paper that was recently launched kicked of a conversation regarding digital money, stating that stablecoins, typically backed by fiat or another asset, but issued by a private firm, need to be regulated in the same way as payments currently handled by banks if they become widespread and can impact financial stabilities.

US Biden government

With the new Biden government also in the US activities surrounding regulating stablecoins are speeding up, and there is a growing optimism that 2021 will ‘bear witness to material progression’ from US regulators and law makers to better understand this technology and clarify the regulatory framework.

Stable Act

In December last 2020, just before the end of the US Congress tenure, a draft of the Stablecoin and Bank Licensing Enforcement Act (Stable Act) was introduced. The law would approve the use of stablecoins and cryptocurrencies as legitimate alternatives to other real-time payment systems. This Act however proposed significant increases in the regulatory oversight of stablecoins. It would limit who can issue the stablecoins, requiring that stablecoins be issued by a bank and would impose certain standards. It is however questionable if this Act in this form will really be approved by the US Congress.

US Fed

The US Fed is now also taking note of the rising usage of stablecoins. They announced it will issue a report later this year to begin a ‘major public consultation’ on crypto regulation, especially stablecoins, laying out the risks and benefits associated with stablecoins as well as a potential digital dollar.
Federal Reserve Chairman Jerome Powell said that the US is at a ‘critical point’ for regulation of these digital currencies, advocating for the application of new rules on stablecoins that are similar to those applied to bank deposits and money-market mutual funds, where the US has a pretty strong regulatory framework. The issuance of a stablecoin should be conditioned on following risk-limiting practices designed to ensure that the tokens are in fact worth that price. There should be liquidity requirements as well.

The President’s Working Group for Financial Markets

The President’s Working Group for Financial Markets, the nation’s top financial regulators in the US, last week met to discuss stablecoins and how to react. This is marking the first publicly-announced meeting of this group of regulators since Joe Biden took office earlier this year. Topics of discussion included the rapid growth of stablecoins, potential uses of stablecoins as a means of payment and potential risks to end users, the financial system and national security. This conversation is clearly only just starting. The meeting promised that the group, would publish recommendations for stablecoin regulation within the next few months. From this discussion it is not yet clear what sort of regulatory framework we might see, and which one would make the most sense for stablecoins.

The regulatory way forward

Stablecoins present peculiar challenges to regulators that ask for narrow cooperation between regulators and the stablecoin industry and global regulatory cooperation.

Stablecoins do not stand for a uniform category but represent a variety of crypto instruments that can vary significantly in legal, technical, functional and economic terms. In order to be effective in limiting risks and not disturbing innovations the stablecoin industry must work together with the regulators to come up with a framework that helps put them at ease while protecting this nascent industry from overregulation.

Another major regulatory challenge relating to global stablecoins is international coordination of regulatory efforts across diverse economies, jurisdictions, legal systems, and different levels of economic development and needs. There is not (yet) a uniform regulatory approach of regulators worldwide relating to stablecoins. Calls for the harmonization of legal and regulatory frameworks include areas such as governing data use and sharing, competition policy, consumer protection, digital identity and other important policy issues.

This all should contribute to more stability of stablecoins.

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

DeFi and Regulation | the European Approach

| 07-07-2021 | Carlo de Meijer | treasuryXL

In an earlier blog about the newest trends in 2021 in the blockchain world I mentioned the spectacular growth in decentralised finance or DeFi. Decentralized finance, an unbundling of traditional finance, is challenging the centralized financial system by disempowering middlemen and facilitate peer-to-peer transactions and let users retain control over their money. Being almost completely unregulated, DeFi promises a dynamic, disintermediating revolution in finance, steadily taking over the traditional financial world. In this blog I will touch some of the high-level implications of DeFi for existing financial regulations, as well as the challenges regulators are confronted with. I will especially focus on Europe’s approach MICA.

What is DeFi?

But first of all what is decentralised finance or DeFi? Decentralized Finance refers to platforms that allow consumers to perform financial type transactions with each. The goal is thereby improving the availability of and efficiency in financial services through disintermediation. DeFi uses blockchain, cryptocurrencies (mainly stablecoins) and smart contracts to manage financial transactions such as lending, borrowing and trading outside the control of traditional financial institutions like banks, brokerage firms, and centralised exchanges. Users thereby interact with the open software protocols through unhosted wallets—which are digital wallets that are managed by users themselves rather than by a service provider.

How does DeFi work

Decentralized finance uses blockchain platforms to disintermediate centralized models and enable the provisioning and settlement of financial services anywhere by using crypto currencies, rather than going through traditional financial intermediaries. By eliminating intermediaries, DeFi users are able to maintain full control over their money through personal wallets (DeFi smart contract tokens) and trading services, as well as directly interact with them via DeFi dApps.

Smart contracts

DeFi makes use of smart contracts that provide the fundaments for the functioning of DeFi apps, because they encode the terms and activities necessary for the functioning of these apps. Smart contracts are computer programs run on a blockchain that controls digital assets, and automate agreement terms between buyers and sellers or lenders and borrowers. They are used to execute a transaction between two or more parties, thereby reducing friction and costs.

Software protocols

DeFi software protocols on blockchains are standards and rules written to govern specific tasks or activities. They are interoperable, meaning they can be used by multiple entities at the same time to build a service or an app, enabling  buyers, sellers, lenders, and borrowers to interact peer to peer. DeFi protocols achieve their investment purposes through self-executing smart contracts that allow users to invest crypto assets in a pool from which other users can borrow. The most common protocols for current DeFi projects are built on Ethereum.

Decentralised applications (dApps)

Decentralised applications (dApps) abstract underlying protocols into simple consumer-focused services.  DeFi can be used for the full range of financial services including crypto asset trading, lending and borrowing, savings, payments, derivatives trading, insuring risk etc.

Governance tokens

Some DeFi protocols allocate so called “governance tokens” to reward users for engaging with the system and for conducting or supporting different types of transactions. Participants typically earn tokens by interacting with and providing services to a protocol, for example by providing liquidity in a decentralized exchange or collateral on a lending platform.

These governance tokens generally give users a right to returns from the project and allow users to vote on changes proposed to the protocols. Because of these associated rights, governance tokens have value and are tradeable. This structure gives a wide range of holders the ability to contribute to a project’s governance and evolution by voting on proposals to change the protocol and, therefore, its incentives and operations.

DeFi platforms

DeFi does not just build financial services natively as software, but it recreates the entire ecosystem of finance on novel technical foundations, so-called DeFi platforms. These  platforms are consumer-facing financial interfaces that require blockchain technology and  crypto stakers (the transaction processors) to operate. The blockchains thereby act like digital highways allowing DeFi transactions to move. Several decentralized platforms exist including decentralized exchanges (DEX), lending and borrowing, trading (complex) derivatives, insurance, asset management etc.

Decentralised exchanges

Decentralized exchanges (DEXs) are marketplaces that allow the trading of digital assets without any centralized controller. They replace the market-making and custody features of exchanges with a powerful algorithm that dynamically adjusts prices and executes trades based on available liquidity. Automated market makers (AMMs) have become a popular means of providing liquidity. They match buyers and sellers of digital assets or let them “swap” one cryptocurrency or tokens for another (exchange trading). Rewards on this platform results from providing liquidity in token pools. Well known examples are Uniswap and Justswap.

DeFi lending platforms

And there are decentralized lending platforms, that allow holders of cryptocurrencies to lend anonymously vast sums of funds instantly to people who want to borrow, provided that they can provide enough collateral to deposit in a smart contract and settle the loan within an agreed timeframe. Lenders earn interest on the loaned amount (credit intermediation). Some DeFi protocols offer crypto loans against fiat collateral and vice versa. Apart from loans, DeFi users can borrow a token to participate in blockchain activities such as governance. Leading examples are Compound, Makerdao, and Aave.

DeFi derivatives platforms

DeFi derivatives platforms establish markets for synthetic assets, in which users can establish derivative positions in cryptocurrencies while posting collateral to support those positions (derivatives trading). They automatically track the value of commodities, stocks, indices, or any combination of financial instruments. Most known example is Synthetix.

Other DeFi platforms

Other DeFi platforms offer insurance, asset management, and other higher-order financial services, to maximize portfolio returns, as well as collateralising crypto assets for proof of stake or liquidity provision.

Non-Custodial Lending Platforms

Cryptocurrencies have further extended into the world of DeFi through the recent creation of non-custodial lending platforms. These are decentralized markets where users participate as depositors or borrowers. The concept of these lending platforms are designed to mitigate any potential losses or defaults through controlling collateral on the blockchain. Retail lenders are able to quickly liquidate unhealthy loans on these lending platforms through the underlying technology of the platform itself. DeFi pools also have the potential of opening up liquidity in cross-jurisdictional markets that have previously not been able to transact. DeFi users are (theoretically) able to extend credit and liquidity through cryptocurrencies to users across the globe, including markets in developing countries that traditionally do not see influxes of western funds.

New DeFi services

Thanks to DeFi, users can now obtain financial services such as margin trading,  yield farming, liquidity mining, and crypto staking  on a distributed ledger. Especially staking platforms and yield farming protocols have surged in popularity. Yield farming is a tool to help provide network liquidity. It is “the act of hunting for rewards” by interacting with DeFi protocols, by temporarily putting depositing assets as collateral in a liquidity pool, that could be used by others including investors and start-ups, in exchange for financial rewards.  Liquidity mining is a specific form of yield farming, in which digital asset owners provide liquidity to DEXs (Decentralized Exchanges) in return for rewards. Since DEXs historically suffered from low liquidity, this is an important development for the ecosystem as well as a major source of revenue for some digital asset investors. While liquidity miners and yield farmers add funds to liquidity pools, stakers either hold funds in a wallet or delegate their coins to a validator node. This involves locking assets in a wallet in order to gain governance rights and token rewards in proof of stake (PoS) blockchain’s native asset.

DeFi market

Decentralized finance has been one of the fastest-growing crypto sectors since 2019. Interest in crypto and decentralized finance (DeFi) rose sharply during the Covid-pandemic and investment has accelerated. Though decentralised finance is still in the beginning stages of its evolution, the total value locked into DeFi of various types (collateral pools, DeFi smart contracts/protocols) in leading platforms such as Maker, Compound, Uniswap and Aave has grown from less than US$1 billion in 2019 to over US$90 billion early June 2021.

This rise was fuelled in part by investors looking for increased transparency and control of their funds regarding its open network as an attractive alternative to traditional banking. Another reason for the firm growth was the maturation of stablecoins, i.e. cryptocurrencies designed to track the value of stable assets, such as the US dollar. And there was the emergence of incentive structures, such asyield farming and governance tokensthrough which participants can earn returns for providing liquidity to DeFi services.

DeFi and benefits

Using DeFi applications has a number of interesting advantages beyond the traditional financial services, in terms of easier access to financial products and liquidity, improved market efficiency, enhanced financial privacy, lower fees and faster innovation.

Easier access

The protocols are easily accessible, making it possible for everyone to experience banking-like services. DeFi applications not only make financial services accessible but also affordable. Besides moving between protocols is relatively frictionless because users have full control of their assets/funds.

Peer-to-peer trade

Since dApps power the ecosystem without intermediaries thereby using self-executing codes that envisage the outcome and resolution of activities on these platforms, it allows for a flexible, direct person-to-person trade with high levels of transparency and zero requirements for joining.

Availability

There are also (theoretical) benefits for international financial transactions. The distributed nature of DeFi platforms and protocols makes them available across the world. The idea is that with a cheaper alternative, remittance charges and commission fees will drop, and currency conversion will have to get cheaper to be more competitive.

Improved market efficiency

Individuals can also borrow of these platforms instantaneously by using crypto assets as collateral. This automation may increase the speed of financial transactions, decrease costs, and—given enough time—broaden the availability of these services.

Lower costs

Such decentralised and non-custodial platforms have low start-up and entry costs as market entrants often remain unregulated and have minimal operating and regulatory costs. The absence or lack of central intermediaries makes it hard for regulators to forbid DeFi services.

Innovation

It may also lead to new types of services, triggering further innovations.  If a community of users is displeased with the service provided by a protocol, that community can vote to change the services supported by it or can fork the existing open source code base and develop a new protocol to meet the community’s needs better.

DeFi and risks

DeFi is an emerging phenomenon that comes with various risks, such as user errors. Who takes responsibility for any mistakes done during a transaction as blockchain is nearly impossible to alter?

And there is the smart contract vulnerability. The engine that runs DeFi applications is embedded in the code bundled together to make a smart contract. When this code has a flaw, it exposes the entire project leading to loss of funds.

Software systems may also malfunction due to a wide variety of factors. For example, what if an incorrect input causes a system to crash? Or, if a compiler which is responsible for composing and running codes makes a mistake. Who is liable for these changes?

While many DeFi tokens have already delivered lucrative returns, they come with considerable risk and price volatility that exceeds that of established digital assets like Bitcoin and Ethereum. Their lower liquidity means that they are more prone to large price swings.

And the anonymity of participants in DeFi transactions, makes it vulnerable for cyberattacks, hacks, scams, false, misleading, or greatly exaggerated recommendations. This may lead to funds theft or loss, without any regulated recourse.

No consumer protections

DeFi has flourished in the absence of rules and regulations. DeFi users however do not receive the protection benefits of transacting with regulated intermediaries. In centralized finance banks are required by law to hold a certain amount of their capital as reserves, to maintain stability and cash you out of your account any time you need. In DeFi they do not receive risk disclosures. Protocols are not subject to risk management requirements, such as capital and liquidity requirements, that protect against loss of consumer funds and systemic risks. So DeFi users may have little recourse should a transaction go foul. There is no help desk or relationship manager to contact if a transaction goes wrong.

Present regulation

DeFi is currently subject to existing regulation laws. The regulatory frameworks that apply to cryptocurrency projects however do not regulate the specifics of DEFI. Their approach is still based on the presence and regulation of centralized intermediaries, and would not work for decentralised DeFi digital asset classes. DeFi transactions conducted between individual users through unhosted wallets would not be subject to existing regulatory requirements, including KYCand AML reviews.Because DeFi protocols support anonymized transactions, there is no meaningful way for market participants to determine what requirements apply to their DeFi transactions.

Regulators are puzzling

Regulators world-wide are gathering speed to step in. They however are puzzling how to deal with DeFi and how to fill the gaps. Considering the fragmented and diverse nature of the DEFI market the task for regulators seems impressive. Who and what is there to regulate? From a regulatory standpoint, DeFi poses several serious and multifaceted risks and challenges, that will become more serious as the market further grows. DeFi does not fit within the historic practical and regulatory model used for financial transactions.

No intermediaries

Present regulation assumes the presence of intermediaries, and it applies regulation to intermediaries as a way to regulate financial markets and related activities comprehensively. But why apply rules designed for centralized finance to decentralised non-custodial, open  information DeFi systems?

Decentralised networks

Blockchain networks are decentralized and global, so participation in DeFi activities presently does not require interaction with the regulated financial system or other national legal regimes, such as taxation and national identity systems. How to look at these centralised networks from a regulatory standpoint?

Governance tokens

As with any new market, classification will be challenging. Governance tokens issued by DeFi projects may not constitute ‘investment contracts’ under securities laws. The absence of intermediaries and a wide dispersal of governance tokens may further weigh against governance tokens being subject to existing securities regulation. How are they going to be classified will determine under what regulatory regime governance tokens will fall.

Codes

Even when a corporate entity develops the software for a DeFi service, the service itself is just software code executing on a blockchain and accessible to all through the internet. This makes regulatory enforcement challenging. Using just the traditional financial services view to regulate the codes is not enough. They not only relate to just blockchain virtual assets, but also around automation and smart contracts more generally. These are very much linked and regulators need to look at those things together.

Source of information

It is also difficult to imagine a practical situation where a user of a DeFi platform is able to provide the source of information about an exchanged private or non-private crypto coin beyond one or two transactions. So what regulatory rules should apply?

WEF Policy Toolkit: regulatory clarity and balanced approach

Policy-makers and regulators are urgently looking for frameworks to address these issues responsibly. The World Economic Forum recently published a policy toolkit for decentralized finance, in a bid to assist governments around the world to appropriately address this phenomenon and help shape regulation of digital asset marketplaces between different countries. Regulators worldwide contributed to the policy document including representatives from lawmakers involved in creating the new European Markets in Crypto Assets (MiCA) rules. The toolkit provides a foundational basis for understanding and examining the critical factors concerning DeFi regulations that should drive policy-making decisions. Authors thereby call for technologically neutral approaches that can balance objectives of regulatory regimes and innovation and market development with policies that are fair, efficient and enforceable.

New regulatory approach: basic principles

As DeFi projects eliminate the need for financial intermediaries, regulators may need to fundamentally rethink their approach. They will need to step away from traditional thinking and take an approach that should have a number of basic principles.

Regulatory clarity

Regulation is key to, at least, set minimum standards to market participants in the DeFi industry, to protect capital and clearly define the regulatory treatment of all crypto-assets that are not covered by existing financial services regulation. Regulators will need to further clarify these guidelines for reporting entities a.s.a.p. to solidify international adoption.

No overregulation

In order not to frustrate full adoption in the DeFi world, government agencies will need to be more flexible in their approach. One should prevent too strict regulation as that could severely disincentivize people to enter the DeFi market. The approach should be based on disintermediation whereby regulatory bodies should look beyond the centralized intermediaries approach.

Balanced approach

To promote the development of the various DeFi markets, it is necessary to put in place a safe and proportionate regulatory framework to support innovation and fair competition. Regulators should thereby maintain an adequate balance between safeguarding positive blockchain-based financial innovation in terms of greater efficiency and broader inclusiveness in finance on one hand and limit the potential of these financial applications being misused for money laundering and terrorism financing.

Level playing field

Given the increasing interwovenness of traditional financial institutions and the crypto market that have to compete against a growing number of non-regulated decentralized and non-custodial DeFi platforms, traditional business may be adversely affected if they fail to compete on an equal basis against them. So regulators should follow a level playing field approach, based on functional and operational equivalency.

European DeFi regulation: MICA

Last year September the European Commission adopted the Markets in Crypto-Assets Regulation (MiCA) proposal. Aim  is to improve harmonisation and legitimisation of how tokens are being regulated generally and the supervision of issuers and firms that qualify as crypto-asset service providers (CASPs). MICA would set clear rules of the crypto assets throughout the European Economic Area (EEA) establishing a common framework and avoiding inconsistencies. MICA thereby follows a technology, asset class and jurisdiction agnostic neutral approach.

MiCA aims to provide greater legal certainty, supporting innovation, ensuring appropriate levels of consumer and investor protection, promoting market integrity and financial stability and thus transform Europe’s current fragmented crypto-asset legislative and regulatory framework into a uniform approach. MiCA will apply to persons engaged in the issuance of crypto-assets and to crypto-asset providers in the EU-27. MiCA itself may be implemented as early as between mid-2021 and early 2022 and aims to be fully operational by 2024.

Main proposals

This new MICA regime clarifies which tokens will qualify as a “financial instrument” and thus fall under the existing financial services regulatory regime, as amended, and which tokens will qualify as “crypto-assets” and thus fall under MiCA’s specific regime for crypto-asset services (CAS).

Assessment of whether a digital asset will be a crypto-asset and subject to MiCA or a token that is a financial instrument subject to the existing financial services regime, will look at the substance over form and thus depends on the content of an instrument and not the technology behind it.

With MiCA, the European Commission intends to include stablecoins within the scope of the tailored MiCA regime on crypto-assets (to the extent not already regulated) and to modify the e-money regime to include a new type of e-money: “ ‘electronic money token’ or ‘e-money token’ means a type of crypto-assets whose main purpose is to be used as a means of exchange and that purports to maintain a stable value by being denominated in (units of) a fiat currency”

Other stablecoins are likely in scope as ‘asset-referenced tokens’, defined as: “a type of crypto-assets whose main purpose is to be used as a means of exchange and that purports to maintain a stable value by referring to the value of several fiat currencies, one or several commodities or one or several crypto-assets, or a combination of such assets.”

For stablecoins that do not fall within the above definition, the issuers must still publish a white paper, notify the regulator and may not refer to their coins as being ‘stable’. Stablecoin (being a type of ‘asset-referenced token’) issuers not already regulated as credit institutions or e-money institutions will need to be authorised and to publish a white paper approved by their home state regulator.

Issuers of ‘significant e-money tokens’ and ‘significant asset-referenced tokens’ will be directly regulated by the European Banking Authority (EBA) and will have additional obligations in respect of capital, interoperability and liquidity management.

ECB and MICA

In February this year the ECB published an Opinion on the current proposed form of MICA regulation. Their proposals generally aim to grant greater powers to the ECB, set prudential requirements for certain stable coin issuers and generally improve anti-money laundering and financial crime prevention measures.

The ECB is generally in favour of MICA’s aims and its contribution to harmonization of crypto asset regulation. The ECB however suggests several adjustments and clarifications, specifically calls for improvements, including greater scope of which tokens and what activity will fall under and be regulated by MICA and by which regulatory authority under MICA and what activity will be subject to the MIFIR/MIFID II framework. The ECB has called for changes to provide a clearer definition of what constitutes a crypto-asset and thus falls into MICA. This to help support the provision of crypto-asset services on a cross-border basis and to establish a truly harmonized set of rules for crypto-assets.

The ECB has suggested a distinction between crypto-assets that would be classified and thus treated as MIFID II financial instruments and those that would fall under the scope of MICA’s regulatory regime. Specifically the ECB has requested a number of changes concerning the supervision of stable coins i.e. what MICA defines as asset-referenced tokens (ARTs). The ECB asks for additional safeguards under MICA, including prudential and liquidity requirements for such issuers. And there is the issue of what financial stability and prudential supervisory aspects will require greater regulatory and supervisory oversight by the ECB, and how this will interact with oversight from other European authorities.

The way forward: regulatory sandboxes and safe harbors

Implementing full-fledged regulations right now however would be unwise. Regulators should get well-required time to gain experience in this new technology, interact productively with the DeFi industry, and provide informal regulatory guidance to them. In the meantime regulators can learn from techniques that are proving effective for the existing cryptocurrency market via so-called regulatory sandboxes. These could create a safe space for regulators and innovative services to work through the various issues. In addition, regulators should start with clarifying relatively easy cases first to provide guidance to the industry. This can give them enough time to solve the harder issues later, while ensuring market participants remain confident in the broad contours of the regulatory environment.

Because DeFi encompasses a broad range of applications and protocols, many of which may lie outside securities law, US SEC Commissioner Pierce suggested implementing a so-called ‘safe harbor’ policy with respect to DeFi and cryptocurrency projects. Disclosure requirements or safe harbors can encourage market participants to provide regulators with information that helps them better understand market dynamics and develop best practices. Without this safe harbor policy in place, it is currently impossible for someone to develop a truly decentralized system without potentially being in breach of securities law throughout the development process.

 

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

Blockchain, IoT and 5G: a Marriage a Trois

| 07-06-2020 | Carlo de Meijer | treasuryXL

Long-time Blockchain has been looked at as an isolated technology. Recently however we see a growing trend of blockchain being integrated with other technologies such as Big Data, Artificial Intelligence amongst others. An interesting development that can be observed is the growing attention of corporates to use blockchain for IoT or Internet of Things applications. And that is not strange. The IoT market is increasing drastically and this is expected to continue in an accelerated way triggered by the recent uptake of the 5G network. But with this there arise a number of big challenges that may limit its future growth. Blockchain is seen by a growing number of corporates as the technology that could solve a number of these issues. Let’s have a look!

But what is Internet of Things?

IoT or Internet of Things has emerged as a network of internet connected devices. These devices range from simple consumer-devices to heavy industrial machines and may include laptops, smartphones, smart gadgets, smart watches, smart and digitalized vehicles, smart bicycles, medical sensors, smart security systems etc. These IoT devices are integrated with high definition technology like sophisticated chips, sensors, or functional software, that makes it possible for them to communicate or interact over the internet smoothly and exchange information with each other. IoT involves first of all sensing, monitoring, and exchange of data, followed by efficient data storing and processing using technologies like cloud computing. Data is thereby transmitted from the device to the IoT network where the information is managed using analytics and then directed back to the IoT equipment. The analytics capabilities of the IoT use these data to convert insights into action, impacting business processes and leading to new ways of working.

In the meantime the Internet of Things has provided many services in the fields of intelligent transportation, smart cities, medical treatment, smart agriculture and many others. These IoT-based solutions allow the automation of daily tasks and enable effective monitoring and control of the connected devices. This may result in improved efficiency and convenience in performing tasks.

Challenges

The advancements in IoT have popularized the development of 5G-enabled-IoT applications. 5G, the next generation of mobile networks, promises remarkable performance improvements  and is envisaged to broaden IoT’s scope and fields of applicability. Such 5G IoT applications however  pose stringent requirements such as high capacity, assured privacy & security, scalability of heterogeneous applications, ultra-low latency, optimized use of network resources, efficient energy management and low costs.

Since current mobile networks including 5G and also more general IoT systems are based on centralized models they may face big challenges to meet-up the requirements of future 5G-enabled-IoT use cases. With the huge number of devices set to enter IoT networks in the coming years, these centralized arrangements have very restricted scalability, while exposing a large number of vulnerable points that could endanger network security and can become extremely costly and sluggish.

a. Scalability
One of the most crucial difficulties with current 5G IoT networks is that of scalability. IoT relies on centralised cloud-based architecture for their control and management. It would be an urgent task for the centralised cloud servers to scale up their capacity and computing power and handle the massive amounts of data collected by a large network of sensors. With the increasing number of devices and the huge amount of data they are generating, current centralised systems to authenticate, authorise and connect different nodes in a network may become a great bottleneck.

b. Security
Another fundamental problem with current 5G IoT systems that may hinder its large-scale development, is their security architecture. A centralised client-server model managed by a central authority would make it vulnerable to a single point of failure. Many IoT devices have very low security features embedded into them. As a result they may get affected by privacy and security breach, while there is reduced safety for users. That make them an easy target for cyber-criminals to exploit the weak security protection to hack them into launching DDoS attacks.

c. Privacy
Another problem is privacy. The IoT network can process data transactions across multiple devices that are owned and administered by different organisations. This makes it difficult to identify the source of any data leakages in case of a cyberattack. Additionally, the IoT generates a vast amount of data, and with multiple stakeholders involved, the ownership of the data is not always clear. This could potentially undermine the reliability of IoT sensors. Measures to ensure the integrity of IoT devices such that they cannot be altered by external interventions are thus key to securing a safe environment for data recording and transactions.

d. No common standards and protocols
The devices in an IoT network are part of different technology standards with different protocols, making it difficult to build a coherent system. The data generated in the networks have different ownership and are highly noncoherent, hence, hard to trace and audit. Data could either be locked in or may not be inter-operated because of different communication standards and protocols and operating systems.

e. Lack of auditability and control over data sharing/usage
In an IoT network a huge amount of data is generated from devices that are proprietary to several enterprises. It is difficult to manage and audit such data in terms of who owns them, where from are they generated and how can they be processed. Most of the times such data is not under the control of all the intermediate parties involved such as equipment vendors, service providers or users who share a common platform.

Blockchain can be of great help

These  issues have become key in IoT systems and if not solved may aggravate when the increase in IoT products will accelerate. Continuing the use of centralized solutions 5G IoT driven applications will not only struggle to meet the demands but will also adversely affect the projected visions of IoT. To solve these issues blockchain or distributed ledger technology (DLT) is increasingly seen as a promising solution to help address these challenges in a unified and decentralised way.

Blockchain, can play an important role in how devices will communicate directly between each. Blockchain, as a distributed database system, can record all information about transactions. This fits perfectly into the basic functions and architecture of the IoT. The distributed nature of blockchain allows the industrial entities and various IoT devices to exchange data to and from their peers, eliminating the centralized operational requirement. Blockchain thereby enables users of 5G IoT networks to interact and transact (store and retrieve data) with ensured data provenance and authenticity, accountability, immutability, and non-repudiation for every user. Blockchain can thereby help alleviate the security, privacy and scalability concerns associated with IoT, by building trust, cost reduction and the acceleration of transactions, without relying on central participants.

How will Blockchain bring these benefits for IoT?

a. Immutability
The distributed ledger in a blockchain system is tamper-proof. Each transaction is recorded, put into a data block, and added to a secure, immutable data chain that cannot be changed. No single organisation has control over the vast amount of data generated by IoT devices. This immutability is regarded as a principal strength of blockchain-based smart contracts, as it removes the need for trust among the involved parties.

b. Improved security
Blockchain’s strong protection against data tampering helps prevent a fraudulent device from disrupting synergy of communication systems by injecting or relaying harmful information. Using blockchain to store IoT data would thus add another layer of security that hackers would need to bypass in order to get access to the network. The blockchain technology thereby holds the potential to securely unlock the business and operational values of 5G networks to support common tasks, such as sensing, processing, storing, and communicating information.

c. Transparency
Blockchain also provides transparency, by allowing anyone who is authorised to access the network to track the transactions that happened in the past. Compared to the ordinary database systems in IoT ecosystems the distributed ledger provides capability to transparent record keeping of the events logged, while the ledger is protected against alterations with the utilization of digital signatures. Through transparency of smart contracts, the trust in 5G IoT networks is decentralized. The deployment of smart contracts in IoT makes the nodes trustworthy and compliant in the specific business ecosystem.

d. Guaranteed integrity
Blockchain as well as blockchain-based smart contracts may also ensure the accountability and integrity of IoT related networks. Smart contracts can be defined as software codes enforcing the regulatory criteria and make them transparently available. These contracts entirely depend on transparency and consistent integrity of all member nodes. The much more robust level of encryption provided by blockchain makes it virtually impossible to overwrite existing data records.

e. Accelerated data change
The performance of the entire IoT ecosystem in terms of higher throughput and latency depends on the accelerated operation of data change in the IoT nodes. As the number of interconnected devices grows, blockchain and smart contracts may provide a viable solution as it can enable fast processing of the growing number of transactions and coordination among the huge number of connected devices. The centralized validation of a particular data can be replaced by decentralized validation with the use of smart contracts deployed on the IoT node itself. This may drastically diminish the data validation time, as well as the chances of manipulation or access.

f. Reduced costs
And as a result of all this, the operational costs of an IoT ecosystem can be minimized when  blockchain and smart contracts are utilized. Blockchain and smart contracts can allow IoT companies to reduce their costs by eliminating the processing overheads (deploying expensive high-end computing infrastructure) related to IoT gateways, associated with middlemen and intermediaries.

Applications of Blockchain IoT

Blockchain IoT applications are increasingly used in various sectors like supply chains, transportation and logistics, retail, automotive, healthcare, manufacturing, construction, government, energy and utility. Corporations are thereby focusing on increasing operational efficiency through real-time data management and automation of tasks. Blockchain IoT applications are  thereby used for purposes like process automation, supply chain management, smart cities, smart homes, asset tracking and monitoring, data analytics, data sharing and communication, smart cars, decision analytics, home automation, and smart grids.

Supply chain
Blockchain and smart contracts may be of great added value in the 5G IoT smart  supply chain. Blockchain IoT applications for tracking purposes are especially used by supply chains to track the location of goods as they are shipped, and ensuring that they stay within specified conditions. The blockchain can store, manage, protect and transfer all this smart information, such as the temperatures, position, arrival times, and status of shipping containers as they move. Sensors give companies end-to-end visibility of their supply chain by providing data on the location and condition of the supplies as they are transported around the globe.  Immutable blockchain transactions help ensure that all parties can trust the data and take action to move products quickly and efficiently.

Maintenance
Blockchain IoT asset tracking devices are also used by a lot of businesses for long-range identification of assets and machinery to record activity and output as an alternative to cloud solutions. This is especially important for predictive maintenance modelling. The ability to track components/spare parts that go for instance into an aircraft, automobile, or other products is critical for both safety and regulatory compliance. IoT data stored in shared blockchain ledgers enables all parties to see component provenance throughout a product’s life.  From engines to elevators, blockchain provides for a tamper-free ledger of operational data and the resulting maintenance.

Smart city and smart homes
Blockchain IoT solutions are increasingly being used in smart cities to enable the services such as payments, e-Governance, security, and surveillance of the smart cities. Smart cities are the implementation of advanced modern techniques in the urbanization to improve the quality of human life.

Blockchain IoT solutions also find their way in smart homes, that are intended to automate the entire home environment comprising of home appliances and devices. Blockchain can thereby fuel different use cases such as smart home monitoring, remote accessing, energy optimization, surveillance and so on.

Data Analytics
Blockchain IoT can also be applied to data analytics to investigate different types of data. It can be used by businesses for predictive and descriptive analysis to improve customer knowledge, enhance operational efficiency, and create business value. Businesses are increasingly using Blockchain IoT data analytics to determine trends and patterns by analysing big and small data to extract meaningful insights.

Smart healthcare 
Blockchain IoT has numerous applications in the healthcare industry. The technology can be used to provide high-quality medical services using smart devices. IoT devices can collect health care data, and these data is stored online. They can be accessed anytime by a physician, Blockchain can as a result enable secure and trusted IoT medical automation systems for real-time monitoring, logging privately medical history, sharing securely medical documents and supporting vital data which can help in making clinical decisions.

Smart farming
The concept of smart farming can revolutionize the agriculture industry. Farmers can use smart blockchain IoT farming applications for optimizing a lot of different activities such as determining the best time to harvest plants, as these devices can detect weather conditions and other environmental data. But also creating fertilizer profiles based on the chemistry of soil, and sensing soil nutrients and moisture levels. Blockchain enabled IoT applications for agriculture purposes can help to boost both the quality and quantity of agriculture production,  while minimizing the cost.

Key players in the Blockchain IoT market

A growing number of companies are leveraging blockchain technology to allow any IoT device to securely connect, interact and transact independently of a central authority. Key players include big tech companies like Amazon, Cisco, Huawei, IBM, Intel, Microsoft and SAP as well as big blockchain platforms such as Ethereum, the Linux Foundation and R3. And a growing number of smaller companies using blockchain to make the Internet of Things safer and smarter have entered (or are entering) the market. Some interesting newcomers:

Ambrosius
Ambrosius is a public permissioned blockchain ecosystem with a large number of decentralized node operators securing the network. The Ambrosus blockchain is optimized for interconnectivity with IoT devices, sensors, existing ERP systems, and other enterprise management software. Ambrosius is used for decentralized applications, securing the Internet of Things, physically tracking real-world assets, and integrating blockchain into enterprise software.

Atonomi
Atonomi is an open platform that encourages third-party development. Atonomi provides IoT developers and manufacturers with an embedded solution to secure devices with blockchain-based immutable registration of identity and reputation tracking. While device identity is recorded and validated on an immutable ledger, device  reputation is calculated and recorded based on monitored transactions. This enables fluid interactions between validated IoT devices, regardless the manufacturer, across the Atonomi trust environment.

Chain of Things
Chain of Things (CoT) is a consortium of technologists and leading blockchain companies. It investigates the best possible use cases where a combination of blockchain and IoT can offer significant benefits to industrial, environmental, and humanitarian applications. So far, CoT has built Maru, an integrated blockchain and IoT hardware solution to solve issues with identity, security, and interoperability.

IOTA
IOTA is a protocol for fast transaction settlement and data integrity, with a Tangle distributed ledger that eliminates the need for expensive mining (validation of transactions). IOTA is an infrastructure for IoT devices that need to process large amounts of micro data. Features of the Tangle ledger are machine-to-machine communication, fee-less micropayments, and quantum resistant data. IOTA has built a sensor data marketplace and is entering the market for data-driven insights, supported by more than 20 global corporations.

Modum.io
Modum.io combines IoT sensors with blockchain technology, providing data integrity for transactions involving physical products. The modem sensors record environmental conditions, such as temperature, that goods are subject to while in transit. When the goods arrive at the next transit point or end customer, the sensor data is verified against predetermined conditions in a smart contract on the blockchain. The contract validates that the conditions meet all of the requirements and triggers various actions such as notifications to sender and receiver, payment, or release of goods.

Xage Security
Xage is the world’s first blockchain-enabled cybersecurity platform for IoT companies. Their technology can manage billions of devices at once and can even self-diagnose and heal possible breaches. Xage is proximality used by IoT companies in the transportation, energy and manufacturing industries.

Blockchain IoT market 2020–2026

An interesting report was recently launched by Markets & Markets, forecasting the development of the global Blockchain IoT market till 2026. Especially the need for IoT security, simplified processes supported with transparency and immutability, and high adoption of blockchain-based IoT solutions using smart contracts and Artificial Intelligence (AI) are expected to surge demand for the blockchain IoT market globally.

Main highlights

  • The global Blockchain IoT market is expected to grow tenfold from USD 258 mio in 2020 to more than USD 2.4 bn by 2026, an average yearly growth of more than 45%.
  • Whereas the hardware segment (including IoT sensors and crypto wallets) showed the highest share up till now, due to growing demand and infrastructure for deploying, developing and managing blockchain applications, software and platforms are forecasted to take the lead.
  • Data security held by far the largest market share in 2020, due to the crypto mechanisms used of the blockchain. The smart contracts segment is expected to be the fastest growing during the forecast period due to the increasing use of blockchain IoT in the construction industry.
  • While the government segment held the largest market share up till now due to the increasing government initiatives and use of blockchain IoT across the many smart city projects, verticals such as supply chain, logistics, automotive, healthcare, manufacturing and construction are also expected to register a high demand for blockchain IoT.
  • The growing adoption of blockchain and IoT technologies across the retail sector is also expected to drive market growth during the forecast period. Retailers increasingly use IoT and blockchain technology to track products in stores, prevent product tampering, and increase security across retail stores.

Final remarks

The expected potential of  the 5G IoT market today is limited by an extremely fragmented IoT ecosystem. Blockchain technology appears as potentially the most suitable and efficient way to the various 5G IoT challenges. For optimising the value of blockchain the creation of common ecosystems with commonly accepted standards and global protocols is thereby of utmost importance. To achieve that, standardized infrastructures, open application programming interfaces (APIs) and collaborations among stakeholders are urgently needed. That means that many stakeholders, even competitors in the same industry, should collaborate and adopt a shared distributed ledger platform with compatible standards protocols enabling users to access all connected applications. If so that would be a great marriage a trois between blockchain, IoT and 5G.

 

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

ECB and a Digital euro: positive consultation results

03-05-2021 | Carlo de Meijer | treasuryXL

Last year I wrote a blog on the ECB plans to investigate if one should introduce a Digital euro. They announced to launch a public consultation on the desirability of such a central bank digital currency for the euro zone.

Now we are a half year later and in a comprehensive analysis of the results of this consultation the ECB published the findings of this inquiry that mirrored a rather positive attitude. The report thereby provides important input into the ECB’s analytical and experimental work and into the upcoming decision of the Governing Council on whether (or not) to launch a formal investigation phase in view of the possible issuance of a digital euro as a payment instrument. So nothing has been decided so far!


Why a digital euro?

In that same blog I mentioned the various reasons why central banks all over the world, including the ECB, are investigating the need and viability of central bank digital currencies (CBDCs). Such as the further digitalisation in the payments world and the continued trend towards a more cashless society. And China’s advancements with their own digital Yuan and the fear that it would become a dominant currency eroding other international used currencies like the dollar and the euro. But also Facebook’s  plan to launch its stable coin named Diem that could be used globally and the big interest of private people and companies to invest in cryptocurrencies such as Bitcoin and Ether with the danger of crowding out fiat currencies.

According to the ECB these developments may undermine central bank’s control over monetary policy and endanger financial and monetary stability in the EU. So in fact the launch of a Digital euro is increasingly becoming a strategic issue for Europe. EU members like France but also the Netherlands have recently begun experimenting with a Digital euro. But any decision would require intensive cooperation between member states.

ECB Digital euro consultation

The ECB recently released its report on the consultation on a digital euro. The consultation that was launched in October last year, received over 8200 responses. The large majority of respondents were private citizens (94%), of which mostly men between 35 and 54 years old, while the other participants were professionals, including banks, payment service providers, merchants and tech companies. Most responses came from Germany (47%), Italy (15%) and France (11%).

Main findings

The consultation report shows that Europe’s citizens are in favour of a digital euro, but under a number of conditions.

The results show that citizens as well as professionals (esp. merchants and other companies) are in favour of such a development, provided that the Digital euro respects privacy (43%) and confidentiality of transactions and that it is sufficiently secure (18%) to prevent fraud. They also support requirements to avoid illicit activities with fewer than one in ten responses from members of the public showing support for full anonymity.

 

“The record level of participation in our public consultation and the willingness of citizens and professionals to support a digital euro are encouraging. Their responses show the high expectations that prospective users have for a digital euro and provide valuable input for our work.” Fabio Panetta, ECB Board member 

 

According to the document, two in five respondents thought that “Digital euro transactions should be visible to either intermediaries or the central bank, which would effectively allow the application of anti-money laundering and combating the financing of terrorism (AML/CFT) requirements.” Additionally, one out of ten respondents believes that transfers under a certain threshold should remain private.

 

“A digital euro would therefore allow people to make payments without sharing their data with third parties, other than what is required by regulation. This differs from private payments, where services are generally offered in exchange for personal data that are then used for commercial purposes.” Christine Lagarde, president ECB

 

The respondents also want a Digital euro that is easy to use, without additional costs (9%), and that allows for fast and reliable payments via payment cards and iPhones (8%).

More than two-thirds acknowledge the importance of intermediaries providing innovative services that allow access to a digital euro and indicate that it should be integrated into existing banking and payment systems. They would like additional services provided on top of basic digital euro payments.

Around a quarter of the respondents take the view that a Digital euro should make cross-border payment faster and cheaper. They also want to be able to use the digital euro outside the Eurozone, though with limits.

 

“A digital euro can only be successful if it meets the needs of .Europeans.” “We will do our best to ensure that a digital euro meets the expectations of citizens highlighted in the public consultation”. Fabio Panetta, ECB Board member

Next steps

The feedback is now to be communicated to the European Parliament as well as the Commission and the Council. And it is up to the Euro system – which includes the ECB and central banks of countries that have adopted the euro – to decide whether the project should be launched.

Following the findings of the consultation, the ECB is set to take a decision on starting formal investigation on a Digital euro on whether to commence central bank digital currency trials by the middle of 2021, before a further six months to one year practical trial of the technology.

And if this decision will be a positive and the green light is given, the Digital euro, a complement (not a replacement) to banknotes and coins, could see the light of day in four years from now, according to ECB president Lagarde. She indicated it may be 2025 before any digital currency would be ready.

 

“Because it’s a technical endeavour as well as a fundamental change because we need to make sure that we do it right. We owe it to Europeans, they need to feel safe and secure. The need to know that they are holding a central bank-backed equivalent of a digital banknote. We need to make sure that we’re not going to break any system, but enhance the system”. Christine Lagarde, president ECB

 

The ultimate design of the digital euro lies with the ECB that will take the public consultation into consideration and look into various possibilities, including use of distributed ledger, definition of spending limits, use of a device for transfers and payments, online/offline capabilities, or availability of cross-border transactions outside Europe.

The Dutch positive stands towards the Digital euro

In narrow cooperation with the ECB and the other national banks in the Eurozone, the DNB is also exploring the possibility of issuing a Digital euro in addition to euro banknotes and coins.

In a recently published report, the Dutch Central Bank said it was ‘ready to play a leading role’ with research and development into its own digital currency as well as a Europe-wide digital currency. The Netherlands would be a suitable testing ground, according to the report, being well placed to develop and trial a Digital euro. The Netherlands is the country where the move out of cash is the largest in Europe. Nearly two thirds of all payments in the country are digital.

The main findings of the report

In this report the DNB researched the satisfaction with the current payment system and the willingness to hold a Digital euro account among a representative group of Dutch citizens. The findings are broadly in line with those of the ECBs public consultation.

While citizens are very satisfied with the current payment options, half of the Dutch population would be interested in opening a current account for Digital euros, an electronic form of central bank money that is available for all citizens and businesses – similar to banknotes and coins, but exclusively in digital form. Relating top the amount they would be willing to deposit into a digital euro account, most of the, opted for €101-500.

Main condition is that privacy is well protected, security features should be adequately safeguarded if people want to open such an account and the risk of theft and fraud of their assets is minimized.

Familiarity with the concept of a Digital euro increases people’s willingness to use it as a means of payment. Almost half of Dutch citizens are familiar with the concept, although most people indicated they did not knew exactly what it entails. 53% said they had never heard of it, 33%had heard about it but do not know what it means while 13% knows exactly what it means.

The most frequently cited reason why the Dutch public believe a Digital euro would be useful and could be a reliable complement to cash and existing electronic payment instruments, is that central banks, unlike commercial banks, do not operate on a for-profit base.

Balancing act

While earlier discussions on CBDC were mostly academic, the focus has increasingly turned to the technical aspects and financial and monetary issues. The ECB received many technical suggestions from the respondents. According to a quarter of individual respondents, end-user solutions comprising (smart) cards or a secure element in smartphones would be preferred to facilitate cash-like features. Building a Digital euro for retail payments may require an infrastructure that is interoperable with existing point of sale terminals or with digital platforms

What may it bring?

A Digital euro could bring many benefits to the population as it would grant greater usability, speed and safer payments transactions while it could leverage technology. It could also enhance digital inclusion, facilitate monetary policy implementation, and help protect against frauds and thefts. Being issued by the ECB and supposed to be not more expensive than the use of cash, it would be a cost-efficient payment solution for individuals and businesses with limited interchange fees, if any.

What about the future of commercial banks?

A digital euro however could pose a number of problems in a number of areas. These should be attention points in the further discussion that should be addressed before the release of the Digital euro to ensure the stability of the financial and monetary system.

First of all for banks, what will be there future?  What about the already identifying competition by fin techs and big techs using crypto currencies?

Lagarde raised that certain intermediaries – that is, banks – are apprehensive about what the issuance of this Digital euro may mean for them, noting that they should not be concerned.

 

“We need to also make sure that we are not going to break the system but to enhance the system.” “Those intermediaries will continue to co-exist, to develop their business and conduct their activities with cash which will continue to be available as will digital currency.” Christine Lagarde, president ECB

 

But in an increasingly digitised world banks may increasingly have to ask themselves how they may serve their customers’ future needs and how they can distinct themselves from their competitors.

And what about financial and monetary stability?

And how to avoid in times of financial crisis that a digital euro will “blow a hole” in commercial bank’s balance sheet. Especially in the event that savers would massively transform their deposits in banks into central bank money, in case of economic or financial crisis. This bank run could increase the cost of financing for banks, and in turn the interest rates on bank loans.

Almost half of the respondents of the ECB Consultation mention a need for holding limits, tired remuneration, penalty rates to excess balances or a combination of the two, to manage/control  the amount of digital euro in circulation and prevent a massive flight to digital euros in times of a financial crisis. A similar share of professional respondents agree.

Competition or cooperation?

Another issue is: will CBDCs trigger competition between central banks or cooperation? With the exception of China, most central banks are looking for (some sort of) cooperation. Under the auspices of the Bank for International Settlements (BIS), the ECB is part of a core group of central banks including the Bank of Canada, Riksbank, the Bank of Japan, the Swiss National Bank, Bank of England (BoE) and the Fed, who are jointly exploring CBDC.

The way forward

The topic of a Digital euro has gained much more public attention in the Netherlands and that is not strange as a much higher proportion of their payments is digital compared to other countries in the Eurozone. But for a Digital euro to get more footing in Europe, what is required is a more in-depth policy debate to be held more broadly across the euro area. This given that it is the Euro system that will decide on the potential introduction of a Digital euro.

If the decision should be taken within the Euro system to experiment with some more concrete type of digital euro the Netherlands said it is ready to play a leading role!

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

Blockchain Technology Challenges: new Third-generation solutions

| 09-03-2021 | Carlo de Meijer | treasuryXL

Notwithstanding the various benefits of blockchain technology, there are still a number of big challenges to overcome before mass adoption can be realised. These range from low scalability to lack of regulation and limited  number of qualified people.

In some of my previous blocks I already went into more detail into these challenges and possible solutions to overcome them. In this blog I will limit myself to the main technological ones including scalability, privacy and interoperability that are limiting its uptake. But above all I will show what third generation solutions have been or are being implemented to tackle the various issues.

A. Scalability

One of the main problems related to blockchain’s technology is scalability, or better said the lack of scale. It refers to the limited rate at which transactions are being processed on blockchain compared to existing methods. Large blockchain networks like Bitcoin and Ethereum are not able to handle as a result of their technological set up. Caps are placed on the number of transactions that can be processed on-chain. This scalability issue is especially a problem for companies that have to process massive transactions and need networks that enable high transaction throughput while maintaining low latency.

Off-chain scaling solutions

For this reason, many view scalability as something to be achieved off-chain, while security and decentralization should be maximized on the blockchain itself. Off-chain scaling refers to approaches that allow for transactions to be executed without overcharging the blockchain. Protocols that plug into the chain allow users to send and receive funds, without the transactions appearing on the main chain.
There are a number of interesting off-chain solutions that are being explored to solve the scalability issue ranging from the implementation of so-called accelerated chips, the use of sidechains and sharding.

Accelerated chips

Accelerated chips could be used to speed up confirmation and transaction times. A forerunner in this is Skynet Core.

Skynet Core

Skynet aims to resolve the issues of blockchain adoption and the functionality of the Internet of Things (IoT). They aim to deliver an end-to-end system that includes a hyper-scalable IoT blockchain network and the licence free blockchain IoT chip named Skynet Core. The project that includes billions of licence free blockchain chips will deploy to devices worldwide, connecting via the Skynet blockchain network.
This blockchain chip can replace an existing CPU and features a core optimized for blockchain technology as well as the Internet of Things. The hardware makes it possible for Skynet Core devices to run blockchain networks with high throughput while providing secure protection from theft of cryptocurrency.  

Side Chains

Another tool to speed up scalability are so-called side chains. A sidechain is a separate blockchain. However, it is not a standalone platform, as it is pegged in some way to the main chain. The main chain and the sidechain are interoperable, meaning that assets can flow freely from one to the other

Side chains are aimed to reduce the load on a given blockchain by sending transactions via these connected sidechains and putting the end state of the transaction on the main blockchain – thereby offloading all the processing of transactions from the main blockchain. There are a number of ways to ensure that funds can be transferred. In some cases, assets are moved from the main chain by being deposited into a special address, and a matching amount is issued on the sidechain. A more straightforward (albeit centralized option) is to send funds to a custodian, who exchanges the deposit for funds on the sidechain.

Next to the first and second generation solutions like Bitcoin’s Lightning network and Ethereum’s Raiden Network, there are a growing number more advanced applications to upgrade scale including AION protocol and Neo’s Trinity.

Sharding

Another scaling solution being worked on is sharding. Main example is the Ethereum Blockchain. Sharding is a way of spreading out the computing and storage workload from a blockchain network into single nodes. This technology divides a blockchain network into many separate areas, called shards, with each shard assigned a small group of nodes to maintain. Each node no longer has to process the entire network’s transactional load. Each node will only maintain the info related to its specific partition or shards, removing the need for all nodes in a network to be apart of a transaction.

Sharding includes transaction sharding and state sharding. Transaction sharding refers to assigning different transactions to different shards. This way, parallel processing becomes possible, leading to high TPS. In contrast, state sharding allows the data state to be stored in different pieces on different nodes. In essence, it means that a single node is only responsible for saving a portion of the ledger.

Multi-layered structure

Another solution to upgrade scale is the use of a multi-layered structure, which is the isolation of transaction processing and data storage. Main projects are Cardano and CPCChain.

Cardano

Cardano (ADA) is the most well-known project which proposes this multi-layered structure. Cardano that can be categorized as a third-generation blockchain (with Bitcoin and Ethereum considered the first and second-generation chains.

Cardano is an open-source and decentralised blockchain project with a layered architecture that is composed of two main elements, the Cardano Settlement Layer (CLS) and the Cardano Computational Layer (CCL), which makes Cardano truly unique. Most other existing blockchain platforms only function with a single layer, which often causes network congestion, slows transactions and drives fees higher.

The settlement layer powers Cardano’s unit of account. This is where peer-to-peer transactions are facilitated, such as the transfer of tokens between users. The settlement layer is responsible for transaction confirmation and the flow of the coin. The computational layer maintains the chain’s security, deploys smart contracts and is programmed to recognize the ID of the data. This layer also serves as a framework that is designed to ensure regulatory compliance with various jurisdictions.

CPCChain

Another promising solution to tackle the scalability issue is CPCChain. CPChain, which is partnered with High Performance Blockchain (HPB), VeChain, Qtum, and ETP Metaverse, intends to build a blockchain-based data platform for next generation IoT systems in combination with distributed storage and encryption computation.

It is aimed to provide the whole process solution from data acquisition, storage, sharing to application, for large-scale distributed IoT systems, enabling high TPS and low transaction latency. CPChain thereby separates its blockchain layer from its application layer, so the blockchain only has to store data IDs (which are on a cloud) rather than the data itself – thereby reducing block sizes.

B. Privacy

Another important challenge to overcome is the privacy issue. Blockchain is built in such a way that all transaction are transparent while its actors can be identified. This is especially a problem for public blockchains, like Bitcoin and Ethereum, where the network ledger is open to anyone and all transactions are transparent – so they can be tracked. This lack of privacy might be an issue for certain types of transactions, for instance in the case of confidential corporate deals.

Protocols

In the meantime several protocols have been developed as alternatives to Bitcoin’s pseudo-anonymity. The three main ones being CoinJoin, Ring Signature and Zero-knowledge proof.

Coinjoin

CoinJoin is the technology used by Dash, developed to introduce a layer of privacy to otherwise public Bitcoin transactions. It is an anonymization strategy that protects the privacy of Bitcoin users when conducting transactions with each other. The protocol requires multiple parties to jointly sign an agreement to mix their coins in a single Bitcoin transaction, making the transaction more difficult to trace. The process is also known as coin mixing.

In the meantime, in order to prevent masternodes from being attacked, Dash introduced Chaining and Blinding, allowing senders to choose multiple masternodes randomly with which to send the transaction. The system enables the mixing of transactions among these master nodes, and transactions appear to be sent by the masternodes and not by the users themselves.

Ring signature

Ring Signature as used by Monero is one of the most famous privacy protocols. A ring signature is a type of digital signature in which a group of possible signers are merged together to produce a distinctive signature that can authorize a transaction. It is composed of the actual signer, who is then combined with non-signers to form a ring. Monero utilizes ring signature technology to protect a user’s privacy in the input side of a transaction by helping the sender mask the origin of a transaction by ensuring that all inputs are indistinguishable from each other.

Because Monero makes use of ring signature technology, it must include a feature that allows for the verification of outputs that are being spent in a ring signature transaction, or else, a user would be able to spend the same transaction output twice i.e. a double-spend. This potential issue is addressed by Monero’s use of key images.

A key image is a cryptographically secure key that is derived from an output transaction being spent, and is made part of every ring signature transaction. This process masks the origin of the transaction, and ensure that all inputs are indistinguishable from each other. Only one key image exists for each transaction output on the Monero blockchain.

On top of the Ring Signature, Monero also utilizes Stealth Address technology to automatically generate one-time addresses for every transaction initiated on the Monero network to ensure the privacy of the recipient. It prevents outputs from being linked to a recipient’s public address. Thanks to Stealth Addresses, this transaction process occurs without publicly linking any transaction to the merchant’s wallet address.

Zero Knowledge Proof

Another solution for blockchain privacy issues, used by Zcash to allow anonymous transactions, is Zero Knowledge proof (ZKP). It is a technique by which a prover can convince the verifier of a fact without revealing the actual content. The technology automatically conceals transaction information, such as sender information, receiver information, and the amounts. Only users who own the private keys of the smart contract being performed have full access to the information. In such cases ZKP can ensure that others only know that a valid transaction has taken place, but no information is available to them about the sender, recipient and type/quantity of asset transferred.

Alternative Methods

At the same time other alternatives are available, such as Permissioned or private blockchain platforms like Quorum, Hyperledger Fabric and Corda, which provide the capability of executing private transactions between two or more participating nodes. This ensures that the transaction details pertaining to the sender and recipient are part of a private ledger and will not be revealed to unauthorized participants.

Or self-Sovereign Identity management platforms that provide the concept of pair-wise decentralized identifiers and verifiable claims that can be presented to third party service providers without revealing all the details of a person or entity and thus protecting privacy

C. Interoperability

While blockchain was conceived as a decentralized technology, individual blockchain networks are not inherently open and are not able to communicate properly to each other. There are a large number of blockchain projects, all of which have different characteristics – such as the type of transactions, hashing algorithms, or consensus models – and which focused on a particular area.

The problem is further deepened by different networks and financial institutions running completely different governance rules, blockchain technology versions and regulatory controls. This has resulted in a series of unconnected blockchain ecosystems operating alongside, but siloed from each other, preventing the industry from reaching its full potential.

Isolated inter-blockchain communication can put a strain to blockchain’s scalability and mainstream adoption. To solve this problem, various new-generation cross-chain technologies that could help different blockchains to interconnect are being explored.

Top Interoperability projects

Most blockchains enable the creation of sidechains, that are blockchains running in parallel to the main blockchain. Next to the more well-known examples of cross-chain communication that are mostly first- or second-generation, like the Bitcoin Lightning Network, or the Raiden Network of Ethereum and the Ripple Interledger Protocol, there is a growing number of interoperability projects that are exploring third-generation solutions such as Cosmos, NeoX and Polkadot blockchain.

Cosmos Blockchain

Cosmos blockchain is an interesting blockchain interoperability project, running on the fault tolerance protocol – Tendermint Byzantine. The blockchain project is aimed to become the hub of many projects  Cosmos blockchain architecture consists of several independent blockchains called Zones, attached to a central blockchain dubbed as the Hub. Zones, which are independent blockchains are plugged into the Cosmos Network. These zones can interact with each other because of the Cosmos Hub and new ones can be connected.

A salient feature of Cosmos is permitting zones to preserve their consensus mechanism. Tendermint Core that enables high-performance as well as consistent and secure Practical  Byzantine Fault Tolerance (PBFT)-like consensus engine, powers each zone in this case.

The cosmos Hub connects blockchain projects to enhance interoperability via the Inter-Blockchain communication protocol. Because of the interconnection, people can send tokens from one zone to another in real time and securely, without engaging the services of a third party. Cosmos blockchain can connect different zones from public to private project thanks to the IBC connection.

NeoX

NeoX is a protocol that implements cross-chain interoperability, to allow multiple participants to exchange assets across different chains and to ensure that all steps in the entire transaction process succeed or fail together. But instead of most protocols NeoX is divided into two parts: cross-chain assets exchange protocol and cross-chain distributed transaction protocol.

Essentially NeoX is the functionality of fusing the concept of Atomic Swaps with Smart Contracts. This means it can allow cross blockchain contract collaboration in a single smart contract. In order to achieve this function, one needs to use NeoContract function to create a contract account for each participant. If other blockchains are not compatible with NeoContract, they can be compatible with NeoX as long as they can provide simple smart contract functionality.

NeoX makes it possible for cross-chain smart contracts where a smart contract can perform different parts on multiple chains, either succeeding or reverting as a whole. This gives excellent possibilities for cross-chain collaborations

Polkadot blockchain

Polkadot blockchain is a high-profile multi-chain technology that is aiming to advance blockchain interoperability. It seeks to enhance the transfer of smart contract data through various blockchains. Polkadot’s ecosystem contains of multiple parachains which are individual blockchains thar differ in characteristics but have become part of the Polkadot environment. In Polkadot blockchain, transactions can be spread over a wide area given the number of chains in the network. All this is done while ensuring high levels of security on dealings. A relay chain is the central connector between these parachains.

Polkadot Blockchain interoperability project seeks to ensure a seamless connection between private chains, public networks, oracles as well as permission less interface. Aim is to enable an internet where independent blockchain solutions will be able to exchange information via a Polkadot relay chain. 

Blockchain Industrial Alliance (BIA): Teaming up

What we also see is that a growing number of these projects are teaming up in order to allow their blockchains to communicate with each other. One main example is the Blockchain Industrial Alliance formed by ICON, AION, and WANChain. This teaming up is aimed at solving the blockchain isolation problem. The Alliance has the shared goal of promoting interconnectivity between the isolated blockchain networks. The Alliance’s main priority is collaborate on research on interchain transactions and communication. The Alliance will focus on developing common industry standards, sharing researching, and protocol architecture. All three blockchain projects that are participating in BIA have the common goal of connecting blockchain protocols.

AION

The AION network is a multi-tier federated blockchain network designed to interconnect the various blockchain entities, making it possible to integrate disparate blockchain systems in multi-tier hub. AION aims to become the common protocol used for these blockchains, enabling more efficient and decentralized systems to be built.

At the core of AION blockchain is a “purpose-built, public, third-generation” blockchain called AION-1,  specifically designed to not only be self-sustaining but connect with other blockchains as well. The AION protocol enables the development of a federated blockchain network, making it possible to seamlessly integrate dissimilar blockchain systems in a multi-tier hub-and-spoke model, similar to the internet. This protocol will enable the transfer of value and data between all AION-compliant blockchains by utilizing bridges.

In essence, AION allows networks to communicate with each other, allowing any DApp to run on any blockchain within the network. On top of that, AION will also allow the participating blockchains to create common chains between them in order to conduct on-chain transactions.

Through AION each participating blockchain will be able to transact with all the chains connected to the ecosystem. Along with solving the interoperability problem, AION also wants to create a system which can work with both private and public blockchains and help in solving scalability. In addition AION helps organizations create blockchains which are interoperable but can have its own unique consensus mechanisms, issuance, and participation.

ICON (ICX)

The second partner is ICON, an  interconnected  blockchain technology and network framework designed to allow independent blockchains to interact with each other. In other words a system of sidechains in order to connect all industry chains to the main network.

ICON is supported through a cryptocurrency token, ICX. Communities are connected to the ICON Network through a decentralized exchange. That allows for the maintenance of a verified ledger shared within the community network itself, allowing participants in a decentralized system to “converge” at a central point. That is done by connecting a community to other communities through the ICON Republic and Citizen Nodes.

WanChain

WANCchain is an online interoperable blockchain solution, with secure multi-party financial platform computing. It relies on a proprietary protocol, the WANBridge model, that allows interconnection of private, public and consortium chains, making it easy to transfer digital assets between different blockchains. The blockchain interoperability solution seeks to rebuild finance by housing all digital assets on one blockchain, aiming to unite the world in isolated digital assets. The current WanBridge model allows for digital assets and data to securely and cheaply be transferred between different ledgers using cross-chain smart contracts.

Based on Ethereum, WanChain enables the deployment of private blockchain smart contract execution aiming to unite the world’s isolated digital assets. Privacy on the blockchain is enhanced by the use of Ring signatures as well as one-time stealth addresses. The Wanchain DeFi ecosystem includes WanSwap and WanLend, as well as several other major products that are now under development such as WanFarm and other DeFi applications. This will allow for much more efficient use of collateral and for WanBridge technology to salescalablyably connect any number of different blockchains.

Forward looking

For blockchain technology to become mainstream and implemented at a larger scale, the bottlenecks current blockchain platforms suffer from – scalability, privacy, and interoperability – need to be addressed. While blockchain technology has undergone rapid improvement since its creation, it’s a relatively young technology and some of the main problems still remain today.

Fortunately, many projects are working on some of the solutions proposed above. As more efficient techniques get invented in the near future these technological barriers will likely be overcome sooner rather than later.

 

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

Bitcoin and Regulation: Towards a Balanced and Coordinated Approach

| 02-03-2021 | Carlo de Meijer | treasuryXL

Cryptocurrencies, especially Bitcoin, are facing increased regulatory scrutiny, and that is not strange. Warnings from regulatory watchdogs all over the globe have come amid a wildly volatile ride for Bitcoin and other crypto currencies. Bitcoin prices quadrupled in 12 months’ time reaching an all-time high of more than $ 40.000 on 8 January after falling back even below $30.000. This is feeding concerns by financial regulators over the lack of a robust and a clear regulatory framework for this rapid evolving crypto marketplace. Regulators worldwide are sharpening their focus on cryptocurrencies and are increasingly looking for a stable framework of regulations and monitoring.

Issues that come up are: why is regulation of the crypto market needed at all and what should be the best regulatory approach?

Existing regulatory patchwork

Crypto regulation in many countries is still lagging behind whereas crypto’s regulatory puzzle is far from complete. Many jurisdictions have looked into regulating cryptocurrency related operations. Thereby they however have taken different approaches on how to go about regulate these which has led to a regulatory patchwork.

These approaches range from a complete outright ban, to a wait-and see approach how matters would play out, while others have introduced some sort of regulation. Major countries and bodies continued introducing regulation just for one area or aspect of the cryptoasset industry at a time. And areas of crypto asset regulation vary from one nation to another, according to each nation’s priorities and values.

Many major countries haven’t yet introduced specific legislation or regulatory guidance that covers the sector as a whole, while others are taking a step-by-step approach. Looking at the G7 countries, they are in varying stages of implementing cryptocurrency regulation, revising existing laws, and providing more clarity to investors and companies in the space. But that is changing.

But why is crypto regulation needed at all?

There is increasingly conviction amongst regulators worldwide that crypto currencies in some form or another are here to stay and continue to play an increasingly normalised role for investors. So we are well beyond the stage where countries could completely ban crypto currencies or adopted a wait-and-see attitude.

We have reached a point where regulators should step in, motivated by the growing interest in cryptocurrency globally and the inherent risks associated with digital assets because they are largely unregulated. Cryptocurrencies should therefore come on the regulatory radar and be held the same standards as the rest of the financial world.

Main stream adoption

There is increased interest by institutional investors in crypto and expectations are that this will continue, triggered by the growing number of new use cases and wider acceptance by traditional banks and financial institutions. This has attracted a strongly growing number of private investors and as aa result to mainstream adoption.

Bitcoin and other cryptocurrencies are increasingly seen as a legitimate hedge against fiat currency weakness and inflation risk, and low returns from traditional safe havens such as sovereign debt. As a result investors are looking more closely at cryptocurrencies. So these cannot be neglected anymore by regulators.

Protection to investors

Though their total market value is still limited compared to fiat currencies Bitcoin and other cryptocurrencies are described by central banks and regulators not as a currency, but much more as a highly volatile and speculative asset. Cryptocurrencies’ volatility are largely a function of thin market volumes and concentrated holdings, possibly in the hands of a few early-adopters known as ‘whales.’ Retail investors should be protected against too much volatility. Providing a regulatory framework will give protection to investors and stakeholders

Closer interaction with the real world

Another argument for more regulation is that, on an increasing basis, cryptocurrencies are becoming part of the incumbent financial system and are increasingly integrated into the existing financial infrastructure. Cryptocurrencies took a step closer to interacting with the real world in October last year when PayPal announced that its US customers can buy, sell or hold four cryptocurrencies: Bitcoin, Ethereum, Bitcoin Cash and Litecoin.

Combat illegal activity

Because of its cross-border crossing character and the lack of surveillance regulators suspect that these cryptocurrencies can be used for criminal activities like money laundering. How many Bitcoin are from a criminal order is hard to predict. But estimates range from 1 percent to 44 percent. Regulators should therefore provide assurances and impose requirements on operators to follow stringent rules to combat illegal activity.

Changing regulatory attitude

But the attitude of regulators worldwide is changing. Recent developments have triggered officials all over the world, including the G7, ECP president Christine Lagarde and the UK CFA, to express their worries about the unregulated growth of Bitcoins and other cryptocurrencies.

The overarching regulatory trend in 2021 will be for governments and regulators to be more favourable towards crypto, increasingly shape crypto into a consumer-friendly and less risky product.

Regulators increasingly recognize that cryptocurrency is here to stay, realizing the true potential of the crypto sector, with their actions being adapted accordingly. They highlighted the need to intensify their work for more stringent robust regulations for cryptocurrencies and create a much improved regulatory landscape to control the crypto markets.

G7 Meeting

At its recent meeting early January the G7 finance ministers and central bank governors reiterated support for their joint statement on digital payments issued in October underlining the need to regulate cryptocurrencies. They discussed ongoing responses to the evolving landscape of crypto assets and other digital assets and national authorities’ work to prevent their use for malign purposes and illicit activities.

ECB President Christine Lagarde

At that same G7 meeting Christine Lagarde, president of the ECBwarned investors about the risk of these cryptocurrencies such as Bitcoin. She also dismissed Bitcoin’s claim as a currency. According to her there is urgent need to implement legislation relative to cryptocurrencies.

“Bitcoin is a highly speculative asset, which has conducted some funny business and some interesting and totally reprehensible money laundering activity”. Christine Lagarde

UK Financial Conduct Authority

In the UK, the Financial Conduct Authority (FCA), issued a stark warning for consumers and retail investors about high-risk crypto investments and the surge of related scams in the industry. The FCA’s concerns include price volatility, the complexity of products offered and the lack of consumer protection regulation around many of the products. Consumers have no recourse to UK regulators for “cryptocurrency bets that turn sour”.

“If consumers invest in these types of product, they should be prepared to lose all their money.” CFA

US Treasury Secretary Janet Yellen

Crypto regulation will also be a top priority for the Biden team. The Biden Administration is expected to bring a renewed focus on regulation and enforcement of the crypto market. The new US Treasury Secretary Janet Yellen – former Federal Reserve Chair – described Bitcoin as a ‘highly speculative’ and not a stable store of value’ when still at the Fed in 2017.

New regulatory initiatives

From a G7 perspective, we already have seen some interesting examples of regulatory initiatives in both the EU and the UK, while the new Biden Administration is certainly coming with their proposals.

European Commission: Markets in Crypto Assets Regulation

The European Commission recently published its first draft for Markets in Crypto Assets or MiCA. A package of legislative proposals for the regulation of crypto-assets, updating certain financial market. The draft regulation should create a clear legal framework for crypto assets and more broadly for Distributed Ledger Technology (DLT), providing regulatory clarity for the industry and ensure unified legislation on cryptocurrencies throughout the EU.

It wants to support innovation while also creating a secure and trustworthy framework for cryptocurrencies, with the same level of protection for consumers and investors as for traditional financial products. The legislative process for MICA within the EU will continue before this becomes a definitive regulation. Expectations are that this draft regulation will be finalized in legal texts in 1,5 to 2 years’ time.

Basic principles

MiCA wants to create the same safe framework as the one we already know from classic financial services. This is mirrored in many of the principles that MiCA imposes on issuers and service providers of crypto assets, such as the prohibition of insider trading and market manipulation.

MiCA is primarily creating a new licensing system for crypto asset issuers and service providers at a European level. It provides substantive rules of conduct and many aspects of consumer protection. MiCA is also introducing a new EU-wide passport for operators licensed under the MiCA regime in their own Member State.

Pilot regime for market infrastructures

The European Commission therefor proposed a pilot regime for market infrastructures that wish to try to trade and settle transactions in financial instruments in crypto-asset form. The pilot regime allows for exemptions from existing rules and allows regulators and companies to test innovative solutions utilising blockchains.

For other crypto-assets that do not qualify as “financial instruments” such as utility tokens or payment tokens, the Commission proposed a specific new framework that would replace all other EU rules and national rules currently governing the issuance, trading and storing of such crypto assets. The proposed regulation covers not only entities issuing crypto-assets but also firms providing services around these crypto-assets such as firms operating digital wallets, as well as cryptocurrency exchanges.

UK Treasury: crypto consultation paper

The UK Treasury has launched a consultation paper that details a series of proposals addressing the crypto community. With the consultation, the Treasury is initiating a “regulatory approach to cryptoassets and stablecoins” for 2021. Aim of this consultation paper is to gather feedback from stakeholders concerning the government’s regulatory approach to crypto asset and stablecoins in payments and investment, as well as the use of blockchain or distributed ledger technology in financial markets.

More broadly, the UK intends to take a “staged and proportionate approach” to new crypto asset developments. Underlying the UK approach is a desire to avoid applying “disproportionate or overly burdensome regulation to entities”, particularly where the financial stability risks are low, stressing the importance of a risk-led approach to regulation.

The Treasury expects to collect insights from the “industry and stakeholders” in the crypto sphere until March 21, 2021. Input received will feed into the government’s response, which will include more detail on how the proposed approach may be implemented in law. The legislation would take the form of high-level principles, leaving it for financial regulators to specify detailed requirements through rules or codes of practice.

Focus on stablecoins

The consultation focuses particularly on developing a “sound regulatory environment” for stablecoins, which the U.K. government considers have most “urgent” risks and opportunities. Stable coins could “pose a range of risks to consumers and, depending on their uptake, to the stability of the financial system. It is not proposing to regulate further any other types of cryptoasset for now, except in relation to financial promotions (in relation to which it has already consulted and will report in due course).

This approach stands in stark contrast to the European Commission’s legislative proposals which already include a comprehensive framework to regulate the entire crypto industry (MiCA) as well as a pilot regime for the creation and testing of digital security infrastructure.

Biden Administration

The regulatory landscape took on new uncertainty as a result of the power shift in Washington to President Joe Biden and a Democratically controlled Congress.

The new US President Joe Biden has frozen all federal regulatory proposals from Trump’s Administration, including some controversial proposed rules from former Treasury Secretary Steve Mnuchin’s on self-hostedcrypto wallets, until his new administration can review them. Former Treasury Secretary Steven Mnuchin drew heavy criticism from cryptocurrency insiders with his privacy-hostile regulatory proposals.

President Biden is putting together a team of financial leaders that should provide more clarity and guidelines for crypto regulations, get clear rules for the entire crypto industry and a better coordination between the various agencies like SEC, CFTC and. The new team brings their stated support for reasonable and equally balanced cryptocurrency regulatory model.

Three of Biden’s top-level financial staff members, including Janet Yellen, the new US Treasure and former Fed chair, Gary Gensler, the new head of the Securities Exchange Commission (SEC) and former chair of the US Commodity Futures Trading Commission (CFTC), and professor Chris Brummer as new chairman of the CFTC  all have a proven understanding of how blockchain and cryptocurrency assets actually work.

Yellen pledged to do a deep review of cryptocurrency markets in collaboration with many other banking and finance regulators, hoping to establish an effective set of rules that limits “malign and illegal activities” while supporting powerful fintech innovations based on blockchain technologies.

What regulatory approach is really needed?

Notwithstanding these new regulatory initiatives, there are still many challenges. At the heart of the legal challenge is how to define cryptocurrencies; as a currency, security on par with stocks and options, tradeable commodity, or a brand new asset class of its own. Settling the thorny issues of legality, taxation, and trading rules will take time, adding to the uncertainty and volatility of the global crypto market.

To be really effective, also given its cross border character, any future regulation asks for both a balanced and above all global approach. Intelligent, well thought-out regulation communicated effectively and uniformly applied can help level the playing field and unleash innovation and further mainstream adoption.

Balanced approach

Providing a balanced regulatory framework should be a necessity for jurisdictions to protect themselves from abuse, while recognising that legal certainty can also be provided through a regulatory regime, which will in turn enable the sector to flourish. Just looking at cryptocurrencies for regulatory purposes may frustrate the underlying technology and its innovative character. The real value in cryptocurrencies is not the currency itself but the potentially disruptive technology that makes them possible, which has the potential to drive innovations. Next to that, because with cryptocurrencies, the technology behind it may develop at a space that is much faster than regulations develop, any regulation would need to be capable of continuous development.

Global coordinated approach

Global regulation continues to be top of mind at the recent G7 meeting. ECB president Lagarde also emphasized the need for countries to work together to regulate Bitcoin. Instead of competing in terms of who can provide the most attractive regulatory regime for the crypto industry, as we have seen in the past, more global regulatory cooperation and coordination and multilateral action is urgently needed. As cryptocurrencies move further into the mainstream, Lagarde therefore called for regulations of Bitcoin and other currencies to be agreed “at a global level”, potentially at the G7 or G20 groups of rich countries.

We are not there yet!

If done in this way, such balanced and coordinated regulation will help protect investors, enable growing competition, tackle cryptocurrency criminality, reduce the potential possibility of disrupting global financial stability stimulate continued innovation.

Looking at these recent regulatory initiatives, one may conclude that there are still big differences in each approaches. The European Commission proposals are the nearest to become effective meeting both the requirements of balance and overall and unified approach in the EU countries. In the UK, whilst new regulations have been introduced, they are still largely behind all the new developments happening in the crypto space. And for the US we still have to wait till the Biden Administration is coming into action. We are not there yet!

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source