Tag Archive for: crypto

Insurance within Treasury

07-04-2022 | treasuryXL | ComplexCountries | LinkedIn |

After many years of weak markets and low insurance premiums, many companies have probably been buying more cover than they may really need. A market where premiums are rising is causing companies to re-evaluate their approach. This re-evaluation involves many complex questions around risk appetite, collaboration with other functions (Legal, HR, Logistics, Manufacturing, IT), the use of brokers, tax, and others. This gives the treasurer the opportunity to really demonstrate his or her value to the business.

This report was compiled by Monie Lindsey. based on a Treasury Peer Call chaired by Damian Glendinning.

Source



Chair’s Overview

The strategic treasurer. The risk manager for the company. Where better for the treasurer to get out of the traditional disciplines of simply managing liquidity and bank accounts, than in managing insurance? Risk management meets budget and operational constraints, and it is a very financial discipline.

This call was initiated by a member who is struggling with increasing premiums as the market hardens, and wanted to know whether other treasurers who are responsible for insurance are taking the same measures, i.e., reducing the purchase of cover and increasing deductibles. The quick answer to that question is yes, in response to significant premium increases, many members are taking another look at the levels of cover. The other question was whether there are additional, more creative ideas.

This triggered a wide-ranging discussion:

  • Should insurance be in treasury? The consensus – not surprisingly – was yes, but responsibility often lies with, or is shared with, legal and HR.
  • How useful are captives? One member finds them useful to accelerate the tax deduction for losses. Others find them useful for centralising risk and losses away from the operating units – this can depend on the company’s management system. Others are wary of the cost and complexity of a captive.
  • Should you use brokers? If so, how effective are RFPs between brokers? One member made savings by changing brokers following an RFP. One member does some negotiating directly with the insurers – but this can be heavy lifting.
  • What is the correct balance between self-insurance and buying risk? There does not seem to be a scientific answer.
  • The classical approach to solving this question is to benchmark versus what other companies are buying – but this does not confirm that this is the correct level for your company.
  • Part of the equation is determining the level of risk and earnings volatility a company is prepared to accept.
  • A company will have different levels of risk retention for different lines of risk
  • Some risks can become very difficult to insure: one participant is having big issues with theft of cargo in the port of Los Angeles, with the activity of organised crime. This is a frequent issue in Latin America.
  • Several participants felt one of the benefits of buying insurance was access to expert advice on risk management, leading to better protected facilities, e.g., better fire prevention, and enhanced anti-theft measures.
  • The use of captives to self-insure HR benefits was raised. This is possible, and can be done easily for some benefits. However, it is an area which is heavily regulated, with many mandatory state run schemes, especially in Europe.
  • On the other hand, travel insurance can often be combined with useful services, such as emergency assistance.
  • There was a discussion about cyber insurance: one participant had experienced a hack, and found that the insurance company provided outstanding assistance in managing the situation before it got out of control. Others were less sure the risk was significant enough to justify the expense.
  • Changes to the business often bring changes to the insurance cover required.

Bottom line: After many years of weak markets and low insurance premiums, many companies have probably been buying more cover than they may really need. A market where premiums are rising is causing companies to re-evaluate their approach.

This re-evaluation involves many complex questions around risk appetite, collaboration with other functions (Legal, HR, Logistics, Manufacturing, IT), the use of brokers, tax, and others. This gives the treasurer the opportunity to really demonstrate his or her value to the business.

Please get in touch to sign up for free updates, request a sample report, or find out about our services. Enquire


Russia Ukraine Crisis Update

16-03-2022 | treasuryXL | ComplexCountries | LinkedIn |

Safety of employees and delivery of salary payments are the highest priorities of treasurers responsible for Russia and Ukraine who also shared their experiences approaches to sanctions compliance, local operations and FX hedging. This report is based on an emergency 90-minute peer call with participation from 15 major companies.

This report was compiled by Monie Lindsey. based on a Treasury Peer Call chaired by Damian Glendinning.

Source



Chair’s Overview

Today’s call was very somber. Two weeks ago (Report: Russia Treasury & Banking Update 21st Feb), members were looking at contingency plans, but the consensus was that most of what was happening was posturing, and that the worst would not happen. Today, there was no discussion of how long hostilities might last – most people agree that there is no easy or rapid solution in sight. Instead, the main priority of most participants is making sure their teams are safe, helping them leave Ukraine if they wish, and making sure salary payments get through in both countries. We all send our best wishes to the many people whose lives have been shattered by this conflict.

The actions and approaches were remarkably consistent across all the participants. Topics discussed and actions taken:

  • The main priority is the safety of the local teams. Nearly every participant has taken extra steps to make sure local staff have cash, including prepaying salaries by up to three months. This is being done in both Russia and Ukraine, as MNCs cannot be sure of being able to remit cash to Russia in the future.
  • Most participants have either exited, suspended, or slowed down their businesses in Russia. Those who are importing goods into Russia for sale locally are continuing business as long as inventories last, but they are not shipping new inventory into the country.
  • There were a few questions about the sanctions, but the general view is that these are clear. Even if a company wants to ship goods into Russia, it is proving very difficult to find logistics companies that are prepared to undertake the shipment.
  • Payments continue for the time being. In Ukraine, the banking system continues to function, and some participants have sent cash into the country to make sure salaries are paid. Paying cash out of Ukraine is no longer possible, but payments continue to be made out of Russia, even if they can be slowed down due to additional sanctions checks.
  • The main sanctions-related discussion was about the extent to which local payments within Russia can still be made using sanctioned banks. The general feeling was that this is allowed, though there was some confusion. Participants have received conflicting advice about whether there is an effective carve-out in the sanctions for salary payments.
  • Foreign banks are registered under local law in Russia, so they can, and do, continue to operate. As usual, some are providing better service than others.
  • One issue raised with sanctions is that they can cause issues for the local staff: it may be illegal under local law for them to apply the sanctions, or it can cause them personal issues. This is usually being monitored closely with HR and Legal.
  • Most companies are re-evaluating their hedging programs:
    • Hedging the rouble has become a lot more expensive, and there is unlikely to be much underlying business to hedge, so most programs will probably stop.
    • In many cases, it is proving difficult, or impossible, to roll existing hedges
    • For NDFs, the reference rate used for settlement is no longer being quoted *(see note below), so it will be necessary to negotiate with the banks about what alternative rate to use
    • No participant was concerned about forwards which require them to deliver roubles outside Russia. However, companies to whom this applies are advised to discuss this situation with their banks: if they find themselves unable to deliver the roubles on the due date, the situation can become messy and potentially expensive.
  • Some participants have bolstered local liquidity in Russia by taking out local bank loans, which continue to be available – though there is some nervousness about how long lines may be available. Many have sent in cash via intercompany loans to make sure salaries and taxes can be paid. Several participants have also bolstered the liquidity of their Ukrainian operations by sending in intercompany loans.
  • There was little discussion about how to continue making payments despite the sanctions. It was pointed out that, even if a bank is barred from SWIFT, payments can still be made using paper instructions – though delays may occur due to the need to implement new correspondent banking relationships and apply additional sanctioned party checks. In any case, the feeling is that sanctions will limit the amount of business giving rise to payments.
  • A couple of participants are being impacted by the removal of international credit cards: this impacts Russian staff currently outside the country on short-term assignments, and those receiving payment by credit card from inside Russia.

Bottom line: the main concern is the safety of local staff and making sure they have enough cash to survive. Business in Russia is basically on hold, but cash is still flowing where it is required, especially for salary payments. Participants are being very careful to adhere to the new sanctions.

Again, we all hope that the bloodshed will soon come to an end.

*Note: 10th March we have subsequently heard that the central bank is providing a daily fix against the USD at a rate that is lower than the market rate (105 – 115 compared to 130-140).

Would you like a full copy of this report?

Request a Copy, but please make a donation to the Save the Children Ukraine Humanitarian Appeal


Crypto Transactions & Corporate Treasury

28-02-2022 | treasuryXL | ComplexCountries | LinkedIn |

CompleXCountries has yet to meet a corporate treasurer who wants to transact in crypto currency, but we are speaking to many who are responding to commercial or regulatory initiatives and having to establish processes and procedures for doing so. This panel discussion between Damian Glendinnig, John Laurens, and Simon Jones explores the new risks and challenges that corporate treasurers face and suggests how they might respond.



Blockchain, crypto mining and the environment: towards sustainable solutions

21-02-2022 | Carlo de Meijer | treasuryXL | LinkedIn |

Blockchain has always been presented as providing speed, efficiency and low costs. But there is also a flipside. Since the crypto industry is booming, including DeFi and NFT, and blockchain technology is going more mainstream the discussion of their negative impact on the environment is heightening.



Blockchain consumes huge amounts of energy and that is growing by the day. This while the combat of the climate crisis has the highest priority all over the world. Especially the electricity usage of Bitcoin and other similar blockchain networks have pulled into a larger conversation around sustainability. To understand this we should go back to the basics of how blockchain works. But above all, are there ways to reduce that and could blockchain also contribute to a positive climate change?

Cleaning-up crypto mining

A recent hearing by the US Committee on Energy and Commercial Staff on “Cleaning up the Cryptocurrency: the Energy Impacts of Blockchain “ shows a very dark picture. Many blockchains, amongst which the two largest platforms Bitcoin and Ethereum, still use a so-called Proof-of-Work (PoW) mechanism to support their resp. crypto currencies that require enormous amounts of energy to operate. According to a recent analysis, the energy required for a Bitcoin transaction could power a household for more than 70 days.

How does mining work?

On the Bitcoin blockchain platform, the infrastructure is distributed and delegated to so-called ‘miners’ around the network. Each time a transaction is made, consensus must be established all across the distributed database (or at least 51% for Bitcoin, for security reasons). This is done through Proof-of-Work (PoW).

Miners are thereby responsible for processing transactions and adding them to the blockchain. These are super-users who compete for the processing work by attempting to solve highly complex algorithmic problems. Mining for PoW cryptocurrencies requires specialised computers that make trillions of guesses per second. In return for this processing, the winner is awarded new cryptocurrencies i.e.  Bitcoin or Ether. This all comes down to the most powerful computer processor exerting the greatest amount of effort. After that other computers on the network quickly verify and a new block containing additional new info is then added to the blockchain. After that the mining process starts over again. A highly energy-intensive process.

As a crypto-miner increases their likelihood of identifying the correct answer by increasing the number of guesses, this process further increases computational power and is creating more energy consumption. Today, PoW miners need a great number of so-called application-specific integrated circuits (ASICS) to have any chance of reliable earnings cryptocurrency rewards on the major cryptocurrency networks. The profitability of mining as well as the increase of the value of PoW currencies requires ever-increasing amounts of energy to power and cool machines.

Environmental impact

While there are many hundreds of different cryptocurrencies, Bitcoin and Ethereum are not only the largest ones but are also the most energy-intensive. In the past few years, their environmental impact has increased greatly in terms of both energy consumption and carbon or CO2 emission.

Energy consumption

The scale of mining has increased substantially triggered by the increased value of mining. This has resulted in a rapidly increasing energy consumption. According to the Bitcoin/Ethereum Energy Consumption Index that is looking at the environmental impact of a blockchain transaction, Bitcoin is the leading coin with the most energy-intensive mining process.

A single Bitcoin transaction uses as much energy as one US household would over 73.82 days (2.5 months). The annual energy usage of the Bitcoin network last year grew from 78 Tera (trillion) watt-hours (TWH) to almost 198 TWH.

Ethereum, while less energy demanding, still uses This is as much electricity for a single transaction as a US household over 8.32 days. The annual energy usage of the Ethereum network grew from almost 15 TWH to more than 92 TWH.

CO2 emission

Bitcoin is also the most polluting cryptocurrency. In total figures and based on 2021 estimations Bitcoin mining edited more than 56.8 million tons of CO2 (or more than 1.000 pounds of CO2 per transaction) to the atmosphere. This would require more than 284 million trees in order to offset the transactions and become carbon neutral. Its total annual energy footprint is similar to Thailand while Bitcoin emits as much CO2 as Kuwait.

ETH mining emitted more than 22 million tons ( or more than 90 pounds per transaction) of CO2. Over the year, that is still as much power as the Netherlands. And as it is projected to emit almost 22 million tons of CO2 by the end of 2021, it would take planting nearly 110 million trees to offset Ehtereum’s contribution to carbon emission.

But taken together, both these blockchains use major economic amounts of energy. These are just ahead of Saudi Arabia and Italy and just behind the United Kingdom. It would be the 12th most consumptive economy on the planet.

To put these figures in perspective global 2021 CO2 emission of Bitcoin and Ethereum mining is equivalent to the emission from more than 15.5 million gasoline-powered cars on the road every year.

 

Bitcoin mining ban

Triggered by the chance of having too little energy left for both consumers and the broader industry, a growing number of countries is now banning or is planning to ban crypto mining.

In China, where 70% of miners worldwide were based, authorities last year has forbidden mining. Whereas since a majority of crypto mining has been moved into lower energy price countries, the present high energy prices caused by the Russian – Ukrainian crisis forced countries like Kosovo and Kazakhstan, but also Iran and India to ban crypto mining. Early this year Russia announced such a ban to prevent winter blockheads. Even in the EU an ESMA official suggested also banning crypto mining. And it is expected that other countries will follow.

 

Ethereum: shift from Proof-of-Work (PoW) to Proof-of-Stake (PoS)

There however are also positive developments within the blockchain world towards climate change. Blockchain technology is still young but is advancing and slowly, but definitely, crypto mining is increasingly driven by more renewable energy. And in the meantime, there is  a number of other ground-breaking energy-saving solutions.

Proof-of-State networks

A promising one is the change-over from Proof-of-Work (PoW) to Proof-of-Stake (PoS) networks, that do not require miners to compete for energy power for zero-sum awards. This could greatly limit energy consumption and carbon emission, thereby mitigating the negative impact of blockchain on the environment.

Proof-of-stake blockchains are newer generation networks. Instead of miners, PoS use a network of ‘validators’ who will stake their own cryptocurrency in exchange for the ability to validate a transaction in exchange for a reward. Effectively, the resource of energy is replaced by capital.

Ethereum 2

Ethereum is now moving forward with their transition from Ethereum 1 (Proof-of-Work), to Ethereum 2 (Proof-of-Stake). With this shift Ethereum hopes that it will make its blockchain both safer to use while greatly minimising energy consumption. Other major PoS networks now include names like Polkadot, Cardano, and Tezos among others.

According to UCL (University College London) research, while using far less energy than proof-of-work (PoW) network Bitcoin (relative to the number of transactions the network can perform at any one time), all the proof-of-stake networks use far less energy – two to three orders of magnitude less than Bitcoin. The same research says PoS-based systems can contribute to the challenges posed by climate change and could even undercut the energy needs of traditional central payment systems, raising hopes that blockchain technology can contribute positively to combatting climate change.

Blockchain and environmental projects: green smart contracts

But there is another – and even more positive – side of blockchain-related to the environment and climate change. Blockchain technology could also be linked to various environmental projects by using so-called green smart contracts.

Green smart contracts

Green smart contracts running on blockchain may unlock new ways to fight climate change and to cope with its impact. At its core, the fight against climate change is going to require a massive shift in global consumption habits. Green smart contracts are an interesting tool for incentivizing participation in global green initiatives. Especially in the areas that ask for large amounts of data collection and verification and rewarding sustainable environmental behaviours, such as regenerative agriculture, carbon offsets, crop insurance etc. Green smart contracts could deliver great promises for environmental issues as these could scale up environmentally conscious blockchain-based solutions. Blockchain could thereby play a great role in stopping or reversing climate change if adopted on a global scale.

Ethereum: DApps and Oracles

The Ethereum platform facilitates the creation of decentralised apps that run on the blockchain. Some of these applications include the management of supply chains, recycling programs, energy systems, environmental treaties, environmental charities, and carbon taxes. These all may help make it more possible to address various environmental issues including air pollution, ocean sustainability, and bio diversity conservation.

This approach relies on networks of so-called oracles, entities that can share data about the world. The development of green smart contracts got a boost as oracles have become production-ready. Today these oracles are broadcasting agricultural data sets onto blockchains, enabling smart contract developers to build applications around crop yields, soil quality, weather reports, carbon offsets etc.

As more and more data sets are fed into blockchains, developers are beginning to produce a wide range of environmentally-conscious smart contracts applications, helping fight against climate change, reduce carbon footprints, sustainable conscious consumption, improve consumption habits etc.

 

New generation consumers and crypto: towards a more climate-conscious approach

New developments like the firm rise in cryptocurrencies, the spectacular growth of DeFi and the growing market for NFTs have attracted many from the New Generations, especially Millennials and Gen Z. This group is increasingly looking for and experiment with these more attractive digital and crypto-assets. But while many of them also worry about climate change and the consequences, most are not aware of the environmental impact of the crypto world.  More delving into the world of blockchain and crypto would not be a bad idea as that could lead to a more climate-conscious approach.


 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

Accepting Crypto Currency In Corporate Treasury

03-02-2022 | treasuryXL | ComplexCountries | LinkedIn |

As more treasuries will have to start accepting crypto, whether it be an emerging market like El Salvador, for digital assets, NFTs and other goods that are sold in the metaverse. This report explores the experiences of treasurers in setting up their systems to accept crypto currency.

This report is based on two treasury peer calls chaired by Simon Jones and was compiled by Monie Lindsey.



This report is based on two treasury peer calls chaired by Simon Jones and was compiled by Monie Lindsey.

The full 14-page detailed report is available to subscribers in our Report Library.

To find out about subscriptions and other value-added services, please make an enquiry.


Chair’s Overview

Following the CompleXCountries call ‘Accepting Bitcoin in Corporate Treasury – Lessons from El Salvador’, (Report Summary Here), the CXC community clearly did not see this as a one off.  The necessity to accept Bitcoin & Crypto may become a reality for more Treasurers, but the path is far from being very clear. The purpose of this call was to share experiences and challenges, and learn from the various solutions Treasurers are putting in place if they have to accept crypto currency to support their businesses.

The session was extremely insightful and even if a Corporate is not accepting Crypto now, this report required reading for the Treasury community.  It is a challenge that will increasingly become more common as corporations drive more digital sales channels.   The regulated Crypto exchanges have seen significant growth over the last few years and the ability to exchange fiat for crypto and back to fiat has become widely available in the marketplace.

We posed the questions: Is this something that they have had to deal with or are going to have to deal with in the future? El Salvador was the first newsworthy case but on this call we gained insight to how it is becoming more mainstream in digital businesses and therefore becoming far more common for corporates around the world.

Non-Fungible Token (NFT) Definition. “A unique digital certificate, registered in a blockchain, that is used to record ownership of an asset such as an artwork or a collectible.” Collins Dictionary, who picked ‘NFT’ as their word of the year 2021.

To summarise the key learning points:

  • Consumer businesses are targeting digital native consumers who are increasingly buying NFTs as collectibles or to demonstrate their alignment with a brand or product. This client base expects to be able to buy or trade NFTs in exchange for crypto assets that they might have accumulated from investments.
  • The marketplace and blockchain the NFT is issued on, will determine the crypto asset that can be used to buy the NFT, e.g. Ethereum or stable coins on the Ethereum blockchain.
  • Coinbase was the exchange of choice for the Corporate Treasurers who took part in this call, primarily because they are publicly listed and regulated in many markets around the world.
  • KYC & Onboarding procedures were no different for Coinbase than for opening a bank account at a relationship bank, it still took weeks, not days.
  • Some Treasurers allow NFTs to be purchased via a crypto currency, but immediately convert back to fiat currency, via the exchange provider, both to avoid volatility and because of uncertainty over the accounting, legal and tax implications of holding crypto currency.  Bitcoin was not widely used, as it was deemed to be more open to money laundering concerns by the exchanges.
  • Crypto Exchange commission continues to be quite expensive and is not as tight as fiat currency exchange.
  • Accepting Bitcoin seemed limited to only El Salvador, where it is legal tender in addition to USD. (Corporates are required to accept BTC in payment should their client require it.)  Other countries may follow.
  • Anti-Money Laundering controls continue to be top of mind and it’s important to make sure the NFT auction houses, marketplaces and collecting exchanges are able to trace the origin of coins to protect their corporate clients.

Conclusion:  Highly insightful session, brings home the reality that as more businesses issue and sell digital assets like NFTs online for their products & services, it will be a requirement to accept crypto coins.  No longer are crypto-assets like bitcoin just for speculative investment, but they are becoming the instrument of choice for some digital native consumers to use for purchases.  Understanding the digital product & services strategy at a Corporate and the implications that might have for a corporate treasurer is fast becoming a necessity to supporting the business.

Would you like the full copy of this report?

Sign up for our updates and get a free copy, plus regular bulletins and more occasional free reports.


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