ETF filings changed the Bitcoin narrative overnight — Ledger CEO

Over the past 12 months, some investors learned the hard way why they needed to move their crypto offline. Those who kept Bitcoin (BTC) and altcoins on crypto exchanges like FTX lost control of their assets, sometimes forever. Events drew a red line under the storied crypto adage: “Not your keys, not your coins.” 

FTX’s loss was hardware wallet manufacturer Ledger’s gain, however. The Bahamas-based exchange’s November 2022 bankruptcy filing delivered to Ledger “our biggest sales day ever,” the firm’s chief experience officer, Ian Rogers, told Cointelegraph, and “November turned out to be our biggest sales month on record.”

Paris-based Ledger has been on a strong growth curve recently, though the past year has not been without controversy. In May, for instance, the firm drew industry ire when it launched a new secret recovery phrase storage service called Ledger Recover. Still, it remains one of the best-known and most-used crypto wallet makers in the world.

Cointelegraph recently caught up with Rogers and Ledger CEO Pascal Gauthier in New York City to discuss the new crypto climate in the United States, the latest trends in crypto storage and differences in doing business in the U.S. and Europe, among other topics.

Cointelegraph: Many think that the crypto/blockchain sector is still in the doldrums or moving sideways at best, but you see reasons to be cheerful even here in the U.S.?

Pascal Gauthier: What happened in 2023 — and went virtually unnoticed — is a change of tone regarding Bitcoin. When the SEC [Securities and Exchange Commission] implied that Bitcoin was a utility and/or commodity — and not a security [like other altcoins] — this triggered two things: large companies like BlackRock began their ETF [exchange-traded fund] application process, and then the media narrative around Bitcoin changed almost overnight.

As 2023 began, Bitcoin was for drug dealers, terrorists, bad for the planet, etc. — and suddenly it became completely kosher. The biggest financial institutions in the U.S. are suddenly doing Bitcoin.

CT: The BlackRock application for a spot-market Bitcoin ETF was a turning point?

PG: Big money is coming into crypto; it’s been announced. It may take a few years to really finally arrive, but if you look at Fidelity, BlackRock, Vanguard…

CT: What about U.S. regulations? Aren’t they still a barrier?

PG: The next administration will decide the fate of crypto in the United States. If Biden stays in power, this administration could continue to be aggressive toward crypto. If it’s someone else, we’ll see what happens.

CT: Let’s talk about offline storage devices. Mark Cuban said in 2022 that crypto wallets were “awful.” Did he have a point?

PG: A lot of our early customers used our [cold wallet] product to “buy and hold.” You would purchase a Ledger [device], you put your Bitcoin in it, and then you put it someplace and forget about it. But that’s not what we recommend now.

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Today, you can connect your wallet to Web3 and use your private keys to do many things, including buying, selling, swapping and staking crypto, as well as engaging with DApps [decentralized applications] and even declaring your taxes.

CT: On a 1 to 10 scale, where would you put cold wallets today in terms of user experience (UX)?

PG: For the industry, it’s a three. For Ledger, maybe a four — and we’re striving to be a 10. The industry has a lot to do in terms of UX and UI [user interface].

Ian Rogers: Your hardware-software combo today is not just about hardware and software. It’s an end-to-end experience.

When you’re buying an Apple iPhone, for instance, you’re not buying a piece of hardware; you’re buying into the Apple experience. We would ultimately like that to be the same thing with Ledger. Our approach is to do the absolute best user experience possible without compromising on security or self-custody.

CT: Still, there’s these UX issues like the 24 seed words you need to recover your private key if you lose your Ledger device. Some users go to great lengths to safeguard those words, even engraving them in steel just in case their house burns down. Doesn’t that sound sort of extreme?

PG: It is a little backwards to have something like a metal plate in your home. It’s not very 21st century. But we came up with a solution for this.

Gauthier (center) speaking at the Viva Technology conference. Source: X

When you use a Ledger product, you end up with your Ledger device and a PIN code. And you will also have those 24 words that become your master password, basically. You need to keep those 24 words safe, and this is a major barrier to entry for a lot of people. They don’t trust themselves with those 24 words. They don’t trust themselves not to lose them.

So, we came up with a service called Ledger Recover [i.e., an optional paid subscription service provided by Coincover that is expected to launch in October] to deal with that. It allows you to shard your private key into three encrypted shards and then send them to three different custodians. They cannot do anything with the [single] encrypted shard. Only you can bring your 24 words together again if necessary.

CT: Don’t we already have something like that with “social recovery,” where you entrust your cold wallet recovery to several friends or “guardians?”

PG: Social recovery doesn’t really work. We’ve done something that resembles social recovery — but with businesses [i.e., Ledger, Coincover and EscrowTech]. You will have to present your ID if you want to initiate the shard recovery.

CT: You were criticized when you first announced the Ledger Recover service in May. Then, the launch was postponed amid the “backlash.” There were security concerns. People said these three shard-holding companies could reconstruct your private key.

PG: There is still a lot of education to be done for people to understand really how security works. People said [at that time] that it might be a good product if it were more transparent and easier to adopt. So we didn’t go live in May, as planned, in order to make the product ‘open source,’ which adds something in terms of transparency though not security,

CT: But couldn’t three sub-custodial companies, at least in theory, collaborate and reconstruct your privacy key?

PG: It’s not possible. They don’t have the necessary tools necessary to decrypt and reconstruct.

CT: Moving on to Ledger’s business model, do you sometimes worry that as big institutions like Fidelity Investments or banks like BNY Mellon enter the crypto space that users may simply park their crypto with them? If they get hacked, those giant custodial institutions will then make them whole again. Or at least that is sometimes the thinking.

PG: We’re a pure technology company. So when Fidelity decides to become a [retail] crypto custodian, they’ll probably come to us and buy a part of our technology to build their own technology stack. 

CT: Your business strides several continents. You’re based in France, but you sell many of your devices in the United States. You have first-hand experience of those two business climates — the U.S. and Europe. Are there key differences when it comes to crypto?

PG: Europe has a tendency to over-regulate or regulate too fast, generally speaking. Sometimes people say, well, you know, Europe has clarity because it has MiCA [Markets in Crypto-Assets, the EU’s new crypto legislation], while in the U.S., there is a lack of clarity and lots of lawsuits.

But in the U.S., the way that the law is designed is slow and bumpy. It takes time to change laws in the U.S., but when change finally does come, it’s often for the better.

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If you look at the biggest tech champions in the world, they’re mostly American or Chinese. Zero are European.

CT: Are you linking heavy regulation with a lack of innovation?

PG: It’s hard to say if they are directly linked, but Europe has always had a heavy hand in terms of taxation and regulation.

Ian Rogers: To me, there’s no question they are linked. At LVMH [the French luxury goods conglomerate where Rogers served as chief digital officer for five years], we worked with a lot of startups. Every European startup wanted to get to the U.S. or China to “get scale” before they came back to Europe. Europe is not a good market if you’re a startup.

CT: But Ledger remains positive about the future of cryptocurrencies and blockchain technology overall?

PG: Things are not necessarily what they seem to be. It was our [late] French president François Mitterrand, who said: “Give time for time.” There’s something going on now, and only the future will be able to make clear what is happening.

‘Massive’ crypto use cases to surface by 2030 — Coinbase exec

Coinbase launched Base, its new blockchain, in late July, and it has already become a major player among Ethereum-based layer-2 chains. 

On Sept. 21, for instance, the chain notched some 677,000 transactions, with 870,163 “new addresses seen,” according to Etherscan.

By comparison, Arbitrum, a prominent layer 2 that launched in June 2021, had 925,000 transactions and 54,233 new addresses on the same day.

Base is now hosting hundreds of decentralized projects, Jesse Pollak, head of protocols at Coinbase, told Cointelegraph at Messari’s Mainnet conference in New York City on Wednesday, Sept. 20, including decentralized inflation oracles, restaurant rewards projects, an insurance aggregator and everything in between.

A major force behind the Base project, Pollak sat down with Cointelegraph at Mainnet for a Q&A encompassing Coinbase’s vision for its new platform, the rising promise of decentralized applications (DApps) and the evolution of blockchain technology.

Cointelegraph: You’ve said Base was created with a “clear vision: bring the next million builders and billion users on-chain.” Those are big numbers. How long will they take to achieve?

Jesse Pollak: It’s less about Base specifically and more about a billion users coming on-chain — embracing the power of this new platform [i.e., blockchain] that’s transparent, open, global — and developing apps that can improve people’s lives. Base is obviously going to play a big role in that, but it’s much bigger than just us. We really see our role as helping grow that pie.

CT: And the timeline?

JP: I see it happening this decade, i.e., one million developer jobs by 2030. There’s already been massive change in the 2020s — not just in the industry but the entire world. It’s going to happen faster than people might expect.

CT: What still needs to be done before we see mainstream adoption?

JP: Three high-level things need to happen. First, we need to make it cheaper for people to use these apps that are being built. We’ve done the first few orders of magnitude of cost reduction with Base. The same app might have cost $5 or $10 to use now costs 5 to 10 cents.

But we don’t think that’s enough. We really want to lower it so far that the cost is almost imperceptible to users.

Second, we want to make it easier for people to use these apps. A lot of that is building better wallet experiences.

Third, we need to have better identity infrastructure on-chain. Today, most consumer borrowing in the United States and other developed countries is under-collateralized borrowing in the form of credit cards or buy-now-pay-later arrangements. And almost none of this is possible on-chain now because we don’t have reliable identity systems.

So, to enable that next wave of big use cases, we’ll need lower costs, better wallets and better identity.

CT: You’ve said that what most people have done with crypto until now is speculate on the crypto markets, and it’s time to move on. Has it been a mistake to focus so much on the market price of Bitcoin, say?

Pollak: I don’t think it’s wrong if you look at the way that technology life cycles evolve. Carlota Perez, for instance, writes that financial bubbles are almost inevitable when you have meaningful technological innovation like the internet or electricity. You have this S-curve of adoption. [See chart below.] In the beginning, a lot of innovation is fueled by speculation as people see potential in the technology. This speculation draws in capital, which basically funds the innovation and eventually leads to impacts that change the world.

Technology adoption often follows an S-curve. Blockchain may now be at a turning (inflection) point.

CT: Where are we now?

JP: We’ve reached the point where it’s time to move out of that [speculative] phase and into the phase of really bringing utility to everyday people. The infrastructure is ready.

Even two years ago, if you wanted to use an app on Ethereum, it was going to cost you $5 or $10 or $100. That’s just not something that is supportive of building everyday use cases.

CT: Speaking of Ethereum, why did Coinbase decide to build its layer 2 on the Ethereum blockchain? Did you ever consider using another mainnet?

JP: We actually looked three times at building a chain: In 2018 and 2020, and then most recently in 2023. And the first two times, we looked at building an alternative layer 1, one which would have been competitive with Ethereum. Our takeaway was we didn’t want to put ourselves on an island disconnected from the rest of the ecosystem.

The third time, we looked at all of the options: Ethereum, alternative layer 1s, layer 2s, etc. What felt natural to us about Ethereum was it is the largest crypto ecosystem by value, by activity, by developers — by order of magnitude or two — and so by building Base as an Ethereum layer 2, we could both contribute to scaling Ethereum and be a part of this ecosystem that’s larger than us.

CT: What about Ethereum’s oft-discussed scalability shortcomings, including network congestion and sometimes ballooning fees? Have those been largely solved through extensive use of layer-2 rollups like Optimism and Arbitrum (and now Base), where transactions are “batched” and added to the mainnet in a single lot?

JP: If you look at the history of Ethereum, the original vision was: We’re going to do all this at layer 1, and we’re going to scale up through sharding. But around 2020 and 2021, as layer 2s emerged, the Ethereum community and core development groups basically said: What if we changed our strategy where instead of trying to introduce all of this complexity at layer 1, we build the infrastructure to enable innovation at layer 2?

That was something that Vitalik [Buterin, Ethereum co-founder] wrote about a lot. And over the last two years, that’s what happened. Coinbase supported an initiative over the last year-and-a-half called EIP-4844, for instance, that introduced data availability for rollups, leading to reduced fees and more transaction throughput.

But do I think we’ve solved the problem? No. These things take years to solve, and I think we are now two to three years into making those investments, and we have another two to three years or more potentially to go. But I think we’ve made a lot of progress.

You can see this at L2Beat. [See chart below]. Two years ago [Sept. 21, 2021], there were eight transactions per second [on average] on layer-2 projects and 13 TPS on the Ethereum mainnet. Today, there’s 58 TPS on layer 2s and 11 TPS on the Ethereum mainnet. So we’ve gone from less than 1x to 5.7 times faster in two years.

On Sept. 20, 2023, average transactions-per-second (TPS) on “projects” was 54.63 TPS, up from 8.03 TPS in September 2021. The Ethereum TPS line, by comparison, changed little during this period.

CT: Are you surprised that a “buzzy” social media DAPP — — was initially Base’s biggest performer after its summer launch? Its fees surpassed $1 million in one 24-hour period. Still, maybe this wasn’t the serious use case that some critics were hoping for.

JP: Well, when the first social apps launched on the internet, some people looked at them and said, hey, these things are toys. When are we going to go do the serious stuff like bringing newspapers online? If you look at where we are today, social apps are used by billions of people every day. They will continue to be a way that people connect, and social apps will play a critical role on-chain.

What’s powerful about this next generation of on-chain social apps is that they will enable people to have sovereign ownership. They will continue to own their creativity, and they’ll continue to be in control — rather than the large corporations that are controlling them now.

CT: Can you tell us about a DApp launched on Base that excites you?

JP: Check out Blackbird, a customer engagement platform for restaurants. You walk into any participating restaurant, you tap your phone, and it instantly knows who you are. They customize the experience for you. Repeat visitors can earn rewards. It’s in 10 or 15 restaurants now in New York City but is soon expanding into California. A lot of people are talking about it on Twitter.

CT: Where will blockchain finally find its “killer app” — to do for the cryptoverse what email did for the internet? Or has it already emerged in your view?

JP: There won’t be one killer app. There will be many killer apps. We’re starting to see some of those emerge. The one with the most real-world adoption is stablecoins. If you look at the total volume of stablecoin transactions over the last year, it’s a massive number. It will be a big driver of economic freedom in the decade ahead. It gives people in places like Argentina or Turkey access to a stable currency like the U.S. dollar.

But stablecoins won’t be alone. We will see many on-chain applications that will change people’s lives for the better.

Collect this article as an NFT to preserve this moment in history and show your support for independent journalism in the crypto space.

How blockchain tech and dMRV can help carbon trading markets

There is a global consensus that greenhouse gas (GHG) emissions are warming the planet, but efforts to accurately measure, report and verify these emissions continue to challenge researchers, nonprofits, corporations and governments. 

This is especially the case with “nature-based” projects to reduce carbon dioxide levels, like planting trees or restoring mangrove forests.

This has inhibited the development of a voluntary carbon market (VCM) on which carbon offset credits are traded. These “offsets” are sometimes viewed as licenses to pollute, but VCMs overall are thought to be beneficial to the planet because they help quantify the environmental impact of industrial and consumer activities and, at least indirectly, motivate companies to curb emissions.

However, VCMs have recently come under intense criticism. A nine-month investigation by the United Kingdom’s Guardian newspaper and several other organizations found that more than 90% of “rainforest offset credits” approved by the leading certification firm Verra “are likely to be ‘phantom credits’ and do not represent genuine carbon reductions.”

This finding shook the carbon trading sector, but it has also spurred some new thinking about ways to measure, report or verify the efficacy of carbon-reduction projects. Digital monitoring, reporting and verification (dMRV), for example, largely automates this process, making use of new technologies like remote sensing, satellite imagery and machine learning. DMRV also uses blockchain technology for traceability, security, transparency and other purposes.

All this is still new, but many believe dMRV can reinvigorate carbon markets following the Verra scandal. It can also compensate for a shortfall of human auditors and inspectors available globally to assess GHG projects, especially the more problematic “nature-based” projects. In addition, it can gather a broader range of data and potentially make it available in real time. Importantly, it will allow a global comparison of projects for the first time.

“A huge difference”

“DMRV will make a huge difference here, since it moves the quantitative comparison of various nature-based interventions onto a global field where they can be comparable with each other — something that is not possible in the current systems as projects self-report against their own baselines,” Anil Madhavapeddy, a professor at the University of Cambridge and director of the Cambridge Centre for Carbon Credits, told Cointelegraph.

Some go even further. “Digital Measurement, Reporting, and Verification (dMRV) technology has the potential to revolutionize the way the voluntary carbon market (VCM) operates,” declared dClimate, a decentralized infrastructure network for climate data, in a March blog post.

Still, questions remain: Maybe this is all too little, too late for averting climate change? And if not too late, won’t progress stall if better methodologies aren’t developed, like quantifying how much a Brazilian rainforest reduces global carbon? Are blockchains necessary for the process, and if so, why? And can dMRV really “revolutionize” voluntary carbon markets, or is this just excessive hyperbole?

“It is not too late,” Miles Austin, CEO of climate tech firm Hyphen Global AG, told Cointelegraph. “We find ourselves at a pivotal moment.” The Verra scandal and continued allegations of “greenwashing” on the part of corporations have made more companies leery of supporting carbon-reduction projects.

“The perceptions of trust and feasibility associated with nature-based assets, both within the public and private sectors, have been adversely affected,” Austin noted. But he added that at this critical juncture:

“DMRV can have a significant impact to not only improve these markets but save them.”

It might be helpful to compare dMRV with traditional MRV, which aims to help prove that an activity — like planting trees or scrubbing smokestack emissions — has actually occurred. It is a prerequisite before a monetary value can be attached to the activity, and a necessity for carbon trading markets to work. 

MRV has been “underpinning” sustainability reporting for years, Anna Lerner Nesbitt, CEO of the Climate Collective, told Cointelegraph. However, “it has a lot of weaknesses,” including a high reliance on subjective data, steep costs, lengthy timelines and a dependence on “international experts” — i.e., consultants.

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According to Cambridge Centre’s Madhavapeddy, the inherent difficulty with quantifying nature-based projects “is that the conventional mechanisms for doing so — over the past decades — have been very manual and hard to compare across projects.”

Quantification mechanisms used for these assessments are far from being standardized. They include assessing “additionality” (i.e., what’s the net difference climatewise of a project?), permanence (how long will its effects last?), and leakage (did a negative externality, like cutting down a forest, just move somewhere else?).

DMRV, said Nesbitt, relies on emerging technologies and more granular data for “a fully digitized MRV protocol that not only collects digital data via Internet of Things, sensors and digital technologies but also processes and stores data on a fully digital and decentralized blockchain ledger.”

DMRV can also potentially reduce the workload of auditors and inspectors called upon to validate emissions-reduction projects, according to Daniel Voyce, chief technology officer of sustainability-focused solutions provider Tymlez, who wrote:

“With manual MRV recording each auditor or inspector might only be able to verify 150 projects each year due to chasing down the data they need and having to collate it all.” 

Digitizing the process could reduce time and costs by 75%, he estimated. 

Can blockchain help fix a “convoluted” process?

What role, if any, does blockchain play in all this? “I think if we are being honest, voluntary carbon markets — and regulated carbon markets — need blockchain for asset issuance and traceability,” Michael Kelly, co-founder and chief product officer at Open Forest Protocol — an open platform for scaling nature-based solutions — told Cointelegraph.

The current MRV process is “convoluted,” he said, with “no visibility into issuance schedules, no traceability, quite frequent double-spending, etc.” As a result, “people are hesitant to touch carbon credits.”

DMRV combined with blockchain could change things. “Once they can see everything about it [a project] — down to the upload of each tree in a sample plot for a 20-year time period — we will see new participants coming into the arena.”

Some incremental improvements in MRV — like digitizing submission forms — don’t really need blockchain tech, noted Nesbitt, but that might soon change with the addition of “features like smart contracts that allow for more inclusive or just asset pricing, baking in a reasonable compensation for local communities involved in carbon credit projects.”

However, there may be limits on how much blockchain tech alone can fix things. Blockchains can enable “transparency, security, automation and immutable records of data flows in an auditable fashion,” but that might not be enough, suggested Hyphen’s Austin, adding:

“DMRV can only be as good as the data and methodology used. If you take a flawed methodology and digitize it with blockchain, you now have an immutable and transparently flawed dMRV.” 

Improving methodologies is crucial in Austin’s view. “Activity-based approaches work well in the case of combustion engines or industrial processes, which you can accurately measure and multiply by a factor,” he told Cointelegraph. 

But these don’t really work on “nature-based solutions.” A forest in Brazil may sequester more carbon dioxide than an equally sized forest in Indonesia based on many variables, including drought, rainfall and humidity, for example.

“Nature is a breathing and living asset; therefore, methodologies need to measure the actual amount of CO2/CO2e [carbon dioxide/carbon dioxide equivalent] that is a sink or source instead of calculating a best guess,” said Austin.

Work is being done in this area, especially in the wake of the Verra controversy. “Researchers in this field are showing how the quality of ‘avoided deforestation’ carbon credits could be improved,” Julia Jones, professor in conservation science at Bangor University, told Cointelegraph. “However, there is, of course, some lag between new research and it getting into policy and practice.”

The Cambridge Center for Carbon Credits actually built a research prototype last year of what a carbon credits marketplace might look like on the Tezos blockchain. “Our first observation was that the blockchain really wasn’t the bottleneck here — all of that infrastructure works fine and has a solid technical roadmap for scaling,” Madhavapeddy told Cointelegraph. The barrier lay elsewhere.

“The blocker to any meaningful deployment came from the lack of supply of credible projects, since the quantification mechanisms” — i.e., additionality, permanence and leakage — “are only just maturing as satellite infrastructure and the associated algorithms are peer-reviewed and deployed.”

Lidar points mapping trees in the Sierra National Forest. Source: Research Gate

Kelly also cited a shortage of “quality carbon development projects and accessible credits,” especially in the nature-based asset subsector, as a significant obstacle for VCMs.

Projects like reforestation, afforestation, mangrove restoration and biodiversity conservation are now short of funding. This project shortfall leads to a low supply of credits, which becomes a sort of chicken-and-egg problem.

“The result of this system is that carbon credits remain a relatively illiquid, convoluted and difficult-to-scale system that disincentivizes stakeholders from financing, purchasing and trading the assets to participate in the market,” said Kelly.

“The biggest barrier right now is the collective credibility of the voluntary markets, and we hope that our work on the digitization and systematic design and publishing of analyses can help bridge that gap,” said Madhavapeddy.

A “perfect storm”?

What about claims, like those cited above, that dMRV technology has the potential to revolutionize the way the voluntary carbon market operates? Is that going too far?

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“DMRV is at the center of strengthening data integrity, which in turn would improve process integrity,” said Nesbitt. “So yes, I think dMRV is vital to set up the voluntary carbon market for success. But saying it will revolutionize the market might be taking it a bit too far given the many dMRV improvements and applications already in implementation.”

Kelly sees two promising trends in the wake of the Guardian expose. Legacy incumbents like Verra and Gold Standard are now more intent on digitizing their processes and “becoming more transparent and trustworthy,” he said, while “stakeholders are more willing to try new solutions, or service providers, especially if they have higher standards for trust, visibility and quality.”

The result could be a “perfect storm for catalyzing a liquid voluntary carbon market — on-chain,” he added.

From the U.S. to Japan, regulators are beginning to embrace crypto

When it comes to cryptocurrency/blockchain regulation, considerable attention has been focused, this past year, on the United States’ action (or inaction). But the U.S. is not the world, just one important player, and crypto, from its beginnings, has been a global enterprise. 

Perhaps, then, it makes sense to step back and ask: What is going on with crypto regulation when viewed through a global lens?

For instance, how do geographic regions such as Europe, Asia and North America compare in terms of crypto legislation, rules and enforcement? Is there any single country or jurisdiction that could serve as an exemplar for regulation? How is the developing world dealing with all this variation? And finally, are there reasons to be hopeful about the way regulatory trends are now unfolding?

If one focuses solely on the negative — the tide of crypto-related collapses, bankruptcies and enforcement actions in the United States this past year — a skewed picture can emerge. Progress in places like Europe might be overlooked, like the European Union’s recent adoption of its Markets in Crypto-Assets (MiCA) regulatory framework.

“Through MiCA, the European Union has been a global model by offering the much needed regulatory clarity that crypto businesses of varying sizes and business models would need,” Caroline Malcolm, vice president of global Policy at Chainalysis, told Cointelegraph, adding:

“Regulatory clarity and consistent implementation of rules will allow businesses to devise their operational program.” 

Nor is Europe necessarily alone in pursuing a forward-looking path. “There is massive momentum on achieving regulatory clarity for digital assets across the world, whether that be in the U.S., Singapore, the UAE or others,” Malcolm said.

A fragmented world

Despite some promising trends, global crypto regulation — laws, rules, enforcement, taxation, etc. — remains a mixed bag. 

“There’s a lot of fragmentation when it comes to regulation depending on the jurisdictions and geographical areas,” Bertrand Perez, CEO of the Web3 Foundation, told Cointelegraph in an interview earlier this week.

“In the U.S. we know, we know what’s happening or what is not happening over there,” continued Perez, who earlier served as chief operations officer at the Diem Association (formerly Libra, Facebook’s high-profile but ultimately failed stablecoin experiment).

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Europe’s MiCA regulations, by comparison, focus on stablecoins. Indeed, MiCA is the EU’s “answer to the Libra project,” Perez said.

Significantly, the Europeans recognize that one can’t have a single regulatory framework for everything crypto, he added. MiCA is step one, “but then they’ve been slicing the use cases.” There will eventually be another regulatory framework for nonfungible tokens and another for metaverse-related use cases.

The EU doesn’t hold a monopoly on progressive thinking either. Switzerland, which is not an EU member, was the first country to develop a clear crypto framework back in 2018.

The Swiss regulatory scheme separates tokens into three categories: security (a.k.a. “asset”) tokens, utility tokens and payment tokens, and also provides a number of licensing schemes dependent on the project’s structure.

In the U.S., by comparison, the Securities and Exchange Commission appears to have categorized all digital tokens — with the possible exception of Bitcoin — as security tokens. But in Switzerland, according to Perez:

“If you are a utility token and or if you’re a security token, the rules of the road are completely different from the regulation perspective.” 

The legal certainty that Switzerland has offered for several years now is the reason that so many crypto-related foundations and companies are based there and the reason so much Web3 innovation comes out of that country, he said. The Web3 Foundation, creator of the Polkadot protocol, is based in Zug, Switzerland. 

Historically, Singapore followed Switzerland’s lead, and for a while, those two venues stood alone in terms of crypto rule-making clarity. “In 2019, when we announced Libra, there were those two choices, either Switzerland or Singapore, in terms of regulation,” Perez recalled. “The two countries were clearly leading the pack and having clear frameworks that were well defined.”

The evolving case of Japan

Today, there are more approaches. “In Asia as a geographical area, every country is having a different approach” to regulation, Perez continued. 

However, Japan is one jurisdiction that is attracting more attention than the others. Japan was formerly the home of Mt. Gox, which was the subject of crypto’s first mega scandal. When that cryptocurrency exchange collapsed in 2014, it arguably made Japan crypto-wary. But if so, the island nation seems to be emerging from its isolation now — at least based on discussions Perez and others have held there recently.

“Japan is still a land of many innovations,” he reported. Indeed, at the WebX conference held in Tokyo in late July, Japanese Prime Minister Fumio Kishida announced, “Web3 is part of the new form of capitalism,” adding that it would be a vital element of Japan’s economic strategy, centered on growth, innovation, wealth distribution, digital transformation and the support of startups.

“The Prime Minister announced that basically he is welcoming Web3 to Japan, where a year ago or even a few months ago it wasn’t clear if they were supportive or not,” Perez told Cointelegraph. “Now it’s clear and the rules are going to be as business friendly as possible.”

Japan wanted to develop and implement clear and well-defined rules of the road for cryptocurrencies before it opened its gates again after Mt. Gox, Perez suggested, and they have those now. As he further noted:

“Japan’s crypto exchanges are the safest in the world now because the regulation is very strong. And now they are broadening their reach and welcoming broader [crypto] use cases.”

The most progressive G7 nation?

Elsewhere, China has been in the process of launching its digital yuan, becoming “the first country to have a central bank digital currency at scale,” according to Perez. Meanwhile, Dubai, the most populous city in the United Arab Emirates, is now “really pushing hard” in the crypto sphere “to attract not only capital but also skills from all around the world,” said Perez.

Asked to rank the largest Western countries in terms of regulatory crypto foresightedness, Perez put the European countries ahead of Japan, with the U.S. bringing up the rear. Within the EU, he would place his native France at the forefront, given that it is “the first European country to clearly implement the MiCA framework ahead of the law being enforced in the European Union.”

France has also done a good job at defining the rules of the road “in a way that is usable from a business perspective.” The U.K., no longer in the EU, is also “beginning to shift and see the value” in crypto and blockchain technology, he added.

Perez even detects “a different tone” among U.S. regulators and legislators; they now seem less likely to view the cryptoverse as a place inhabited chiefly by drug dealers and money launderers. He also observed that cryptocurrency reform is being spearheaded by legislators “on both sides of the aisles” within the most recent U.S. Congress.

What about low- and moderate-income countries — where do they stand with regard to crypto regulation?

“Most of those countries are basically waiting for the big players like the U.S., the European Union and Japan,” Perez said. They will watch to see which frameworks work best and can be adapted to their particular circumstances.

Which regulatory elements would he especially like to see duplicated globally? “If I had to recommend one framework, I would choose a combination of the Swiss token framework and parts of the EU’s stablecoin framework,” Perez answered.

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These would offer some flexibility and encourage innovation. Within the EU framework, there is even room now for a token to be reclassified over time. A token might begin its “life” as a security token, but later evolve into a utility token. As the Web3 Foundation’s chief legal officer, Daniel Schoenberger, explained to Cointelegraph in May:

“A token can be used initially as a fundraising instrument. If a token is used for fundraising purposes, it should be subject to all applicable laws and regulations. However, over time that same token may serve a functional purpose devoid of speculative investment. This is part of the nature and innovation of blockchain technology.”

When asked whether he viewed the global regulatory glass as half empty or half full, Perez noted that this past year was generally a difficult one for the crypto sector amid scandals and bankruptcies like FTX and Celsius. 

However, “I think we’ve passed through the worst,” Perez said. Some harsh criticism was heaped upon the industry, but that in turn may have led to “a bit more transparency” as well as reinforcing the need to build projects that last. Perez continued:

“So from that perspective, I’m very optimistic in terms of regulation. I’m also optimistic regarding U.S. policymakers. People are really starting to get it.” 

Blockchain technology lets East African farmers sell globally

Small farmers in the developing world may be on the cusp of an agricultural breakthrough. With emerging technologies like satellite imagery, drones and machine learning boosting productivity, it’s becoming more viable than ever to sell their produce in places like Western Europe. 

There’s just one catch: avocado farmers in East Africa or coffee growers in Latin America have to be able to document that their crops have been grown in accordance with sustainable agricultural practices. 

Their harvest bounty can’t come at the expense of denuded forests or through the assistance of child labor. And if their products are labeled “organic,” they will have to provide certification that no synthetic fertilizers and pesticides were used.

This is where blockchain technology could play a significant role. 

Generating an immutable record

“Blockchain creates a great solution with an immutable record, particularly [when] combined with mobile” and other emerging technologies, Jon Trask, CEO of Dimitra — an AgTech firm active in 18 countries, which has worked with government agencies in Brazil, India, Uganda and Nepal — told Cointelegraph.

On July 20, Dimitra and One Million Avocados (OMA) — a sustainability-focused tech group — announced a partnership to help Kenyan avocado farmers boost production and quality through cutting-edge emerging technologies, including blockchain.

Dimitra Technology announced the partnership on Twitter.

Dimitra’s multitech platform, which also includes mobile technology, artificial intelligence (AI), Internet of Things devices, satellite imaging and genomics, will give small farmers “greater access to solutions to further promote sustainable farming practices, primarily in pest and disease prevention and data reporting,” according to the press release.

Another key goal of the partnership is to help farmers in East Africa “overcome traceability issues to ensure maximum value of produce and to align with international regulatory frameworks.”

It’s not just in Kenya or the African continent where this movement of agricultural goods from the Global South to the Global North is picking up, either. “We have the same situation in Indonesia, Brazil and a few other Latin American countries,” Trask told Cointelegraph. “When they [farmers] are exporting their produce, they can get more dollars per kilo.”

Documentation will be critical for would-be exporters, especially with Europe’s new deforestation regulation, which went into force in June — though its main obligations won’t apply until yearend 2024. “You will have to prove that your firm has not been involved in deforestation,” explained Trask, adding:

“When an avocado farmer in Kenya goes to export their produce, they need to create certain documentation to show the origin of the produce. There is security associated with that document. It’s easy to create a fraudulent document.”

Enter blockchain, the traceability tool par excellence. “Blockchain-traced data is immutable and can serve as proof for farmers to get certifications or loans,” researcher SzuTung Chen, who recently completed a master’s thesis on coffee growing in Colombia, told Cointelegraph. “A blockchain company is working with carbon credit companies, for example, so that the farmers that are operating sustainable practices can have recorded data of their farming and get additional income.”

One of the biggest problems facing small farmers is information asymmetry, Chen explained. “Coffee brands and roasters capture the highest margin of the coffee price because they are closer to the end customers, and can leverage branding and marketing.”

Farmers, on the other hand, don’t know where their coffee goes after they sell it, the destination of their coffee or any coffee market trends — “which keeps them in a vulnerable situation in the supply chain,” she adds.

What blockchain can potentially do, she continued, is facilitate two-way transparency, so not only do stakeholders at the end of the supply chain know where the coffee comes from, but farmers also know what happens in the downstream supply chain.

More powerful than blockchain alone

Dimitra will use satellite imaging technology to help Kenyan farmers prove they aren’t ravaging woodlands to grow their avocados, but this technology can also be used to enhance productivity. By applying machine learning models to satellite imagery, Dimitra has developed algorithms that can pinpoint where more fertilizer is required or where irrigation needs to be stepped up, for example.

A multitech solution may generate synergies too. As Monica Singer, South African lead and senior strategy at ConsenSys, told Cointelegraph:

“When you are able to create an ecosystem using mobile and Internet of Things devices and AI, where relevant, it will be a more powerful solution than the blockchain ledger on its own.”

Is this cross-disciplinary approach the wave of the future? “I believe that blockchain can’t do it on its own,” Trask said. “We need to combine technologies in order to provide the services that the agricultural industry needs.”

It may be different in the financial sphere, conceded Trask, who has spent the past six years working on blockchain-related projects — his supply chain-related experience goes back even further. DeFi use cases can often stand on their own, but agriculture is different. “When we combine those technologies — machine learning and visual imaging and drones with blockchain — we can get more bang for the buck.”

The firm has “trained” machine learning models to recognize what a tree looks like using satellite images. A “tree” must have a certain canopy, height, etc. The firm can generate deforestation reports that illustrate within the boundaries of a farm where trees have been removed and where they have been added over a period of time.

Dimitra says Kenyan farmers can double their productivity by applying emerging technologies available today, but how much of that gain derives from digital ledger technology per se?

“It does require a combination of technologies,” answered Trask, but one shouldn’t overlook blockchain’s importance. “We originally did a project in East Africa around cattle,” he said, adding:

Farmers discovered that they could “get 50% to 100% more per pound of beef than they would if they didn’t have a traceability [blockchain] system.”

If African avocado farmers can meet the European Union’s documentation requirements, “they can get 30%, 50%, maybe even a couple hundred percent more on export.” Further gains from AI-driven enhancements in areas like irrigation and fertilization could result in a further doubling of productivity, he suggested.

Others agree that blockchain technology can become a factor in its own right with regard to the continent’s agricultural sector, particularly if its record-keeping capabilities are used for quality assurance, as Shadrack Kubyane, co-founder of South’s Africa’s Coronet Blockchain and eFama App, told Cointelegraph.

The importance of tamper-proof agricultural records was driven home to Kubyane by the world’s worst-ever listeriosis outbreak, which occurred in South Africa in January 2017 and had a death toll exceeding 200.

That case “continues to be contested in the courts to this day,” he said. The primary suspect remains a major food processing and distribution entity that, to this day, insists it was not the major source of the outbreak. “Had blockchain been in full force across that specific food chain, then the determinant factors and source of the outbreak would have been determined in two-and-a-half seconds or less, rather than waiting six-and-a-half years for a still-pending verdict.”

A “game changer”

ConsenSys’s Singer is bullish about blockchain’s future use on the continent. “Supply chain technology with track-and-trace functionality using blockchain technology will be a game changer in Africa,” she told Cointelegraph. “We have a high penetration of mobile phones in the continent. We also know that blockchain technology is most useful when there are many intermediaries and when we need to have an audit trail of transactions involving many parties in a transparent manner.”

In Africa, the farmer is often the last to benefit from the sale of produce, “in particular when there is dependency on many intermediaries.” Among other virtues, blockchain tech also helps with “right-sizing intermediaries,” Singer added. Moreover, “We currently have very few sophisticated technologies for track-and-trace.”

Some of blockchain’s key attributes resemble those of traditional African bartering systems, like the one used in the small village where Kubyane grew up.

During the harvest season, crops could be traded for livestock in various quantities as needed. This made for some blockchain-like benefits, including traceability, as “people knew exactly where their food came from”; transparency, since “goods could be exchanged without intermediaries adding unnecessary markups”; and supply chain control, as “many farming families had control over their entire supply chain — however small scale — from seed banks to direct sales to consumers.”

A barter system has many limitations, of course, including a lack of scalability, and Kubyane is against turning back the clock on Africa’s modern food supply chain. But blockchain technology can help with many contemporary challenges, including “food traceability, post-harvest losses, lack of supply chain transparency, unfair trade practices, and monopolies that marginalize small and semi-commercial farmers,” he told Cointelegraph.

Patience is required

Overall, it may take some time to move the African farming needle. “Certainly, it will take years,” said Trask. For instance, a farm cooperative may come in and sign a contract with Dimitra and say that “they’re going to onboard 30,000 farmers. We probably never get 100% adoption; we may only get 80%.”

Moreover, only 10% of system users may be “power users,” he continued. Some may be participating because food giants like Nestle and others have told them “they had to have traceability,” Trask noted. Other farmers simply don’t want to convert to new technologies.

Another challenge is, implementing these solutions sometimes “requires too many parties to be involved or to learn about the technology,” according to ConsenSys’s Singer.

Solutions must also be accessible, affordable and scalable, added Kubyane. “It is of utmost importance to have patient capital at a significant scale.”

In sum, synergies from melding blockchains with other emerging technologies like satellite imagery, AI, mobile tech and others may one day revolutionize agriculture in the developing world. But until that day arrives, farmers in East Africa and other regions can potentially fetch higher prices for their products by tapping export markets like the EU and North America.

But to secure a permanent place at dining tables in these Western economies, they will have to convince regulators and sustainability-minded publics that their crops weren’t grown by razing woodlands or employing child labor. To accomplish that, private and public blockchains, with their enhanced tracking, tracing and certification capabilities, may prove invaluable.

Will BlackRock’s ETF slingshot Bitcoin’s price skyward?

Traditional financial firms finally believe that digital assets are here to stay. Or so one might conclude from the slew of announcements last week from some of the world’s premiere financial players.

Among them is BlackRock — the world’s largest asset manager with $9 trillion in assets under management (AUM) — filed for permission to build a “spot market” Bitcoin-based exchange-traded fund (ETF) — something the United States Securities and Exchange Commission has resolutely resisted.

Others include Fidelity Investments, Charles Schwab and Citadel launching EDX, a new cryptocurrency exchange. In Germany, Deutsche Bank — boasting $1.4 trillion in balance sheet assets — applied for a license to custody crypto. There were others too.

Collectively, these developments boosted crypto trading markets. Bitcoin (BTC) gained 20% in the week, surpassing the $30,000 mark for the first time since April. If allowed, a BlackRock Bitcoin ETF listing on the Nasdaq stock exchange would arguably make Bitcoin more accessible to a larger investing public.

Some even anticipated a stampede to Bitcoin due to the BlackRock filing, as others followed with their own, including Invesco and WisdomTree. Fidelity Investments filed for a spot Bitcoin ETF on June 29.

“The Great Accumulation has begun,” declared Cameron Winklevoss on Twitter, while MicroStrategy’s Michael Saylor added, “The window to front-run institutional demand for #Bitcoin is closing.”

Others professed little shock about these developments, however, even after a year of crypto-related scandals, bankruptcies, lawsuits and regulatory uncertainty in the United States. By this view, the institutions were just bowing to the inevitable.

“I’m not surprised, since from a fundamental point of view, the movement of digital value is the next obvious evolution of the internet,” Jim Kyung-Soo Liew, associate professor of finance at Johns Hopkins Carey Business School, told Cointelegraph. “What is surprising is how the U.S. hasn’t embraced it.”

Last week’s events raise some questions: How enduring are Bitcoin’s most recent price gains? There have been institutional investor sightings before. Will this time be different, or will Bitcoin and other cryptocurrencies resume their sideways market activity?

On the other hand, a firm the size of BlackRock really could transform the BTC market, some believe.

Bitcoin has a fixed supply limit of 21 million BTC and its existing inventory is relatively illiquid. Sixty-eight percent of BTC in circulation hasn’t moved at all in the past year, according to Glassnode. There isn’t a lot of stock on the shelves for BlackRock and others to snap up, in other words. If demand exceeds supply, doesn’t that inevitably mean price gains for BTC?

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Also, where do retail investors fit in among the new institutional arrivals? Maybe ordinary crypto users are also needed to stabilize the price of Bitcoin.

Finally, assuming the so-called Great Accumulation really is happening, how far can it go? The cryptoverse has a market capitalization of about $1 trillion today, roughly half of which is in Bitcoin. Could the crypto market cap reach a 10-fold increase of $10 trillion in five years?

Has the “great accumulation” begun?

“Anyone watching the flurry of ETF filings understands the window to purchase pre-IPO bitcoin before ETFs go live and open the floodgates is closing fast,” declared Winklevoss, adding: “If bitcoin was the most obvious and best investment of the previous decade, this [spot Bitcoin ETF] will likely be the most obvious and best trade of this decade.”

Is the co-founder of the Gemini cryptocurrency exchange right?

“Clearly, there is significant investor demand for Bitcoin access through regulated investment funds from a broad spectrum of U.S. investors,” Sui Chung, CEO of CF Benchmarks, told Cointelegraph, “Otherwise, BlackRock, Fidelity, Invesco and other major asset managers would not have filed S-1s for Bitcoin ETFs.”

The entry of BlackRock and other investment managers into this new asset class isn’t so unexpected, either. “We’ve long known that BlackRock is enabling BTC investments for clients through their Aladdin platform and Bitcoin private fund,” Doug Schwenk, CEO of Digital Asset Research, told Cointelegraph. 

The recent negative news stories swirling around Binance and Coinbase “are not related to Bitcoin and may be seen as an opportune time for a better-known, more regulated brand to provide alternatives that end-buyers can trust. A BTC ETF is a natural step.”

Winklevoss, Saylor and others warn that retail investors had better buy Bitcoin now to get its ostensibly cheaper “pre-IPO” price before BTC’s price skyrockets. Are they correct?

“There is some truth to that given the finite supply of Bitcoin and increasingly low rate of supply growth,” added Chung. “However, plenty of investors bought in the $50k to $69k range and they are still underwater; on top of that, cash earns 5%+ at the moment. To me, trying to time the market, especially one as volatile as crypto, is a fool’s errand.”

Moreover, the Winklevoss scenario “depends on how certain one is that institutions are truly coming and that the ETFs and other infrastructure plays by large institutions will play out,” Justin d’Anethan, head of business development for the Asia-Pacific region at Keyrock — a Europe-based digital asset market maker — told Cointelegraph.

“Forward-looking investors will probably try to front-run that move and buy before any of this is truly released. I’m personally a bit less certain about how soon this will happen, though,” d’Anethan added.

Assuming BlackRock succeeds in its ETF quest and other institutional investors follow, would that stabilize the price of Bitcoin at a substantially higher level than the current $30,000? Or does long-term price stability also require broad retail participation?

“It all depends how much AUM they can gather if they are approved,” answered Chung. “If it’s a substantial amount, then it stands to reason that it would lift the price substantially given the finite supply. Bitcoin and its price is agnostic as to who buys Bitcoin and through what means. Buying demand just has to outstrip selling demand and the price will appreciate.”

Carol Alexander, professor of finance at the University of Sussex Business School, told Cointelegraph that a slew of spot Bitcoin ETFs could actually make BTC less stable and more volatile. “If there’s too many ETFs, all these market makers trying to hedge their positions could be selling at the same time or buying at the same time. It could increase volatility… I disagree with what Winklevoss said.”

Alexander has her own BTC price scenario, which assigns retail investors a key role. In March, when BTC was trading around $20,000, she predicted the coin would rise to $30,000 by June and move sideways through the summer. That has largely come to pass. “So the question is, what’s going to be happening in September?” she asked.

“I’m not saying it will — but it could go up to around $50,000. That’s because people come back after the summer, and there’s more liquidity in the markets.”

But it’s also because retail investors are no longer scared after the long string of crypto drawdowns, scandals, bankruptcies and regulatory actions of the past year. The growing investment in the digital asset market by large financial institutions like Fidelity Investments and JPMorgan Chase has arguably had a calming effect on retail investors.

“I think we’re going to be seeing much more acceptance from really ordinary people starting in September as you get some more regulatory clarity about things. That extra volume of trades could bring the price back up to — I’m not saying $68,000 where it was, that would be too high […] — but there’s that sweet area around the $50,000 mark, which I think will be the next long-term resistance level.”

In a June 19 global survey by Nomura Laser Digital, 90% of professional investors said it was “important” that any digital-asset funds or investments have the backing of a large traditional financial institution — at least before considering putting their clients’ money into it. Maybe this past week’s announcements by BlackRock, Fidelity, Deutsche Bank, et al. are the signal they were waiting for.

“Perhaps,” Schwenk said. “Only time will tell. It’s hard to pick when the tipping point will be. We have had participation from other large traditional firms — BNY Mellon, State Street, Standard Chartered, Franklin Templeton, etc. That hasn’t been enough to satisfy the respondents in the survey yet, but eventually, they will see enough momentum.”

Ten-fold growth over five years?

In the medium term, how high could things go? With the active participation of large TradFi firms like BlackRock, Fidelity and Deutsche Bank, could crypto market capitalization grow from $1 trillion to $10 trillion or more over the next five years, for instance? 

“Five years ago, the entire market cap of liquid crypto, as measured by the CF Large Cap Index, was around $250 billion and hit a high of around $2.6 trillion in late 2021,” said Chung. “So 10X would seem to be within the realms of possibility.”

Major institutions putting their distribution networks to work to support further adoption would also provide “a significant tailwind,” he added. “However, interest rates were not 5% in that previous five-year period — they are now. What impact that might have is impossible to know.”

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Alexander was less bullish. “A Bitcoin ETF — I don’t even see that it’s needed.” Most ETFs are a basket of equities or a basket of currencies. An ETF with a basket of cryptocurrencies like Bitcoin, Ether (ETH) and Solana (SOL) “would make a lot more sense,” in her view.

‘Exciting times’ for Bitcoin?

Sightings of institutional investors just outside the boundaries of the cryptoverse have been reported before, but they have never quite entered en masse. Why might this time be different?

“Institutional investors are very slow and thoughtful in their due diligence process,” Johns Hopkins’ Liew said, but “they have finally come to see the Bitcoin light. It’s just too exciting to pass up and their customers are pushing them for products.” From an empirical perspective, some crypto exposure is a good means of diversifying an investment portfolio, he noted, summarizing:

“If institutional investors enter the party, their demand would certainly drive prices higher. It would definitely be exciting times for BTC.” 

“The involvement of large financial institutions, whether it be for ETF applications or the new EDX exchanges, represent a significant shift and a decisive moment for crypto markets, in the U.S. and globally,” concluded d’Anethan. 

Unfazed by SEC tumult, top banks work to make blockchains interoperable

Amid all the tumult in the crypto world, some of the world’s largest banks have been quietly reflecting on ways to bring digital assets to institutional customers. And last week, a plan emerged.

A collaboration, under the guidance of the Society for Worldwide Interbank Financial Telecommunication, better known as Swift — the global financial communication and payments network — will soon be testing ways for permissioned bank-owned blockchains to not only talk to each other, but also communicate with public blockchains like Ethereum.

Participants in this global experiment include more than a dozen financial heavyweights, including Citi, Lloyds Banking Group, BNP Paribas, BNY Mellon, and the Australia and New Zealand Banking Group. Chainlink, the decentralized oracle network, is developing the technology to “bridge” these sundry blockchains.

“Institutional investors increasingly are considering investments in tokenized assets,” stated the Belgium-based Swift, which connects more than 11,000 financial institutions worldwide, in its June 6 blog. Its headline neatly summarized the task at hand: “Swift explores blockchain interoperability to remove friction from tokenized asset settlement.”

The problem is that digital assets today are tracked on a wide range of blockchain networks that are not interoperable, Swift further explained. Each chain has its own functionality and liquidity profile, and there’s a lot of technical “friction” when giant institutions try to interact with one another, let alone public blockchains like Ethereum or Polkadot.

This test phase will look at three specific use cases, according to Swift:

“The first use case will involve the transfer of tokenized assets between two wallets on the same public blockchain network (Ethereum Sepolia testnet). The second involves the transfer of tokenized assets from a public blockchain (Ethereum) to a permissioned blockchain. And a third use case will test the transfer of tokenized assets from Ethereum to another public blockchain.” 

Chainlink, for its part, “will be used as an enterprise abstraction layer to securely connect the Swift network to the Ethereum Sepolia network, while Chainlink’s Cross-Chain Interoperability Protocol (CCIP) will enable complete interoperability between the source and destination blockchains,” Swift stated. 

Unfazed by SEC lawsuits

In an interview with Cointelegraph last week following the news, Chainlink co-founder and CEO Sergey Nazarov was asked about the fact that the concurrent Swift/Chainlink announcements seemed to be overshadowed by news of the two United States Securities and Exchange Commission lawsuits against crypto exchanges Binance and Coinbase.

News about infrastructural advances sometimes appears to get lost. Or maybe the industry is evolving on parallel tracks now — the regulatory/markets track and the technical/infrastructural?

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“Yes, there’s these two parallel worlds,” answered Nazarov. “The cryptocurrency markets go up and down. Historically, what I’ve seen is that when the cryptocurrency markets contract, banks lose interest” in digital assets and blockchain technology.

“But I’m not seeing that this time,” he said, stating that the banks are holding fast, quietly working on infrastructure solutions, despite the enduring “crypto winter.”Meanwhile, Swift and its client banks don’t seem to think that the blockchain industry will be consolidating any time soon. “There’s unlikely to be a single prevailing blockchain network,” said Tom Zschach, chief innovation officer at Swift.

“We would expect to see a multitude of different platforms emerging, each serving different customer segments with their own bespoke capabilities and requirements. In such a highly fragmented ecosystem, it would simply not be feasible for financial institutions to connect to each and every platform individually.” 

‘It’s the main problem’

Building “bridges” so private and public chains can share information won’t be easy. Historically, cross-blockchain bridges have been vulnerable to hacks, with some $2 billion stolen from bridges in 13 separate heists by mid-way through 2022, according to a Chainalysis report. Is security still a challenge?

“I would say it’s the main problem,” answered Nazarov, “because the bridges that exist today haven’t been around for long.” Fortunately, those hacked in 2022 didn’t hold extraordinarily large amounts of value, he added.

But looking ahead, “we’re talking about bridges that can move around trillions of dollars of value.”

Transfers in the trillions will have to become de rigeur, or standard practice, if “the blockchain industry is to grow into what it should be — not $1 or $2 trillion” in market capitalization, but something on the order of $10, $20 or $50 trillion, said Nazarov. And so interoperability “is, in fact, the main infrastructure problem that our industry actually has to solve.”

He added that Chainlink has been working on interoperability issues for years, so why should one expect Chainlink to succeed where others have failed regarding cross-blockchain bridge security?

All the cross-blockchain bridges built to date are basically “dumb bridges” that do “whatever you tell them to do, even if that’s fraud,” said Nazarov. Chainlink, by comparison, has built an active risk management network, or ARM network, that “monitors that bridge, whether it’s for information or for value, or whether it’s misbehavior.”

Elsewhere, Nazarov compares the state of interoperability in the blockchain industry to that faced by internet developers several decades ago with email. It’s really about improving the user experience.

Today, “a bank doesn’t want to tell its customers to integrate with their chain,” said Nazarov, “because it takes too much time. Imagine you and I wanted to email each other, and I was on Gmail, and you were on Yahoo Mail. And in order for us to communicate, I told you, ‘Well, you have to get a Gmail account, then I can email you.’ It doesn’t make any sense. Right?”

The internet solved the problem with the Transmission Control Protocol/Internet Protocol and some email protocols that allowed email users on different platforms to communicate easily. “This is the same kind of dynamic here,” he added.

“This is about the ability for all chains to create value with each other. Because if you have a chain that can’t gain the value of all the other chains, then our industry is kind of like moving at half speed.”

Progress still in a middle stage

What about a timeline? When do Swift and Chainlink anticipate this will all be rolled out at scale?

It’s hard to say, said Nazarov. “It’ll be a gradual increase over time. As more and more banks begin to interface with the private chains of other banks and those private chains connect to public chains, you’ll see a gradual increase over time. Now we’re in the mid stages.”

A single large institution could lead the way, “then the rest of them will go in,” he speculated, citing the example of French bank Société Générale deploying its own euro-denominated stablecoin CoinVertible (EURCV) on Ethereum in April. It was the first institutional stablecoin to be deployed on a public blockchain. “That has never happened before,” said Nazarov. “I’m seeing more and more [people] talk about this.”

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In addition to those previously mentioned, the financial institutions and financial market infrastructure firms participating in the Swift interoperability project include Clearstream, Euroclear, Six Digital Exchange and the Depository Trust and Clearing Corporation — among others.

All in all, overcoming this fragmentation among blockchain networks “will be key to the long-term scalability of the market,” said Swift, emphasizing the importance of “removing friction in international transactions” while pledging to work “with our community to explore a potential solution.”

The nuances in the global banking world are somewhat different, of course. Banks generally prefer to talk about “digital assets” rather than “crypto” or “cryptocurrencies,” Nazarov noted, but regardless of how one references it, the fact remains that “clients of the banks now consistently want to take part in that industry.”

Does the US have a crypto ‘tax loophole’ problem?

The crypto sector appears to have dodged another bullet. At the time of publication, the United States has reached a political agreement to raise its debt ceiling, avoiding a calamitous default on its obligations, and this resolution probably won’t include any new taxes on cryptocurrencies. 

But that doesn’t mean the question of U.S. crypto taxation is settled. The debate is likely to continue and may be transformed into something more partisan than previously assumed.

To recap: On May 21, at the Group of Seven (G7) Summit in Hiroshima, Japan, U.S. President Joseph Biden spoke out against a debt-ceiling deal with Republican lawmakers that would protect crypto traders. The protection the president referenced was tax-loss harvesting, a tax minimization strategy legal in the U.S., but viewed by many as a loophole.

However, it was the phrasing of the president’s remarks as much as their content that drew attention. Biden said:

“And I’m not going to agree to a deal that protects wealthy tax cheats and crypto traders while putting food assistance at risk for nearly a hundred — excuse me — nearly 1 million Americans.”

It’s not every day that a U.S. president speaks out about cryptocurrencies — let alone from a high-level international conclave — so Biden’s choice of words may be worth examining. He seemed to equate “crypto traders” with “wealthy tax cheats.” If so, it might suggest that crypto support may now be breaking more along Democrat/Republican lines than was earlier presumed.

This also raises some questions: Is tax-loss harvesting with cryptocurrencies a loophole in the U.S. tax system that should be closed? Would investors or traders even miss it if it were eliminated?

On a more political level, was it surprising to hear a U.S. president grouping “crypto traders” with “wealthy tax cheats” in a single phrase? One has heard many claims recently that crypto and blockchain have no party affiliation in the U.S., with lawmakers on both sides of the aisle favoring crypto reform legislation. 

Is tax loss harvesting widely used by U.S. crypto investors?

“Tax-loss harvesting is an important tool for cryptocurrency investors for two key reasons,” Nathan Goldman, associate professor at North Carolina State University’s Poole College of Management, told Cointelegraph.

First, cryptocurrencies’ prices are more volatile than traditional securities, like equities. For example, General Electric’s stock traded at $74 at the end of 2021 and $66 at the end of 2022. During the same period, Bitcoin (BTC) tumbled from around $47,000 to nearly $16,000. Goldman noted:

“Given the dramatic ups and downs, there is ample opportunity for investors to sell during the down periods, creating a tax loss that can be used to offset another gain — also known as tax-loss harvesting.”

The second reason for the strategy’s popularity with crypto investors is that it isn’t subject to wash sale rules. With most securities, “tax-loss harvesting carries the penalty that the taxpayer cannot repurchase the security for 30 days — often referred to as ‘wash sale rules,’” explained Goldman. During that time, the stock might increase in value, which the investor would not recognize. “However, cryptocurrency does not have those rules.”

“This rule — or lack thereof — has a lot of important tax considerations, and, thus, many investors are likely making use of it,” said Goldman.

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“It is definitely an issue, as there is some empirical evidence that crypto investors engage in this strategy,” Omri Marian, professor at the University of California Irvine School of Law, told Cointelegraph. “The President’s 2024 budget proposal estimates that closing this loophole will bring in about $24 billion over 10 years, which is not insignificant.”

According to a March 2023 White House statement explaining the Administration’s 2024 budget proposal:

“The Budget saves $24 billion by eliminating a special tax subsidy for crypto currency and certain other transactions. Right now, crypto investors aren’t subject to the same rules of the road that investors in stocks or other securities have to follow, allowing them to report excessive losses. […] The Budget eliminates this tax subsidy for crypto currencies by modernizing the tax code’s anti-abuse rules to apply to crypto assets just like they apply to stocks and other securities.”

However, not everyone agrees that tax loss harvesting is rampant or will add much to government coffers if the “loophole” is closed. “Crypto not being subject to the wash sale rule is a loophole in the system,” Shehan Chandrasekera, head of tax strategy at CoinTracker, told Cointelegraph. “That said, I don’t think the government is losing billions of dollars from that. This is because crypto is still a small segment of the economy.”

“From a pure volume perspective, I wouldn’t think it’s massive,” Markus Veith, digital asset practice leader at Grant Thornton, told Cointelegraph, referencing that amount being lost in foregone taxes. Crypto is not yet that impactful to the domestic and global financial services industry. Meanwhile, crypto prices are recovering, “which also begs the question of how many losses are still out there,” said Veith.

Traders and cheaters

Wasn’t it surprising that the U.S. president publicly linked “crypto traders” with “wealthy tax cheats” in a single sentence — and at a meeting of G7 leaders, no less?

“Personally, I would not call someone who engages in legal tax planning a ‘tax cheat,’ even if I do not like their behavior,” said Marian.

Then, too, maybe Biden’s remarks were taken out of context. He may have been talking about two “loopholes” being closed. One was the wash sale rule for crypto, “and the other is like-kind exchanges for real estate investors,” said Goldman, though both align with wealthy investors.

President Biden mentioned crypto in a press conference in Hiroshima. Source: The White House

“Those comments [i.e., Biden’s] appear to be more related to the real estate investors. If anything, I am more taken aback by him calling them ‘tax cheats,’” he added. 

An accounting firm executive who preferred to remain anonymous told Cointelegraph that he would have thought the U.S. president had more important issues on his plate than crypto wash rules. This was a G7 meeting, though, and on May 16, the European Council had just adopted the world’s first comprehensive set of rules for crypto assets, known as the Markets in Crypto-assets regulations or MiCA. Maybe “that came up in conversation,” and then the discussion shifted to the debt ceiling with crypto still on the president’s mind, the source speculated.

Maybe the U.S. president has a point, however. Perhaps tax-loss harvesting with crypto is an abuse of the U.S. tax system and should be banned.

“It is indeed a problem, in my opinion,” said University of California’s Marian, even if wash trading is currently legal in the U.S. “I don’t see why crypto should have a favorable tax treatment over other investment assets.”

On the other hand, tax loss harvesting and the like didn’t begin with crypto. “Tax planning strategies are much older than the crypto industry, and triggering tax losses to offset income is absolutely something that has been there for a long time,” JJ Schneider, tax reporting and advisory partner at Grant Thornton, told Cointelegraph.

The whole issue could remain problematic until the U.S. determines the actual nature of cryptocurrencies, suggested Goldman:

“The U.S. government struggles with defining what cryptocurrency is. The IRS [Internal Revenue Service] treats it like a capital asset. Other entities treat it like a currency, while others treat it like it’s a security.”

If all entities were to treat cryptocurrency like a currency, “then it may make more sense to follow currency’s rules for wash-sales,” continued Goldman. “However, if it were to go by way of the IRS, then wash sales become potentially problematic.”

The bottom line: One must first define the nature of cryptocurrencies before gauging if their holders are profiting from tax loopholes.

Transparent regulations

So is more regulatory clarity needed in the U.S., especially if the country hopes to attract institutional investors whose participation might make cryptocurrencies less volatile?

“There’s a big hope that institutional adoption is moving forward,” said Grant Thornton’s Veith. “But with what the industry perceives as lack of clarity, I don’t see that necessarily going up.”

“More guidance is needed,” added Goldman, and cryptocurrencies need to be defined and treated similarly across all financial sectors like taxes, financial reporting, etc.

Marian agreed, but only up to a point. “I do believe there are important areas in which guidance on crypto taxation is needed.” But the claims of uncertainty and lack of guidance are exaggerated, in his view. Marian added:

“For most transactions that most taxpayers engage in, there are relatively clear answers in the law. People simply do not like these answers.”

Nor is the U.S. necessarily the only country that continues to struggle with crypto and taxes. “I think all countries are in the process of figuring out the right tax framework for digital assets,” CoinTracker’s Chandrasekera stated.

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The final debt ceiling legislation resulting from weeks of negotiations published on May 28 as the ‘‘Fiscal Responsibility Act of 2023’’ still needs to pass both houses of Congress. But there is no mention at all in the nearly 100-page document of “cryptocurrencies,” “wash rules,” Bitcoin mining or anything remotely crypto-related.

“Yes, one of the victories is blocking proposed taxes,” tweeted Republican Representative Warren Davidson of Ohio. Crypto lives to fight another day.

Will compromise on anonymous crypto appease US regulators, spur adoption?

Cryptocurrencies were designed to be anonymous or pseudonymous, so there is an inherent tension when protocols come up against jurisdictional authorities. 

In the United States, the blockchain and cryptocurrency sector has jousted with regulators over the need to comply with Know Your Customer (KYC) and Anti-Money Laundering (AML) rules, and even over adherence to economic sanctions regimes. 

Most recently, a top U.S. Commodity Futures Trading Commission (CFTC) official suggested in a speech that it behooves the industry to verify the digital identity of its users. The CFTC has historically been friendly to the crypto sector — at least when compared with other U.S. agencies like the Securities and Exchange Commission — so its views might be worth considering.

However, is it possible “for all crypto companies to distance themselves from [digital currency] mixers and anonymity-enhanced technology,” as CFTC commissioner Christy Goldsmith Romero urged in an April 25 speech?

What about decentralized exchanges? Romero said central parties maintain them, and they could do KYC and AML if they wanted to. But would forcing compliance risk driving decentralized finance (DeFi) innovation abroad?

“Sure, it’s possible for companies to distance themselves from anything they want — software does what we tell it to do,” Preston Byrne, a partner at the law firm Brown Rudnick, told Cointelegraph, adding:

“The real question is whether the United States, as a policy matter, wants to cut off its companies from DeFi when DeFi growth overseas is exploding.”

Whether crypto protocols have to comply with AML/KYC rules and other aspects of the U.S. Bank Secrecy Act (BSA) depends on whether they are “money transmitters” or “money services businesses” under the applicable state and federal laws, according to John Wagster, who heads the technology industry team at law firm Frost Brown Todd. But whether they can comply is another matter. He told Cointelegraph:

“Centralized protocols clearly have the ability to implement AML/KYC compliance, albeit at the risk of losing crypto idealists who will only use products that allow permissionless, anonymous access.”

What about DeFi projects? “Decentralized protocols can implement BSA compliance, but the individual steps must be approved by the protocol’s DAO — or another governance mechanism — and some aspect of the implementation will likely need to be performed by community members or service organizations authorized by the DAO,” Wagster added.

But the BSA isn’t the only potential challenge for crypto firms looking to set up business in the United States; it might not even be the most serious.

All companies must comply with the Office of Foreign Assets Control (OFAC) “to ensure their platforms are not being used by individuals from prohibited jurisdictions,” like North Korea and Iran, or by specially designated nationals, said Wagster. However, “some aspects of OFAC compliance can be implemented autonomously through the use of third parties like Chainalysis, which provides access to its OFAC API free of charge.”

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In August 2022, OFAC sanctioned digital currency mixer Tornado Cash, which the agency accused of laundering more than $7 billion of digital currency since its creation in 2019. This included over $455 million stolen by a North Korean state-sponsored hacking group. Mixers like Tornado facilitate anonymous transactions “by obfuscating their origin, destination, and counterparties, with no attempt to determine their origin,” according to the U.S. Department of the Treasury. OFAC has since prohibited U.S. firms and individuals from doing business with Tornado Cash.

Some believe that decentralized exchanges can also shut out mixers if they set their mind to it. “When the whole Tornado Cash debacle happened, decentralized exchanges like Aave and dYdX actively blocked addresses that interacted with mixers,” Justin Hartzman, CEO and co-founder of Toronto-based cryptocurrency exchange CoinSmart, told Cointelegraph. As Hartzman further explained:

“While mixers do tend to protect user identity, it is fairly easy to tell which addresses have interacted with these protocols, thanks to blockchain’s transparency.”

Still, even if crypto firms can resist anonymity-enhanced technology, would that be beneficial? Perhaps preserving privacy coins and anonymous crypto is important globally as a counterweight to growing government surveillance.

“The answer to this question is in the eye of the beholder,” said Byrne, adding that the desirability of privacy-enhancing technology is a political question. “I think the point of crypto is to make this technology so commonplace that it ceases to be a political question because its existence must be assumed.”

Privacy coins and regulations ‘don’t gel’

“If you want widespread adoption, regulations are going to be crucial,” said Hartzman, adding that “privacy coins and regulations don’t gel.” While doubting privacy coins are going away, their usability will probably remain highly “niched” and restricted, he explained. “Blockchain was never anonymous, and it won’t be moving forward in my view.”

Frost Brown Todd’s Wagster, for his part, agreed that there was a basic incompatibility at hand:

“Anonymizing technology and BSA compliance do not mix. If a protocol is required to be BSA compliant, that protocol cannot permit users to mask their identities.”

Protocols seeking high adoption by attracting institutional investors are “unlikely to defend the use of mixers because their institutional users are not going to get involved with a platform that is in danger of a government enforcement action,” continued Wagster. Meanwhile, DeFi lenders who permit anonymizers will just have to do business outside U.S. jurisdiction.

Are ‘mixers’ worth saving?

Is the verification of digital identity, as requested by the CFTC commissioner, really such a burden for crypto users, and is it worth the industry’s while to fight for “mixers” like Tornado Cash and Blender?

Anonymity is not a life and death matter for the vast majority of crypto users, in Hartzman’s view. “Most people are simply using crypto to make money and trade these radically different and exciting assets.” They aren’t using mixers either. “I would say that most don’t even know how to use these protocols.” Brown Rudnick’s Byrne added:

“Tornado Cash and Blender aren’t worth saving in my opinion, although I am sympathetic to the arguments […] that the Treasury Department probably doesn’t, or at least it shouldn’t have the power to sanction particular technologies.”

Wagster noted that BSA requirements like AML and KYC are enforced by the U.S. Treasury through the Financial Crimes Enforcement Network, “not by the SEC or CFTC.”

Many centralized crypto protocols will likely embrace AML/KYC/OFAC requirements because they are widely used in the traditional financial world and “because institutional money managers may have a fiduciary duty to use compliant providers.”

On the other hand, some crypto-native DeFi protocols may want to avoid BSA compliance, Wagster said, as “compliance runs against the ethos of crypto that favors privacy and monetary freedom over the government’s desire to prevent money laundering and terrorist financing.”

Mixers aren’t always used for nefarious purposes, either. People living under oppressive political regimes may use these tools to protect their wealth and freedom, CoinSmart’s Hartzman noted, but “the fact is that hackers are abusing these protocols to safely steal money from hardworking people.”

Compliance regimes can vary in importance too. KYC/AML compliance may be one thing, but sanctions evasion is arguably another. As the sad saga of Ethereum developer Virgil Griffith illustrated, it’s a surefire way to incur the wrath of U.S. authorities.

“Treasury has worked to expose components of the virtual currency ecosystem, like Tornado Cash and, that cybercriminals use to obfuscate the proceeds from illicit cyber activity and other crimes,” declared the Treasury in August 2022.

While acknowledging that most digital currency activity is “licit,” the department said that cryptocurrencies “can be used for illicit activity, including sanctions evasion through mixers, peer-to-peer exchangers, darknet markets, and exchanges. This includes the facilitation of heists, ransomware schemes, fraud, and other cybercrimes.”

Give regulators what they want?

As a strategic matter, would it better suit the crypto sector to give U.S. regulators what they want, i.e., ID verification? Consumers have been doing it for years for other activities like opening a bank account, and if developers don’t like it, they can just set up shop outside U.S. jurisdiction.

“Ultimately, some DeFi providers will likely end up adopting AML/KYC procedures, whether they are required to or not, both to avoid unwanted government scrutiny and to attract institutional money,” predicted Wagster. “Others will hold true to their ideological preferences because that’s why they got into crypto in the first place.”

Hartzman, based in Toronto, cites the Canadian regulatory approach, which, in his view, has worked well. “All exchanges must register with the Ontario Securities Commission/Canadian Securities Administrators and undergo stringent regulatory processes and audits.”

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What’s needed in the U.S., though, is a regulatory framework designed specifically for cryptocurrencies, Hartzman continued:

“It seems U.S. regulators have still not decided if cryptocurrencies are securities or commodities or something else. [SEC chair] Gary Gensler’s train-wreck of a hearing pretty much proved that these regulators are behind the eight-ball when it comes to the crypto industry.”

Byrne also suggested that U.S. regulators may arrive too late to the party to do anything forcible on the anonymity question. “While I can understand that U.S. regulators want to exercise regulatory control, I think that commercial reality outside our borders is going to start demonstrating the practical limits on their power sooner rather than later.”

Shapella could bring institutional investors to Ethereum despite risks

Ethereum’s Shanghai/Capella upgrade — also known by the portmanteau Shapella — may not be the technical marvel of last year’s “Merge” or introduce turbocharged speeds to the network. 

Volumes of over 100,000 transactions per second will have to wait for future “danksharding” upgrades, according to the Ethereum Foundation.

But the hard fork remains an important step on Ethereum’s roadmap to the future, i.e., further shoring up the network’s new validation mechanism while (potentially) removing barriers for institutional investors.

Currently scheduled for 10:27 pm UTC on April 12, the upgrade will allow stakers to unlock their Ether (ETH) rewards — or even exit staking entirely — for the first time since September’s Merge.

Pre-fork publicity hasn’t matched that surrounding last autumn’s change of consensus mechanisms from proof-of-work to a proof-of-stake (PoS). “This time, we won’t have a war room,” Freddy Zwanzger, Ethereum ecosystem lead at Blockdaemon, told Cointelegraph. Still, “there’s always risks” when one reshuffles the deck like this.

Ethereum’s stakers and validators will shortly be able to withdraw $32 billion of Ether from the Beacon Chain, which accounts for about 15% of the ETH’s circulating supply, according to Coinbase’s April 5 newsletter. Some worry that the upgrade, also known as the Shanghai hard fork, may lower the overall number of validators and put selling pressure on the network, among other concerns.

“Every hard fork brings some upgrade risk,” Paul Brody, EY’s global blockchain leader, told Cointelegraph, especially in cases like this where you’re enabling withdrawals. On the technical side, there could be bugs latent since “day zero” in some of the network’s staking smart contracts, for example, that may not emerge until the withdrawal date — though Brody doesn’t think that’s likely.

The upgrade should mitigate risks for investors. “Lower volatility plus a yield makes for a more familiar and less risky asset to hold long-term,” Rich Rosenblum, co-founder and president at GSR, a crypto market-making firm, told Cointelegraph.

More institutional investors?

Will Shapella really attract more institutional investors to the blockchain, as some believe? Research and brokerage firm AB Bernstein stated in a late-February research report that the upgrade could bring in staking from new institutional investors, and Blockdaemon’s Zwanzger, whose firm has many institutional clients, foresees more interest in Ethereum staking opportunities from large professional investors. Some institutional investors have been reluctant to lock up funds without a clear withdrawal option.

“There’s probably going to be a queue for the first couple of weeks,” Zwanzger said. “So they might be better off waiting until that comes down to normal levels.”

According to Rosenblum, “Once the PoS network is fully operational, more institutions will feel comfortable holding ETH, especially once the staking yield becomes more accessible.”

EY’s Brody, on the other hand, doesn’t see much of a change. “A lot of the big institutional investors that we know and work with are basically sitting on the sidelines. They want to comply, but they want to be more comfortable that they know what the rules are.” Comprehensive crypto reform legislation in the United States would probably be more likely to get them off the sidelines.

Longer-term risks

So what about regulatory risk, particularly in the United States? For years Bitcoin (BTC) and Ether were thought to be impervious to Securities and Exchange Commission (SEC) scrutiny, with many U.S. regulators tacitly agreeing that the native coins for decentralized systems like these were more like commodities than securities, placing them under the Commodity Futures Trading Commission’s jurisdiction. But with Ethereum’s move to a staking validation mechanism, some think the SEC may now have Ethereum in its sights.

Still, “I wouldn’t consider it a significant risk for the network,” even if that happens, said Zwanzger. The Ethereum protocol is global, and not all jurisdictions will likely share the SEC’s view of what needs regulating. Of course, other countries could ultimately choose to follow the U.S., so one never knows.

Others worry that Ethereum’s move to staking may herald increasing network centralization. In March, Cointelegraph reported that “concentration of ETH staked through third parties raises concerns over decentralization at Lido and Coinbase in particular.”

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“The battle to keep Ethereum sufficiently and properly decentralized is probably one of the most important ones out there in terms of governance and organization,” Brody told Cointelegraph. If any single staking partner were to have 33% of the ecosystem, that “could potentially — and I say potentially — have an impact on transaction finality, although you would get slashed for doing so.” If any single or cooperating group of entities controlled two-thirds of the staking infrastructure, “you would have the potential to change the governance of the chain” — something that would be “very suboptimal,” he said.

But these dangers remain largely theoretical given how things have evolved since the Merge. “A relatively vibrant staking ecosystem” has emerged, said Brody, with “a few highly centralized custodial players” but also “some semi-centralized custodial players” like Lido, which is a liquid staking pool leader that invests with funds from tens of thousands of individual crypto wallets. There are also prominent staking groups that are “trying to be more fully decentralized,” like the Rocket Pool, he added.

“As long as this remains a very competitive ecosystem,” dangers from centralization are unlikely, Brody continued. Moreover, as more enterprise users join the network and become de facto stakeholders, including “Fortune 1000” companies, the system “becomes quite heavily decentralized.”

Zwangzer said that centralization was more of a threat in the pre-Merge days when a few proof-of-work pools dominated ETH mining. In any event, he added:

“I don’t think this is going to become a problem as long as we can keep the centralized [cryptocurrency] exchanges at bay.”

“The golden age of digital monopolies”

One might wonder why decentralized digital networks are even important for commerce and society. Cointelegraph posed this question to EY’s Brody, who believes that public blockchains, especially Ethereum’s, “are going to be the big global winners,” with the caveat that public blockchains will first need to be “privacy-enabled.”

Decentralized blockchain-based networks simply offer the world’s best hope to develop monopoly-resistant global digital marketplaces, he said. “We live in the golden age of digital monopolies” like Amazon, Google and Facebook, mainly because that is simply the nature of networks. According to Metcalfe’s Law, as a network grows, its value increases exponentially. The first to market has a good chance to dominate.

But monopolies come at a social and economic cost. New York University finance professor Thomas Philippon has estimated that monopolies cost the median American family $300 a month, and the inefficiencies they entail “deprives American workers of about $1.25 trillion of labor income.” According to Brody, “If we want to fully digitize the economy, and we want to do it without digital monopolies, we should be doing it on public decentralized systems.”

In recent years, EY Global has been devoting significant resources to “industrializing blockchain privacy technology” through its Starlight project, a zero-knowledge proof compiler that enables secure, private business logic on the public Ethereum blockchain. The project is still in beta, but developers can now experiment with building privacy-enabled features for solidity smart contracts. The goal is to enable blockchain-based business agreements where business logic is shared at the network level, but privacy from potential competitors is still preserved.

This last point is critical. In the business world, no company wants another firm to know its commercial secrets, after all. A pharmaceutical manufacturer, for instance, may want to track its medicine packets through its supply chain, beginning with the drug’s raw materials, through to distributors and hospitals.

Each packet can be attached to a nonfungible token recorded on a public blockchain. The pharma firm may also want to attach some business agreements as well. For example, a distributor selling one million units of the manufacturer’s drug could trigger an automatic rebate payment to the distributor via a smart contract. But the pharma firm doesn’t want the whole world to know about this rebate agreement.

“We are starting to build a blockchain-based inventory management system that’s going to use privacy technology to manage those individual tokens,” said Brody. It’s starting on a private chain, but they “are building it with privacy technology because they want to go on to the public chain so that anybody can join with them using these standards.” Brody added:

“So essentially, you’ll be able to take an entire business contract and supply chain operations and run it under privacy on public Ethereum at a cost-effective level.”

Tasks like tracking products and attaching business agreements to digital ledgers may seem mundane, but their economic impact could be huge. “Somewhere between 2 and 5% of all the money on earth in corporations is spent administering stuff, keeping track of it, moving it around,” said Brody. “By using smart contracts and tokenized assets, we could drive that down dramatically.”

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All of this brings us back to Shapella and why such upgrades matter. A trouble-free launch would be further evidence that Ethereum is still on course to achieve the three key goals laid out in the Ethereum Foundation’s roadmap: scalability, security and sustainability. Or as Blockdaemon’s Zwanzger told Cointelegraph:

“It also will reinforce the confidence in the network and in the protocol design so that a developer launching a project can be sure that, for example, gas fees and scalability will not be a big problem over the next one or two years.”

Unwinding the hyperbole: Are US-based crypto firms really being ‘choked’?

An extended market price drawdown (crypto winter) throughout 2022 has tested the crypto industry’s mettle, and more recently, a crackdown by United States regulators on some prominent entities like Coinbase, Binance and Kraken has further shaken the sector.

So maybe it’s only natural for the industry to employ colorful, vivid language to describe what’s been happening. There’s a notion making the rounds that the U.S. government is out to “un-bank” or “de-platform” the crypto sector. This process even has a name: “Operation Choke Point 2.0.”

U.S. President Joe Biden’s administration is using the financial rails “as an extra-judicial political cudgel” to crack down on the crypto industry, wrote Castle Island Ventures’ Nic Carter, who described it as a coordinated, multi-agency effort to discourage banks from dealing with crypto firms.

According to Carter, this alleged strategy follows a template used earlier by the Obama and Trump administrations. In 2018, under federal pressure, “Bank of America and Citigroup de-platformed firearms companies, and BoA began to report client firearm purchases to the federal government,” he wrote.

In late March, Quantum Economics’ Mati Greenspan told Cointelegraph that this so-called un-banking could “already be underway,” particularly in light of the recent collapses of crypto-friendly banks like Silvergate, Silicon Valley Bank and Signature Bank. In Greenspan’s view:

“Crypto is seen as a ‘threat’ to the U.S. dollar’s dominance in global trade — a significant and long-standing benefit to the U.S.”

In that same article, attorney Michael Bacina warned that the “regulation by enforcement model” being practiced in the U.S. would simply “drive crypto-asset innovation offshore,” and on April 1, the CEO of a French digital assets data provider told The Wall Street Journal that U.S. agency actions could “shift the center of gravity of crypto assets trading and investments” toward Hong Kong.

A coordinated effort by regulators?

It’s time to step back and ask: Are these fears justified? It is sometimes difficult to separate the truth from the tight knot of hyperbole in the crypto space, but are U.S. regulators really seeking to “de-platform” crypto?

“I don’t think there’s necessarily a concerted or intentional effort by regulators to ‘de-platform’ crypto,” David Shargel, a partner at the Bracewell law firm, told Cointelegraph. “But, the crypto ecosystem has moved from a niche product to the mainstream, and regulators are playing catchup.” Regulators also recognize that crypto isn’t going anywhere, he added.

Does the suggestion that cryptocurrencies represent a threat to the U.S. dollar’s dominance in global trade provide a further incentive to ban them?

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Crypto may indeed have the potential to disrupt global trade flows — at least to some minor degree — but the dollar is more threatened by other geopolitical factors “such as the U.S.’ own waning influence on the global stage, the rise of China, and Western sanctions on Russia,” Zhong Yang Chan, head of research at CoinGecko, told Cointelegraph.

Recently, International Monetary Fund experts said, “Crypto assets, including stablecoins, are not yet risks to the global financial system.”

“The general consensus seems to be that the dollar remains well entrenched as the world’s dominant currency, and that the use of cryptocurrency, standing alone, won’t change that — barring some other major political or economic shift,” Bracewell’s Shargel added.

“A perfect storm brewing”

Still, the administration in Washington may be getting nervous about the U.S. dollar, said John Deaton, a managing partner at Deaton Law Firm, who also runs the CryptoLaw website, and has supported Ripple in its litigation with the U.S. Securities and Exchange Commission (SEC). Speaking to Cointelegraph, he said there is a convergence of issues at play here:

“China and Russia have agreed to trade oil and gas in the Chinese yuan, not U.S. dollars. Kenya’s president has told his people to dump their USD. Saudi Arabia may agree to trade oil in non-USD denominations.”

At the same time, the U.S. government needs to print more money, adding to an already high inflationary environment, leading people to look at gold, silver and Bitcoin (BTC) as alternatives. “The fear isn’t just about crypto — it’s that a perfect storm is brewing against the U.S. dollar,” Deaton said.

Deaton deems the Operation Chokepoint 2.0 scenario plausible, but he also has a nuanced view of crypto regulation and U.S. regulators. “If we are being honest, the crypto industry has caused itself quite a few self-inflicted wounds, and the industry is to blame for giving itself a black eye when it comes to public perception.” Many in the crypto industry, like himself, “don’t oppose regulation; we seek it,” he said, adding:

“We just want smart, tailored legislation that protects investors from fraud but provides entrepreneurs with clear rules and guidance, and fosters innovation.”

Dealing Binance a ‘fatal blow’?

Deaton was asked about another suggestion heard last week that the U.S. Commodity Futures Trading Commission (CFTC) is “attempting to strike a fatal blow to Binance” with its recently announced lawsuit against the world’s largest cryptocurrency exchange. Is that really the commission’s end game?

“If you look at the CFTC’s case against Binance in a vacuum, I would agree that it is hyperbole to suggest that it is a regulatory attempt to cause a death blow to Binance,” said Deaton. “Binance, like many other entities that grew very fast and very quickly, may have cut corners. If so, they will pay a big fine and move on.”

The problem is that the Binance suit comes after Coinbase received a Wells notice from the SEC, and the government’s seizure of Signature Bank, with reports that the Federal Deposit Insurance Corporation wanted all crypto depositors out before it would allow a sale of that bank. “When you add those things together, it appears like coordination, not coincidence,” Deaton told Cointelegraph.

“Hyperbole seems to drive the crypto news cycle,” commented Bracewell’s Shargel when asked about the industry’s response to the recent CFTC action against Binance. “The CFTC’s lawsuit is certainly serious, but it’s probably too soon to call it a fatal blow.”

In its complaint, the CFTC asked the court to impose several penalties, including a permanent bar on Binance and its CEO, Changpeng Zhao, from the commodities markets. “But, for now, the complaint is just a complaint, and the outcome of the case — whether through settlement or otherwise — remains to be seen,” said Shargel.

The view from abroad

Viewed from overseas, recent U.S. regulatory actions are sometimes difficult to fathom. Syren Johnstone, executive director of the compliance and regulation program at the University of Hong Kong — and author of the book Rethinking the Regulation of Cryptoassets — has been disappointed with the U.S. SEC’s seeming attempt to label everything a security.

“None of the regulatory approaches I’m seeing globally truly promote innovation,” Johnstone told Cointelegraph. “Dumping everything crypto into a financial markets context is straight-jacketing the greater potential for the technology.”

Other countries are closely following recent U.S. regulatory actions, though not necessarily approvingly. “Overseas regulators are looking at the U.S. approach to crypto assets as a situation they want to avoid,” Johnstone noted.

“Globally, there are concerted efforts to bring greater regulatory oversight to crypto,” added CoinGecko’s Chan. “However, each country has its own legal system, and different countries may take different paths toward regulating crypto activities. This may include placing crypto under the ambit of securities, but there may also be other possible paths such as classifying crypto as payments instruments, or commodities.”

Time to cool down the hype?

If the industry continues to use the language of persecution, could it potentially hurt — rather than support — crypto adoption? Shargel commented:

“I’m not sure if hyperbole serves the wider cause of crypto or blockchain adoption, but it might help to coalesce the crypto community, especially as regulators seem to be expanding their enforcement dragnet.”

“I do not believe it is hyperbole to say the U.S. government has initiated a war or campaign against crypto,” opined Deaton. “Operation Chokepoint 2.0, which Nic Carter warned people about, has been proven accurate. Some said he was a conspiracy theorist or engaging in hyperbole. He wasn’t either. The regulators protect the status quo, which means they protect the incumbents in power from the disrupters who are gaining traction or market share. That’s what we are witnessing.”

A downbeat President’s report

Elsewhere, many in the crypto community were disappointed by the Biden administration’s recent economic report, which devoted 35 of its 507 pages to digital assets. Dan Reecer, chief growth officer at decentralized finance platform Acala Network, called it “an attack on crypto,” adding that it was released “just days after Operation Chokepoint 2.0 was executed on crypto-friendly banks.”

Admittedly, the report wasn’t exactly a ringing endorsement of cryptocurrencies. “Crypto assets currently do not offer widespread economic benefits. They are largely speculative investment vehicles and are not an effective alternative to fiat currency,” it declared.

However, there is nothing in the report that describes crypto as threatening U.S. dollar dominance in global trade or about a pressing need to “de-platform” crypto entities.

On the contrary, the report acknowledged that cryptocurrencies “underlying technology may still find productive uses in the future as companies and governments continue to experiment with DLT [distributed ledger technology].” It conceded that “some crypto assets appear to be here to stay.”

The eighth chapter of the report, which focuses on digital assets, is primarily a rehash of things that people working in the field have known for years — how Bitcoin is mined, the risks of algorithmic stablecoins, the crypto sector’s role in ransomware, its volatility and its unsuitability as a medium of exchange, etc. But one major shortcoming is that it fails to recognize the technology’s future possibilities.

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All in all, U.S. regulators face a balancing act. The government has every right to crack down on bad actors, but it shouldn’t kill innovation in the process. The SEC can’t expect to regulate everything in the crypto space — not everything is a financial security.

For instance, if the agency declared Ether (ETH) a security — because the Ethereum network uses ETH in its staking consensus mechanism — then that would rightly be considered regulatory overreach.

“In the aftermath of FTX, it’s no surprise that regulators are inclined to act,” Chris Perkins, president of crypto venture firm CoinFund, and a member of the CFTC’s Global Market’s Advisory Committee, told Cointelegraph. “And, they should be empowered to pursue enforcement actions to prevent other ‘FTXs.’ But, it’s important that we don’t throw the baby out with the bathwater.”

Crypto reform coming to US in 2023, says former White House chief of staff

In the United States, crypto reform legislation isn’t the province of a single political party, and that’s why a former U.S. Congressman, who also played a prominent role in the Trump administration, believes that passage of a federal “digital assets” law this year is a real possibility.

“Democrats aren’t all on one side; Republicans aren’t all on the other side,” said Mick Mulvaney, who was budget director and later acting White House Chief of Staff from January 2019 to March 2020, told Cointelegraph, further explaining:

“I do think in this Congress, which has got functionally about 14–16 months left before it sort of shuts down before the next election cycle, you will get a meaningful piece of legislation on blockchain/crypto — what we’re referring to collectively as digital assets.”

Mulvaney’s government resume is long and varied. In addition to six years in the U.S. House of Representatives representing South Carolina, he was also director of the Office of Management and Budget from February 2017 until March 2020, as well as special U.S. envoy to Northern Ireland, a post from which he resigned on Jan. 7, 2021 — the day after protesters inspired by President Donald Trump attacked the U.S. Capitol Building. Mulvaney is now a strategic adviser to Astra Protocol, a Switzerland-based Web3 Know Your Customer (KYC) platform.

Centralized versus decentralized finance

Mulvaney has an interest in Bitcoin (BTC) and blockchain technology that goes back nearly 10 years. In 2016, he co-founded the Congressional Blockchain Caucus. Today, he says decentralized finance (DeFi) protocols have some key advantages over their centralized counterparts. Moreover, it’s now possible to integrate key compliance processes like KYC and Anti-Money Laundering into DeFi platforms — something that would reassure regulators.

“There’s a weakness in the system when it comes to the centralized and a strength that comes from decentralized finance,” he said. Much of the fraud commonly associated with the crypto space can be attributed to centralized entities, from Mt. Gox to FTX. DeFi, in his view, brings additional layers of transparency that make engaging in fraudulent activities more difficult, “and over the past decade has proved that it is the better system […] Even regulators are beginning to understand this,” he told Cointelegraph.

‘Regulators dropped the ball’

When speaking with one of the Trump administration’s leading financial managers, it would be hard not to ask about the current banking crisis. Silicon Valley Bank (SVB) was arguably ground zero in this upheaval, with some critics — most notably Senator Elizabeth Warren — criticizing the Trump administration for loosening banking regulations that might have averted SVB’s bankruptcy.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, enacted in response to the financial crisis of 2007–2008, introduced the idea of “stress testing” large U.S. banks deemed too big to fail. However, the testing threshold was revised in 2018, which meant SVB and Signature Bank (also troubled) were no longer considered “systemically important financial institutions” subject to stress testing. As Warren wrote in The New York Times:

“Had Congress and the Federal Reserve not rolled back the stricter oversight, S.V.B. and Signature would have been subject to stronger liquidity and capital requirements to withstand financial shocks.”

Is Warren correct that the previous presidential administration was at least partly to blame? “It would have happened anyway,” answered Mulvaney. “The changes in 2018 were relatively narrow in scope. Essentially, it took banks under $250 billion [in balance sheet assets] out from the very highest level of regulation.”

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Silicon Valley Bank was still subject to bank regulation, just not the very highest. Meanwhile, duration risk, marked by taking short-term deposits and investing them in long-term assets — arguably the key factor in SVB’s downfall — “is one of the simplest, most basic things that the SEC [Securities and Exchange Commission], the FDIC [Federal Deposit Insurance Corporation] and the Fed are supposed to look at,” said Mulvaney. “The very lowest levels of regulation should have caught this.”

“The regulators dropped the ball,” he stated, emphasizing that this was a management failure “at a bank that happened to deal with crypto customers. This was not a crypto-induced problem, and I think that’s important to note.”

Crypto has bipartisan support

Why is Mulvaney so optimistic about the prospects of federal crypto or blockchain legislation this year? Despite everything one hears about political polarization in Washington DC, especially in Congress, some issues remain “fairly bipartisan,” he explained. One is antipathy to China. Another is suspicion of Big Tech. But a third is “an interest in crypto and blockchain.”

Take the House Financial Services Committee, on which Mulvaney once served. Its Digital Assets Subcommittee is chaired by Republican French Hill, a crypto and blockchain supporter, but the subcommittee also includes crypto supporters on the minority (Democrat) side, including Ritchie Torres, who spoke with Cointelegraph earlier this year about the prospects for digital assets reform legislation.

Mulvaney’s official portrait. 

Bi-partisanship extends to the U.S. Senate, too, where Republican Cynthia Lummis and Democrat Kirsten Gillibrand jointly introduced the Responsible Financial Innovation Act in 2022, which aims to create a regulatory framework for digital assets. Mulvaney explained:

“You have a group of people in both parties who just want to know more; they’re interested in the topic, they want to educate themselves.[…] That’s where we are right now with crypto and blockchain.”

Next generation of compliance

Astra Protocol, where Mulvaney now serves as a strategic adviser, bills itself as the next generation of compliance — a decentralized KYC Platform for Web3 that “brings the financial regulatory standards for 155+ countries and over 300 sanctions and watchlists to the crypto industry without sacrificing anonymization.” KYC is a process that many banks and businesses use to verify the identity, suitability and risks of potential customers.

But how can one ensure anonymity when trying to verify identities and conduct background checks?

“I think everyone has come to realize that there are different levels of it [anonymity],” said Mulvaney. “For example, I can tell you who I am. And once you know who I am, you can prove to me who you are so that we can deal with each other with a certain level of trust without telling the whole rest of the world who we are.”

Astra Protocol states that its “patented technology” calls upon experts from major global firms to verify a user’s credentials and perform KYC checks of prospective DeFi users. This enables DeFi protocols to adhere to data privacy regulations without accessing investors’ personally identifiable information. The idea is something like zero-knowledge proofs.

“Astra Protocol has no idea what transpired between a DeFi protocol and a regulatory delegate,” the project states. A DeFi project or exchange will be able to know that you are who you say you are and, importantly, that “you’re not on a sanctions list. You’re not a drug dealer. You’re not a child pornographer, you’re not a bot,” added Mulvaney.

Coming to grips with new technology

So far, the Biden administration hasn’t identified itself as a great friend of cryptocurrencies and blockchain technology. Were things different in the previous administration? What, if anything, was being said about crypto inside the White House?

“It was pretty much what you would see in the general public at the time,” answered Mulvaney: “‘We’re not really sure what it is. It’s a new piece of technology […] What are the opportunities,’” and so on.

He recalled conversations on the subject with then-Comptroller of the Currency Joseph Otting, “trying to figure it out.” For instance, which agency should take the lead in regulating digital assets: The Commodity Futures Trading Commission (CFTC), the SEC or a banking agency? “It was unsettled,” recalled Mulvaney. “It was unknown because it was so new.” But that was appropriate for the time. “You don’t want ironclad positions,” especially when adjusting to new technology.

Anyone but Gensler

“I hope that’s what the current [Biden] administration is doing,” i.e., engaging in open-minded discussion. “I get the impression that [SEC chairman Gary] Gensler is sort of dominating the debate. He’s clearly a [crypto] skeptic. I don’t think that’s particularly healthy. I don’t want my regulator taking sides.”

Which government department or commission should take point on crypto? Mulvaney leans toward the CFTC, which would regulate crypto more like a commodity, not a security. Many in the crypto community would probably favor CFTC primacy too. He added:

“I just don’t think Gary Gensler has the mindset to do that [act objectively]. So right now, put me down as supporting anybody other than the SEC because Gensler is still there.”

Remaining obstacles

What does the former acting White House chief of staff think about crypto and blockchain’s long-term prospects? Does the technology have an Achilles heel that will hinder global adoption?

It will not fail because it is (allegedly) being misused by criminals and terrorists, he stated. Lawmakers are slowly learning something that law-enforcement agencies have known for a while. “Crypto is actually a lot better for law enforcement than cash — because while it’s anonymous, it’s still traceable,” said Mulvaney.

The biggest resistance will likely be from “countries that are worried about their own currency being replaced.” He doesn’t include the U.S. in this group, but European Union countries might be candidates. “The Europeans may worry that eventually the euro may be replaced by a digital currency because the euro is sort of held together with needle and thread.”

What about the International Monetary Fund (IMF), which has warned its 190 member countries against making Bitcoin and other private money “official currency?” Is that a responsible position for the world’s lender of last resort?

“No, I think they’re way out of their lane,” answered Mulvaney. The IMF was set up to do a certain thing, “which is to lend money to countries to help them to develop.” Whatever a country wants to adopt as its official currency “is really not the IMF’s business.”

He believes in the “competition of ideas” and “if you get a certain country that wants to adopt Bitcoin or any particular cryptocurrency, I think that’s fine. It’s helpful and could spur more innovation.”

Bitcoin and gold

Mulvaney’s interest in Bitcoin goes back almost a decade and came about “by accident.” He was attending a conference on the gold standard, and “there was a young lady there, talking about something I’d never heard about before, which was Bitcoin, and explaining how it was fixed in total number,” and so on.

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“I remember turning to her at the end of the conference and saying, you know, it’s not exactly the same as the gold standard, but it’s got some interesting parallels. I’d like to know more about it.” They spent some time discussing the new technology, its history, how it worked, and where and how it was being adopted. “I was just fascinated.”

What specifically drew him to Bitcoin? “The value is set by technology.” Later on, as head of the Office of Management and Budget, he saw firsthand “what we’ve done to the currency. I’m very much aware of how much of it [U.S. dollars] we’ve printed over the course of the past ten years.”

“That scares me to death. So to have something that the government cannot, at least in theory, change the value of unilaterally by fiat — that appealed to me, and I think it appeals to a lot of people.”

Rattled crypto industry could emerge stronger after USDC depeg

USD Coin (USDC), the world’s second-largest stablecoin, may simply have been in the wrong place at the wrong time. 

The place was Silicon Valley Bank (SVB), a commercial bank with $209 billion in assets, where USDC issuer Circle had deposited $3.3 billion of its cash reserves for safekeeping.

The time was the present: one of rapidly rising interest rates in which institutions like SVB, which had long been gathering short-term deposits to buy long-term assets, got whipsawed.

For several harrowing days, USDC lost its peg to the U.S. dollar, sinking to as low as $0.85 (depending on the exchange) before recovering to $1.00 on Monday, March 13. This was the coin that many considered to be the poster child for fiat-based stablecoins, i.e., the most transparent, compliant and frequently audited.

An unpredictable turn of events?

“It’s ironic that what was supposed to be the safest place to put stablecoin reserves caused a depegging,” Timothy Massad, a research fellow at the Kennedy School of Government at Harvard University and former chairman of the United States Commodity Futures Trading Commission (CFTC), told Cointelegraph. “But it was a temporary problem, not an indication of fundamental design weakness,” he added.

Still, a depegging remains a serious affair. “When a stablecoin loses its peg, it defeats the purpose of its existence — to provide stability of value between the crypto and fiat worlds,” Buvaneshwaran Venugopal, assistant professor in the department of finance at the University of Central Florida, told Cointelegraph. A depegging unnerves existing and would-be investors, and it isn’t considered good for crypto adoption.

Some viewed this as an outlier event. After all, the last time a Federal Deposit Insurance Corporation (FDIC)-insured bank as large as SVB collapsed was Washington Mutual back in 2008.

“For a bank run like this to have happened would have been far-fetched to many — until the bank run happened,” Arvin Abraham, a United Kingdom-based partner at law firm McDermott Will and Emery, told Cointelegraph. “Part of the problem is that the banking partners for the crypto space tend to be some of the riskiest banks. Circle may not have had options at some of the bigger banks with safer profiles.”

Long-term consequences

The depegging raises a slew of questions about USDC and stablecoins — and the broader cryptocurrency and blockchain industry.

Will the U.S.-based stablecoin now lose ground to industry leader Tether (USDT), an offshore coin that kept its dollar peg during the crisis?

Was USDC’s depegging a “one-off” circumstance, or did it reveal basic flaws in the stablecoin model?

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Did Bitcoin (BTC), Ether (ETH) and some other cryptocurrencies demonstrate resilience during the bank crisis while some banks and stablecoins faltered? And, what more can be done to ensure that other depeggings don’t occur in the future?

“Some people will point to this as a reason to not encourage the development of stablecoins, while others will say that the vulnerabilities of large banks are exactly why we need stablecoins,” added Massad. Neither is really accurate in his view. What is needed is comprehensive banking and stablecoin regulation.

Investors could lose confidence in both USDC and the entire stablecoin sector in the short term, said Abraham, “but in the long term, I don’t think this will have a significant impact.” Still, the situation highlighted poor “treasury management” on the part of Circle, suggested Abraham, adding:

“Keeping almost 10% of total reserves in one bank that is not viewed as ‘too-big-to-fail’ is a risky move for any business, let alone one that purports to maintain a stable peg to the dollar.”

That said, Abraham expects Circle to learn from this experience and eventually emerge stronger than ever. “This scare will likely cause Circle to take a step back and think about better controls to institute, so it is not subject to extreme counterparty risk again. It will make USDC, already a great product, even safer.”

USDC was never really in any existential danger, in Abraham’s view. Even if the U.S. government had not stepped in to “back-stop” depositors, “USDC would have been fine as its deposits were already in the process of being transferred out prior to the FDIC receivership being initiated.” The billions in reserves held by SVB would have settled in another bank by March 13 in any event, Abraham said.

Bitcoin and Ether show robustness

The good news is that Circle survived, and crypto pillars like Bitcoin and Ether held up surprisingly well while the banking contagion spread to other institutions like Signature Bank, First Republic Bank and Credit Suisse.

“Is anyone else surprised that a top Stablecoin [USDC] could just depeg by ~10% instantly, with virtually no ripple effects across other coin prices? Especially since this is pretty core to a lot of DeFi trading,” tweeted Joe Weisenthal. ARK Invest’s Cathie Wood even celebrated cryptocurrencies as a safe haven during the banking crisis.

Others, though, were more measured. BTC and ETH began to fall on March 10 and the early part of that weekend, noted Abraham. “If the U.S. government had not stepped in to backstop depositors in the U.S., and HSBC had not bought the U.K. bank, there would likely have been significant pain across the crypto sector when the markets opened again on Monday [March 13].”

Bitcoin’s price fell slightly on March 9–10 before rebounding. Source: CoinGecko 

Others suggested that USDC basically did everything right; it was just unlucky. “USDC reserves are pretty much made up of cash and short-dated securities, with 80% held in the latter, probably the safest asset out there,” Vijay Ayyar, vice president of corporate development and global expansion at Luno, told Cointelegraph. “Hence, USDC in itself has no real issues if one takes a deeper look at what transpired.”

In Ayyar’s view, the more urgent need is “to have a full reserve dollar digital system that helps us move away from the systemic risks in the current fractional system.”

What does this mean for stablecoins?

What does this decoupling signify for stablecoins in general? Does it prove that they’re not really stable, or was this a one-off event where USDC happened to find itself in the wrong Federal Reserve-member bank? One lesson arguably learned is that stablecoin survivability isn’t entirely about reserves. Counterparty risk also has to be considered.

“Fiat-backed stablecoins have a number of intersecting risk factors,” Ryan Clements, assistant professor at the University of Calgary Faculty of Law, told Cointelegraph, further explaining:

“Much of the discussion to date on the risks of fiat-backed coins like USDC has focused on the issue of reserve composition, quality and liquidity. This is a material concern. Yet it is not the only concern.”

During the current crisis, many people were surprised “at the extent of the duration mismatch and lack of interest rate hedges at SVB, as well as the extent of Circle’s exposure to this bank,” said Clements.

Other factors that can unhinge a stablecoin are issuer insolvency and reserve custodian insolvency, said Clements. Investor perceptions also have to be considered — especially in the age of social media. Recent events demonstrated “how investor fears of reserve custodian insolvency can catalyze a depegging event due to a redemption run against the stablecoin issuer and a sell-off of the stablecoin on secondary crypto-asset trading platforms,” he added.

As the University of Central Florida’s Venugopal earlier said, depeggings erode the confidence of new investors and potential investors sitting on the fence. “This further delays the widespread adoption of decentralized financial applications,” said Venugopal, adding:

“The one good thing is that such mishaps bring in more scrutiny from the investor community — and regulators if the ripple effects are large enough.”

Wherefore Tether?

What about USDT, with its peg holding steady throughout the crisis? Has Tether put some distance between itself and USDC in the quest for stablecoin primacy? If so, isn’t that ironic, given Tether has been accused of a lack of transparency compared with USDC?

“Tether has also had its share of questions raised previously with regard to providing audits on its holdings, which has resulted in a depeg previously,” said Luno’s Ayyar. “Hence, I don’t think this incident proves that one is stronger than the other in any way.”

“The crypto markets have always been rich in irony,” Kelvin Low, a law professor at the National University of Singapore, told Cointelegraph. “For an ecosystem that is touted to be decentralized by design, much of the market is centralized and highly intermediated. Tether only appears to be stronger than USDC because all of its flaws are hidden from view.” But flaws can only be hidden for so long, Low added, “as the FTX saga demonstrates.”

Still, after dodging a bullet last week, USDC may want to do things differently. “I suspect that USDC will seek to strengthen its operations by diversifying its reserve custodian base, holding its reserves at a larger bank with stronger duration risk management measures and interest rate hedges, and/or ensuring that all reserves are adequately covered by FDIC insurance,” said the University of Calgary’s Clements.

Lessons learned

Are there any more general insights that can be drawn from recent events? “There’s no such thing as a completely stable stablecoin, and SVB perfectly illustrates that,” answered Abraham, who, like some others, still views USDC as the most stable of stablecoins. Still, he added:

“For it [USDC] to go through a 10% depegging event shows the limitations of the stablecoin asset class as a whole.”

Moving forward, “It will also be very important for stablecoin investor transparency to continually know what proportion of reserves are held at which banks,” said Clements.

Low, a crypto skeptic, said that recent events demonstrated that no matter what their design, “all stablecoins are susceptible to risks, with algorithmic stablecoins perhaps the most problematic. But even fiat-backed stablecoins are also susceptible to risk — in this case, counterparty risk.”

Also, stablecoins “are still subject to the risk of loss of confidence.” This applies to cryptocurrencies like Bitcoin, too; even though BTC has no counterparty risk or depegging issues, continued Low. “Bitcoin prices are [still] susceptible to downside pressures when there is a loss of confidence in the same.”

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Ayyar stated that USDC already had diverse banking partners, with only 8% of its assets at SVB. “Hence, that in itself is not the solution.” One needs to think more long-term, he suggested, including implementing comprehensive consumer protections “as opposed to relying on the current patchwork approach.”

As for former CFTC chief Massad, he cited the need for reforming both stablecoins and banking, telling Cointelegraph:

“We need a regulatory framework for stablecoins, as well as an improvement in the regulation of mid-size banks — which may require a strengthening of the regulations, better supervision, or both.”

Crypto industry may escape lasting damage from Silvergate liquidation

Banks are the lifeblood of a nation’s economic system, and any bank collapse is disturbing. Last week saw two failures. On March 8, Silvergate Capital — the cryptocurrency-focused banking company — entered into voluntary liquidation. On March 10, United States regulators shut down and seized the deposits of tech-oriented Silicon Valley Bank in what was being called the second-largest bank failure in U.S. history. Both California institutions were victims of bank deposit runs. 

The fallout from the collapse of Silicon Valley Bank (SVB) could be significant, though it’s too early to tell. Stablecoins like USD Coin (USDC) and Dai (DAI) losing their dollar pegs is never a good sign, but they were recovering by Sunday, March 12. However, it’s unlikely that the Silvergate Bank debacle will cause long-term harm to the crypto sector.

The fall of the San Diego-based Federal Reserve-member bank should be a minor event compared with the earthquake unleashed by FTX’s November 2022 bankruptcy, sources told Cointelegraph. FTX’s implosion damaged scores of crypto firms, including Silvergate Bank. By comparison, the fallout from the bank’s liquidation should be more contained. It might even provide some valuable lessons about diversification — a fundamental principle of risk management that seems to be forgotten when markets soar.

There will likely be short-term consequences that will likely make life more difficult and costly for crypto firms to find banking services in the United States. And it’s not just the U.S. that is seeing some turmoil.

In Latin America, which is primarily a crypto foreign exchange (FX) market where many firms buy stablecoins like USDC and Tether (USDT) as a means of sending funds abroad, “the Silvergate fallout was problematic,” Thiago César, the CEO of fiat on-ramp provider Transfero Group, told Cointelegraph.

“Most crypto exchanges lost their U.S. dollar rails.[…] It impacted the alternative FX market in LATAM fueled by crypto.” Local Brazilian dealers in USDT and USDC suddenly couldn’t replenish their inventories, César reported. (This interview was conducted before the SVB seizure, which rattled some stablecoin firms further.)

Josh Olszewicz, head of research at Valkyrie Digital Asset Management, told Cointelegraph: “The lack of on and off-ramps as well as general banking needs of consumers and businesses interacting with the crypto industry may be hampered in the near term.” Coinbase, Paxos, Gemini, Bitstamp and Galaxy Digital, among others, were using Silvergate as a banking partner.

That said, the Silvergate collapse probably doesn’t present long-term obstacles. “Fundamentally, a bank exiting the crypto industry does not hurt any blockchain, including Bitcoin,” Olszewicz added.

Lessons learned?

Joseph Silvia, partner at law firm Dickinson Wright — and former counsel to the Federal Reserve Bank of Chicago — views Silvergate Bank’s liquidation more as a “cautionary tale” than a harbinger of tougher times for the crypto sector. The bank was insufficiently diversified and dependent on the crypto industry for its deposits. Similarly, Silicon Valley Bank was arguably too concentrated on tech-based venture capital firms. In both cases, a trickling away of customer deposits rapidly turned into a torrent. 

More than 90% of Silvergate’s deposits were from crypto-related firms, and after FTX’s November implosion, nervous investors withdrew those deposits in what amounted to a classic bank run. This activity did not go unnoticed by U.S. bank regulators. The Federal Reserve and the Office of the Comptroller of the Currency issued a joint statement in February, warning banking organizations about “liquidity risks” as the result of “crypto-asset market vulnerabilities.”

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In the wake of Silvergate’s liquidation, some traditional banks may now shut the doors entirely to crypto accounts, while others may severely limit acceptance of crypto deposits, said Silvia. This will probably increase costs for U.S. crypto firms as their banking options become more limited.

Aside from being too concentrated on a single high-risk industry sector, Silvergate may have invested in the wrong assets. As Austin Campbell, an adjunct professor at Columbia Business School and managing partner of Zero Knowledge Consulting, told Cointelegraph, “Essentially, you either want a highly diversified deposit base if you have longer-dated assets because you can’t easily survive a run and need the diversification, or if you are highly concentrated, you should have a much shorter duration asset base so that you can easily liquidate in the case of a mass withdrawal.” Campbell added:

“Silvergate was highly concentrated and had longer duration securities. You can’t do both. You need to pick one. They would have been fine being this concentrated if they didn’t extend out duration on the asset side.”

Campbell doesn’t think Silvergate’s collapse will be as consequential for the crypto sector as FTX’s collapse — nor even have much of an impact in the broader banking industry. Silvergate’s assets totaled $11.4 billion at the end of 2022, which is mid-sized by U.S. bank standards. 

By comparison, JPMorgan Chase’s year-end balance-sheet assets stood at $3.66 trillion, more than 300 times larger. SVB, with $209 billion in assets, is somewhere in between. Silvergate is “the definition of a small problem” from a mainstream banking perspective, observed Campbell, who went on to say:

“For crypto, FTX was a big issue not just because of the volume but because of the staggering depth of the fraud and mismanagement. Silvergate appears to have just messed up asset-to-liability matching, which is an age-old problem in banking. It was not that the CEO was stealing billions from the customers.”

“FTX was a much more serious problem,” agreed Justin d’Anethan, institutional sales director at the Amber Group — a Singapore-based digital asset firm. D’Anethan added, “Countless entities were funded, trading, custodied, earning yields and lending to either FTX the exchange or Alameda the fund. That rippled into the entire crypto space.”

Silvergate may have an impact in the U.S., “but it still leaves crypto [firms] with many alternatives and substitutes, and, if anything, the impetus to be more decentralized,” d’Anethan continued. In the short term, “other crypto-friendly banks like BCB, Prime Trust, SEBA” offer on-ramp/off-ramp and FX conversions. “Naturally, for mainstream or institutional adoption, you do need fiat rails for fresh capital to come into crypto markets. But, at this point in time, there’s nothing that makes me think we’ll be lacking those.“

Others suggested that U.S. regulators are intent on scaring off traditional banks from doing business with cryptocurrency exchanges. Will it result in crypto firms moving out of the United States, with users going to peer-to-peer transactions as in China, as Samson Mow recently suggested?

“I think many US-based businesses will already have or be in the process of finding overseas solutions. And this will benefit jurisdictions that are more crypto-friendly. I’m thinking of Dubai, Singapore, Hong Kong, maybe the U.K. or Switzerland,” said d’Anethan, adding:

“For retail, if based in the U.S., it will be trickier. Ironically, in a bid to protect retail investors, regulators might stop them from getting exposure to an industry that — if history is any guide — keeps on growing and gaining adoption worldwide.”

Valkyrie’s Olszewicz even saw a positive outcome if the U.S. finally got sensible crypto regulation. “Potentially, as digital asset businesses and exchanges become increasingly regulated, the larger traditional banks may become warmer to establishing relationships with those in the digital asset space. If not, then yes, more and more businesses and capital will move offshore as crypto isn’t going anywhere anytime soon.”

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“I think the long-term impact will be banking relationships moving elsewhere, and in a positive case, becoming both more diversified and more resilient,” said Columbia Business School’s Campbell. “The U.S. regulators, however, are moving in the other direction and taking this as an example that crypto is the problem — it’s not, poor risk management was — so this may also force crypto to build stronger banking relationships both in Asia and in Europe, especially in a post-MiCA [Market in Crypto-Assets] world.”

Just growing pains?

More regulatory clarity about cryptocurrencies and blockchain technology would be helpful, Dickinson Wright’s Silvia suggested. At some point, U.S. regulators may become more explicit in their advisory statements — warning banks, for example, that if they accept crypto deposits, the total value cannot exceed 5% of overall liabilities. In the meantime, crypto deposits remain a liquidity risk, Silvia added. “They’re not as sticky as traditional deposits.”

Some U.S. crypto firms may need to find new banks, while traditional banks may be more hesitant to accept crypto-related deposits — at least for now. But the nascent crypto industry isn’t going anywhere, added Silvia, who views current turmoil as growing pains. Some weeding out of bad actors is probably necessary at this stage. That said, the crypto sector remains “an interesting value proposition,” he told Cointelegraph.

Is the IMF shutting the door prematurely on Bitcoin as legal tender?

There’s been little sunlight this crypto winter, so it may seem odd to present the “Bitcoin as legal tender” argument again. That is, will or should any country — other than El Salvador and the Central African Republic (CAR), which have already done so — declare Bitcoin (BTC) an official national currency?

The International Monetary Fund (IMF) raised the issue again last week in a paper putting forth nine crypto-focused policy actions that its 190 member countries should adopt. First on its list of “don’ts” was elevating crypto to “legal tender.” Or, as the multilateral lending institution’s executive board assessment stated:

“Directors generally agreed that crypto assets should not be granted official currency or legal tender status in order to safeguard monetary sovereignty and stability.”

Maybe it’s not fair to ask the question with crypto back on its heels, but was the IMF right to warn its member banks about cryptocurrencies? And if so, what exactly is lacking in the composition of private digital money that makes it unsuitable as an official national currency? Maybe it’s Bitcoin’s well-documented volatility, but if that’s the case, couldn’t the world’s oldest cryptocurrency still grow into a new role as an auxiliary scrip — perhaps in a few years when it has more users, is more liquid, and exhibits less price variance?

The IMF must tread carefully

“The IMF’s mandate is to promote global economic stability and growth. It is therefore reasonable that the IMF has recently advised countries to refrain from granting legal tender status to crypto-assets, which are, by design, often disruptive in nature,” Gavin Brown, associate professor in financial technology at the University of Liverpool, told Cointelegraph. “Such disruption does arguably present just as many opportunities as threats, but the IMF must tread a more prudent path when faced with such open-ended uncertainty.”

“There are very good economic reasons why most countries would not want to adopt cryptocurrencies like BTC as their local scrip,” James Angel, associate professor at Georgetown University’s McDonough School of Business, told Cointelegraph. “In short, they don’t want to lose the profits from printing their own money or the economic control over the economy that fiat currencies provide.”

While crypto maximalists may skewer governments for printing money non-stop to paper over deficits, “sometimes, the right thing to do is to print money,” added Angel, “like in the Great Recession or the pandemic. The trick is not to print too much, which happened in the pandemic.”

‘Bitcoin was made for the Global South’

In its policy paper, the IMF had multiple arguments for its position beyond crypto’s well-documented volatility. It could expose government revenues to foreign exchange rate risk. Domestic prices “could become highly unstable” because businesses and households would spend time deciding whether to hold fiat or BTC “as opposed to engaging in productive activities.” Governments would have to allow citizens to pay taxes in Bitcoin — and so on.

Adopting crypto as legal tender could even affect a government’s social policy objectives, the IMF paper stated, “particularly for unbacked tokens, as their high price volatility could affect poor households more.” 

But questions remain. Even if the IMF arguments are valid and hold in most circumstances, aren’t there exceptions? What about developing countries struggling with inflationary currencies, like Turkey?

“Bitcoin was made for the Global South,” Ray Youssef, co-founder and CEO of Paxful — and a founder of the Built With Bitcoin Foundation — told Cointelegraph. “In the West, a lot of attention is paid toward the suspected volatility of Bitcoin. That’s because the world runs on the dollar and the West is shielded from global inflation. Right now, Turkey has an inflation rate of over 50%, and Nigeria has an inflation rate of over 20% — in these economies, Bitcoin is a strong bet.”

But even in instances like these, it may not be so easy. “In order for cryptocurrency to be used effectively as legal tender in developing countries, governments will [still] need to heavily invest in the technological infrastructure and a suitable regulatory framework,” Syedur Rahman, a partner at law firm Rahman Ravelli, told Cointelegraph. If this can be done, it “will assist in financial inclusion.”

“Adopting a foreign/hard currency or monetary standard is a last resort to rein in hyperinflation,” commented Angel. “But even weak governments like to have the power of the printing press, as it provides a taxation mechanism to pay the troops.”

The Central African Republic made crypto legal tender in April 2022 — the second country to do so, after El Salvador. Some CAR representatives said that crypto would help reduce fees for financial transactions in and out of the country. Maybe that, too, is a valid reason to elevate crypto to official currency.

Rahman acknowledged that “there are benefits such as seeing a reduction in transaction fees for financial transactions. If there is a weak traditional banking system or lack of trust, then cryptocurrency undoubtedly can provide an alternative means of payment.”

“Remittance is a great use case for Bitcoin,” said Youssef. “Money transfer companies charge high fees and funds can take days to arrive.” Bitcoin cuts down on fees, and transactions can take minutes. People who may not have a bank account can take advantage of remittances too. “This is a huge deal when you look at the amount remittances bring into some countries. In El Salvador, remittances account for over a quarter of the country’s GDP.”

Others were dismissive, however. “I think legal tender status in this context is likely a gimmick. I’m not sure how I might be more motivated to send BTC to someone living in CAR just because BTC is now viewed as legal tender in that jurisdiction,” David Andolfatto, economics department chair and professor at the University of Miami’s Miami Herbert Business School, told Cointelegraph.

Moreover, the act of granting a “foreign” currency legal tender status “seems to me to be an admission that a country’s institutions cannot be trusted to govern society effectively,” added Andolfatto, a former senior vice president of the Federal Reserve Bank of St. Louis where he became one of the world’s first central bankers to deliver a public talk on Bitcoin in 2014.

Bitcoin remains questionable as legal tender because it does little to quell the so-called “flight-to-safety” phenomenon, wherein the demand for money shifts violently with sudden changes in consumer or business sentiment, Andolfatto explained.

“These violent swings in the price level are unnecessary […] What is needed is a monetary policy that expands the supply of money to accommodate the demand for money in times of stress. The provision of an ‘elastic currency’ serves to stabilize the price level for the benefit of the economy as a whole.”

“Transaction fees are a friction on global economic activity,” noted Brown, and developing nations often bear the burden of these inefficiencies. Still, “In my view, a pivot to crypto assets, such as in El Salvador today, is a risk too big to take,” Brown said. Georgetown’s Angel added, “El Salvador and CAR are special cases since they did not have their own currency to start with.” 

More maturity

Bitcoin is still relatively young and volatile. But with wider adoption, including institutional investors, couldn’t it become a stable asset, more like gold? “There is some merit to this argument,” says Andolfatto. “I believe BTC price volatility will diminish as the product matures.” But even if BTC remains stable for long periods of time, “it will always be susceptible to ‘flight-to-safety’ phenomena that would generate sudden large deflations — or inflations if people are dumping BTC,” he added. “BTC will appear stable, but it will remain fragile.”

Youseff, like some others, suspects the IMF has ulterior motives in all this. The fund is interested in self-perpetuation, he suggested, adding:

“Bitcoin has proven to lower inflation, give more people access to the economy and international work, increase transparency and act as a universal translator of money. It also has the potential to lessen a country’s reliance on international centralized power — like the IMF. It’s not hard to connect the dots on why the IMF is not welcoming of Bitcoin.”

“Cryptoassets such as Bitcoin are still young in currency terms,” noted Brown, but their inherent weaknesses like price volatility and pseudo-anonymity could present “insurmountable challenges from the perspective of nation-states. Nonetheless, Bitcoin has become a backstop alternative when fiat currencies fail through macroeconomic events such as hyperinflation and controls around capital flight.”

If not the lead, still a supporting role?

For the sake of argument, let’s agree with the IMF, crypto skeptics and others that there is no future role for Bitcoin as legal tender or official currency — even in the developing world. Does that still preclude BTC and other cryptocurrencies from playing a useful social or economic role globally?

“I see a very useful role for crypto technology, which is why I have been a vocal proponent of CBDCs [central bank digital currencies] since 2014,” answered Angel. “There are very good reasons why over 100 central banks are working on these.”

But he’s skeptical about Bitcoin because “governments have a long history of pushing private money aside. I’m surprised that it has taken as long as it has for governments to react and attempt to push aside Bitcoin in order to get all the seigniorage revenue for themselves.”

Overall, crypto assets such as Bitcoin may continue “to be held in limbo by many nation states and regulators,” opined Brown, given that they are inherently anti-establishment but also “near impossible” to ban in free societies.

Bitcoin and other digital assets can still serve a positive role as “the trigger forcing the monopoly, which are central banks,” to think again about their monetary policies “and to innovate in response,” said Brown.

SEC vs. Kraken: A one-off or opening salvo in an assault on crypto?

In a year of crypto upheavals, the United States Securities and Exchange Commission’s settlement with crypto exchange Kraken, announced on Feb. 9, set off yet another tremor. Agency chief Gary Gensler took to mainstream media last week to explain the agency’s action, which seemed to be an attack on crypto staking — part of the validation mechanism used by a number of blockchain platforms, including Ethereum, the world’s second-largest network. 

The immediate issue, in the agency’s view, was that Kraken had been selling unregistered investment products. Indeed, it was advertising big returns on staking crypto — up to 21%, Gensler told

“The problem was they were not disclosing to the investing public the risks that the investing public were entering into,” Gensler said. Moreover, the SEC’s action, which required Kraken to shell out $30 million and shut down its staking operation, could have been easily avoided, he seemed to imply:

“Kraken knew how to register, others know how to register. It’s just a form on our website. They can come in, talk to our talented people on disclosure review teams. And if they want to offer staking, we’re neutral. Come in and register, because investors need that disclosure.”

Not all in the crypto industry were totally satisfied with this response, however. “I find the SEC’s ‘all crypto projects have to do is come in and register’ line unbelievably insulting,” tweeted Morrison Cohen LLP attorney Jason Gottlieb. “There is simply no path to registration for many crypto products.”

“The registration of staking program securities is not as simple as filing a form on the SEC’s website,” Michael Selig, an attorney with Willkie Farr & Gallagher LLP, told Cointelegraph. “Public offerings of securities are heavily regulated and expensive to conduct.”

Others view the agency’s decision to charge Kraken as the first salvo in a general assault on crypto by U.S. regulators. “If approved by a court, the settlement marks a potential turning point for cryptocurrency regulation and the SEC’s broader efforts to bring the industry under its jurisdiction,” reported CNN. “The move could lead to a wider clampdown,” speculated The New York Times, including possibly banning staking for retail U.S. investors.

But maybe the industry was over-reacting. That is, staking as practiced by Ethereum and other blockchains as a way to reward network validators may not be on the SEC’s radar screen at all. The agency could be motivated by consumer protection concerns primarily and, in this instance, it wanted to make an example of Kraken, especially in light of FTX’s November collapse and the bankruptcy of assorted crypto lending firms.

“Yes, I am sure they [the SEC] wanted to make an example of Kraken, especially because it promoted the opportunity to make returns of up to 21%,” Carol Goforth, university professor and Clayton N. Little professor of law at the University of Arkansas, told Cointelegraph.

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“Kraken set the returns for amounts staked, not the underlying blockchain protocols. […] Honestly, the way that Kraken operated its program looks like an investment contract under Howey,” she said. The SEC uses the Howey Test to determine whether a transaction qualifies as an investment contract, which then requires SEC registration.

Bill Hughes, senior counsel and director of global regulatory matters at ConsenSys, told Cointelegraph, “It’s a one-off action that is intended to not just resolve Kraken’s offering but, importantly, to send signals across the space about what features of staking-as-a-service the SEC believes are problematic.” If another staking service fails to pay attention to these signals, they too can expect the SEC to take action, said Hughes, adding:

“I think the SEC hopes the market gets the message and adjusts accordingly — as they’d probably prefer to move on to other issues.”

“The U.S. Kraken case is primarily about sanctioning its [Kraken’s] blatant and non-transparent behavior vis-à-vis their retail customers, and not for just offering a staking-as-a-service per se,” Markus Hammer, an attorney and principal at the Switzerland-based Hammer Execution consulting firm, told Cointelegraph.

Is Ethereum at risk?

The market didn’t necessarily see this as a one-off action on the part of the agency, however. Ether (ETH) plummeted around 6.5% on the day of the settlement announcement, its largest one-day decline since mid-December. As widely reported, Ethereum moved last year from a proof-of-work to a proof-of-stake (PoS) consensus mechanism. Dubbed “the Merge,” this technical makeover was hailed by many for radically reducing the network’s prodigious energy usage and carbon footprint. But some, at least, feared Ethereum was now in the sights of U.S. regulators because of its new staking protocols.

Equating Kraken and Ethereum could be a mistake, though. As Matthew Hougan, chief investment officer at Bitwise Asset Management, told Cointelegraph:

“The SEC’s enforcement action against Kraken is not an enforcement action against Ethereum for using a proof-of-stake consensus mechanism. It was an enforcement action against Kraken for offering a staking service. Those are different things.”

Moreover, Ethereum could continue to function securely as a PoS network even if the SEC were to ban all staking services in the U.S., said Hougan, though he doesn’t expect that to happen. “Activity would simply migrate offshore or be done directly by individuals,” he said. More than enough ETH could still be staked to ensure network integrity. “The main result would be that U.S. investors would lose out on both the opportunity and the risk of staking. The world, however, would go on.”

“The action is not against staking platforms but against staking service providers that organize and operate pools,” Goforth said. “If the organizer controls the pools and the rates of return” — as with Kraken — “then this action does suggest that the SEC will treat the program as involving the distribution of investment contracts.”

By comparison, she said, “if the blockchain protocol allows others to set up pools,” as with Ethereum, “that is not necessarily within the rationale of this order.”

Hughes agreed. There is nothing in the SEC’s complaint that implies that staking itself is problematic. “SEC’s action focuses squarely on the Kraken custodial staking program, which promised a specific yield, pool funds and did not disclose risks or fees. It says nothing about ETH staking or any other chain’s consensus mechanism,” he said.

Ethereum also hosts many use cases that have nothing to do with investing (e.g., elections). Just because the network has moved to a proof-of-stake consensus mechanism doesn’t by itself mean that its native coin, Ether, should now automatically be classified as a security. One has to look at “the nature of the underlying multi-purpose blockchain and respective ecosystem,” said Hammer. Moreover, these will need to be assessed blockchain by blockchain, he added.

An opening volley?

All this may be well and true, but could this really be an opening fusillade as part of a broader post-FTX attack on cryptocurrencies and blockchain technology — and not just “investment solutions” offered by a few centralized service providers?

“The SEC tends to act in an incremental way, bringing new enforcement actions that build upon prior enforcement actions,” Selig told Cointelegraph. “The crypto industry is sensibly concerned that the SEC is focused on custodial staking programs today but will set its sights on staking more broadly in the future.”

Hughes tends toward the more limited view, mainly “because that is what this complaint is on its face. Whether the SEC gets more aggressive and goes after core blockchain functionality is to be seen.”

Blockdaemon CEO and founder Konstantin Richter appeared to agree. “With the complaint, staking itself does not appear to be the issue,” Richter told Cointelegraph. “This indicates that institutional investors that have the ability to stake can continue without using a centralized custodial exchange.”

Hougan, for his part, isn’t quite so confident that a clampdown isn’t coming, telling Cointelegraph:

“Crypto is facing a coordinated regulatory crackdown in the U.S. You are seeing that crackdown in the SEC’s recent statements and actions, and in recent efforts by the FDIC, OCC and Federal Reserve to restrict the crypto industry’s access to the traditional banking system.”

These actions are worrisome but not surprising, continued Hougan. The numerous failures over the past year like FTX, Celsius, Genesis, BlockFi, Voyager and Terra have “pointed to some significant risks in the crypto ecosystem and the need — in certain cases — for better regulation.”

“This is far from the first salvo in a U.S. assault on crypto,” said Goforth. “The SEC has been relatively hostile to crypto assets for years; this seems to be a continuation of that approach […] as it continues to devote resources to case-by-case enforcement rather than offering a genuinely helpful roadmap for compliance, such as by drafting exemptions based on tailored disclosures.”

‘First inning of a nine inning game’

Gensler may have been disingenuous when he invited exchanges like Kraken to just fill out a form on the SEC’s website. SEC registration is an involved undertaking. “It is an incredibly difficult process, often costing a million dollars or more — in legal, accounting, and investment advisor fees — the first time an issuer seeks to register a conventional security,” noted Goforth. It also can take a long time to get approved.

It doesn’t necessarily follow, however, that Gensler will go after Ethereum and other PoS platforms. The agency chief, it might be remembered, once taught a course on blockchain technology at the Massachusetts Institute of Technology, and he knows a good bit about decentralized networks and their purposes. He probably understands that the technology offers all sorts of non-investment use cases, even PoS platforms with validators that have “skin in the game” as they work to ensure network integrity.

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Indeed, the Kraken settlement might have only confirmed that “that the SEC still is not clear about when consumer protection regulations apply to the crypto world,” Hammer opined. Before the Merge, both the SEC and the Commodity Futures Trading Commission regarded Ether as a commodity rather than a security.

Overall, the jury could still be out as to whether the SEC is engaged here in a limited regulatory action or is instead discharging the opening volley in a wider war on cryptocurrencies and blockchain technology. Most favor the former interpretation, but as Hougan concluded:

“Whether the current regulatory crackdown is going to strangle crypto or ultimately unleash its full potential — I think it’s too early to say. The right kind of regulatory progress could be incredibly positive for crypto, but overly restrictive or punitive regulation would be crippling. […] We’re in the first inning of a nine-inning game.”