China Is Determined to Bend DeFi to Its Will

https://www.financemagnates.com/cryptocurrency/china-is-determined-to-bend-defi-to-its-will/

It might be imagined that the concept of a financial system that cannot be controlled by a central bank would be anathema to China’s ruling party, but decentralisation is not an uncommon feature of Chinese society.

A paper published in the China Economic Review in 2020 referred to that country’s unique blend of political centralisation and decentralisation of economic power and responsibility, noting that even after the centralising reforms in the last three decades, the fiscal system is largely decentralised.

For a certain subset of cryptocurrency users, decentralised finance is filling the gap for cryptocurrency services in China, although there is a major limitation in the shape of the efficiency and liquidity of centralised exchanges.

So while volumes at decentralised exchanges continue to increase, especially in the wake of major centralised finance exchange collapses, Zennon Kapron, the Managing Director of Asian fintech strategic consulting firm Kapronasia, stated there are no decentralised exchanges that can match the liquidity and depth of trading that centralised exchanges provide, and nor will they in the near future.

Angel Zhong, a senior lecturer in finance at RMIT School of Economics and a trading trends expert, agrees that decentralised finance is to at least some extent filling the gap left by China’s crackdown on centralised cryptocurrency exchanges.

“However, it is important to note that the Chinese government’s regulations may also extend to DeFi activities,” she added. “It has been monitoring DeFi projects and activities within China and the regulatory landscape is rapidly evolving.”

Users of DeFi platforms often resist the implementation of KYC standards, citing privacy concerns. The lack of KYC protocols in DeFi raises the risk of non-compliance with anti-money laundering and countering the financing of terrorism (AML/CTF) obligations.

“There is scope for regulation in China, in particular with a strong focus on developing responsibilities about KYC,” Zhong mentioned. “China could also use its firewall to ban access to DeFi wallets.”

The ability to regulate crypto has always been in the on- and off-ramps, namely the banks and payment providers. China has approached this in a few different ways in the past, from encouraging banks to avoid doing business with crypto exchanges to completely banning them from doing so.

“The challenge with DeFi is of course the fact that there may not be any ramps for the regulators to regulate,” Kapron explained. “With no traditional fiat rails and an often amorphous and complex structure, DeFi exchanges might be the toughest challenge yet for the Chinese government and regulators.”

The Shanghai government’s investment in the blockchain firm, Conflux was seen by many as an attempt to build its own version of DeFi. Conflux Network’s Co-Founder, YuanJie Zhang, noted that DeFi teams in China either maintain a relatively low profile or rebrand themselves as headquartered in Singapore or Hong Kong.

“Their founders mostly live overseas and handle investors, partnership and listing preparations, while their coders work remotely (and anonymously) in second tier cities,” he said. “Chinese crypto players trust mainstream DeFi rather than Chinese-founded DeFi protocols given the risk of rug pulls and hacks – although Hong Kong’s crypto policy may change the dynamics.”

In a keynote speech at the Hong Kong Web3 festival in mid-April, Keith Choy, the interim Head of Intermediaries at the Securities and Futures Commission (SFC) of Hong Kong noted that decentralised finance (DeFi) presented a number of regulatory issues.

He referred to financial stability implications arising from the interconnectedness of DeFi and virtual asset ecosystems, as well as between DeFi and the traditional financial world, and the limited transparency of these interconnections. Choy also touched on DeFi’s vulnerability to market integrity issues, such as price oracle manipulation or front-running transactions.

Then, there is the issue of who should be held accountable when things go wrong.
The SFC’s view is that as long as a DeFi activity falls within the scope of the securities and futures ordinance, it would be subject to the same regulatory requirements as a traditional financial activity.

Choy suggested that identifying the individuals who should be held accountable in DeFi may not be as difficult as imagined since some DeFi protocols can be controlled by a relatively small group of developers, operators or related parties.
But, Zhang is less optimistic, suggesting that Hong Kong’s regulators will focus on regulated exchanges, stablecoins, and then crypto wallets. “The decentralised space takes more time to discuss and develop a framework for regulation,” he declared.

Zhang also downplays the likelihood of the Chinese government building its own decentralised finance network given the lack of consensus on infrastructure.
“Many participants, policy makers and corporates are still in the consortium phase,” he added. “Conflux is the sole public chain admitted by the government in a different track, and Hong Kong will be an experiment where the DeFi ecosystem operates at arm’s length to the Ethereum virtual machine (a core piece of Ethereum that helps power the blockchain and smart contracts) ecosystem.”

Others take a different view though, with Kapron suggesting the development of China’s central bank digital currency (the e-CNY) could theoretically provide the rails for a government-sponsored DeFi ecosystem with clear Chinese characteristics. “In other words, it may be decentralised, but also have clear opportunities for the government to monitor and potentially control transactions on the platform,” Zhang stated.

A senior figure at a DeFi platform liquidity network suggested that something resembling a decentralised network could be rolled out over the next decade with some sort of automation layer using permissioned smart contracts, adding that China is very good at identifying the valuable parts of technology and applying it to its own rules, as evidenced by the e-CNY.

“With the rapid development and substantial growth in DeFi around the world – as well as the challenging nature of regulating and policing DeFi projects – it is becoming increasingly likely that the Chinese government takes part in DeFi, similar to how it joined the game of central bank digital currency,” concluded Zhong.

It might be imagined that the concept of a financial system that cannot be controlled by a central bank would be anathema to China’s ruling party, but decentralisation is not an uncommon feature of Chinese society.

A paper published in the China Economic Review in 2020 referred to that country’s unique blend of political centralisation and decentralisation of economic power and responsibility, noting that even after the centralising reforms in the last three decades, the fiscal system is largely decentralised.

For a certain subset of cryptocurrency users, decentralised finance is filling the gap for cryptocurrency services in China, although there is a major limitation in the shape of the efficiency and liquidity of centralised exchanges.

So while volumes at decentralised exchanges continue to increase, especially in the wake of major centralised finance exchange collapses, Zennon Kapron, the Managing Director of Asian fintech strategic consulting firm Kapronasia, stated there are no decentralised exchanges that can match the liquidity and depth of trading that centralised exchanges provide, and nor will they in the near future.

Angel Zhong, a senior lecturer in finance at RMIT School of Economics and a trading trends expert, agrees that decentralised finance is to at least some extent filling the gap left by China’s crackdown on centralised cryptocurrency exchanges.

“However, it is important to note that the Chinese government’s regulations may also extend to DeFi activities,” she added. “It has been monitoring DeFi projects and activities within China and the regulatory landscape is rapidly evolving.”

Users of DeFi platforms often resist the implementation of KYC standards, citing privacy concerns. The lack of KYC protocols in DeFi raises the risk of non-compliance with anti-money laundering and countering the financing of terrorism (AML/CTF) obligations.

“There is scope for regulation in China, in particular with a strong focus on developing responsibilities about KYC,” Zhong mentioned. “China could also use its firewall to ban access to DeFi wallets.”

The ability to regulate crypto has always been in the on- and off-ramps, namely the banks and payment providers. China has approached this in a few different ways in the past, from encouraging banks to avoid doing business with crypto exchanges to completely banning them from doing so.

“The challenge with DeFi is of course the fact that there may not be any ramps for the regulators to regulate,” Kapron explained. “With no traditional fiat rails and an often amorphous and complex structure, DeFi exchanges might be the toughest challenge yet for the Chinese government and regulators.”

The Shanghai government’s investment in the blockchain firm, Conflux was seen by many as an attempt to build its own version of DeFi. Conflux Network’s Co-Founder, YuanJie Zhang, noted that DeFi teams in China either maintain a relatively low profile or rebrand themselves as headquartered in Singapore or Hong Kong.

“Their founders mostly live overseas and handle investors, partnership and listing preparations, while their coders work remotely (and anonymously) in second tier cities,” he said. “Chinese crypto players trust mainstream DeFi rather than Chinese-founded DeFi protocols given the risk of rug pulls and hacks – although Hong Kong’s crypto policy may change the dynamics.”

In a keynote speech at the Hong Kong Web3 festival in mid-April, Keith Choy, the interim Head of Intermediaries at the Securities and Futures Commission (SFC) of Hong Kong noted that decentralised finance (DeFi) presented a number of regulatory issues.

He referred to financial stability implications arising from the interconnectedness of DeFi and virtual asset ecosystems, as well as between DeFi and the traditional financial world, and the limited transparency of these interconnections. Choy also touched on DeFi’s vulnerability to market integrity issues, such as price oracle manipulation or front-running transactions.

Then, there is the issue of who should be held accountable when things go wrong.
The SFC’s view is that as long as a DeFi activity falls within the scope of the securities and futures ordinance, it would be subject to the same regulatory requirements as a traditional financial activity.

Choy suggested that identifying the individuals who should be held accountable in DeFi may not be as difficult as imagined since some DeFi protocols can be controlled by a relatively small group of developers, operators or related parties.
But, Zhang is less optimistic, suggesting that Hong Kong’s regulators will focus on regulated exchanges, stablecoins, and then crypto wallets. “The decentralised space takes more time to discuss and develop a framework for regulation,” he declared.

Zhang also downplays the likelihood of the Chinese government building its own decentralised finance network given the lack of consensus on infrastructure.
“Many participants, policy makers and corporates are still in the consortium phase,” he added. “Conflux is the sole public chain admitted by the government in a different track, and Hong Kong will be an experiment where the DeFi ecosystem operates at arm’s length to the Ethereum virtual machine (a core piece of Ethereum that helps power the blockchain and smart contracts) ecosystem.”

Others take a different view though, with Kapron suggesting the development of China’s central bank digital currency (the e-CNY) could theoretically provide the rails for a government-sponsored DeFi ecosystem with clear Chinese characteristics. “In other words, it may be decentralised, but also have clear opportunities for the government to monitor and potentially control transactions on the platform,” Zhang stated.

A senior figure at a DeFi platform liquidity network suggested that something resembling a decentralised network could be rolled out over the next decade with some sort of automation layer using permissioned smart contracts, adding that China is very good at identifying the valuable parts of technology and applying it to its own rules, as evidenced by the e-CNY.

“With the rapid development and substantial growth in DeFi around the world – as well as the challenging nature of regulating and policing DeFi projects – it is becoming increasingly likely that the Chinese government takes part in DeFi, similar to how it joined the game of central bank digital currency,” concluded Zhong.

FX-Like Funds Segregation Can Save Crypto Markets

https://www.financemagnates.com/institutional-forex/fx-like-funds-segregation-can-save-crypto-markets/

In the second part of our two-part article on crypto market structures, Finance Magnates considers the likelihood of the crypto market eventually adopting the same structures as the FX OTC interdealer market.

The phrase ‘there is more that unites us than divides us’ has been used in various ways by many politicians over the years as they sought to heal divisions in their parties or nations. But, it could equally be applied to the FX and crypto markets, where fragmentation and the absence of a single regulatory authority are just some of the common factors.

The collapse of FTX highlighted shortcomings in the segregation of customer assets and measures to prevent firms from trading against their customers. Traditional financial market infrastructure (such as in the FX market) benefits from the compounding effects of both operational procedures and regulations that have been developed over time in response to different market failures. The concept of segregating trading and custody is one of the results of this evolution.

Segregation of Customer Funds

Tom Flanagan, Digital Assets Head of Platform Trading at TP ICAP

The crypto asset market would benefit greatly from embracing this model to provide new market participants with the necessary confidence, suggests Tom Flanagan, the Digital Assets Head of Platform Trading at TP ICAP.

“This segregated model is proven to mitigate conflicts of interest – and the single point of failure risk – that arise from co-mingling asset custody with trading,” he says.

Markets Should be Transparent

Another element of the FX market structure that Flanagan reckons crypto would benefit from is the transparency and liquidity analytics accessible within wholesale FX venues.

“Most crypto venues are anonymous with a lack of information detailing the type of flow and the market participants involved,” he says. “Statistics such as fill rates and round-trip time (along with more advanced analytics such as pre and post-trade mark-outs) provide clients with better information on the types of liquidity their firm is dealing against in an anonymous marketplace and whether it is a beneficial flow to them and their franchise.”

According to Flanagan, a global code of conduct akin to the FX Global Code would also help to level the playing field and provide a layer of transparency for how all institutional market participants should interact.

Christo de Wit, Country Manager at Luno South Africa

“Using a third-party custodial solution requires a degree of trust, but there are benefits in terms of convenience, and for many traders it would be more secure,” says Christo de Wit, the Country Manager at Luno South Africa. “Of course, it is important that customers understand how centralized custody and self-custody work and the risks and benefits associated with both before making a decision.”

Centralized Orderbooks Might Help

It has been suggested that the creation of a centralized settlement utility would increase the stability of the crypto market, although de Wit cautions that there could be negative as well as positive effects.
“A centralized settlement utility in the crypto market would enhance efficiency, mitigate counterparty risk, and streamline settlement processes,” he says. “However, it would also pose a systemic risk and introduce counterparty dependency.”

Typically, FX OTC is traded away from centralized markets. However, Deribit believes in the potential of centralized liquid order books where large sizes can be traded.

David Wells, CEO at Enclave Markets

“Crypto will use capital market models for addressing market structure issues such as separating custody from market making and capital allocation services,” suggests David Wells, the CEO at Enclave Markets.

He reckons the infrastructure used to run these systems will be crypto-native and much more efficient and stable than what exists in traditional financial markets, which rely on technology and code bases that are decades old.
Thomas Restout, CEO of EMEA at B2C2, says crypto will become OTC driven as exchanges become harder to trade on. “As the settlement and credit process improve, I see strong convergence with FX markets,” he adds.

Danny Bailey, Senior Institutional Sales Lead at Bitstamp

Crypto and FX markets have a similar base of trading 24/7, and therefore it is not surprising that a similar client-based crypto OTC offering has emerged in the last few years, suggests Danny Bailey, the Senior Institutional Sales Lead at Bitstamp.

“As more institutions trade crypto, there will be more of an interdealer appetite,” he adds, “Although this will take time and require a robust risk management and regulatory framework.”

It is a natural transition for institutional digital markets to move to an OTC-style trading model, cleared either bilaterally or through a central clearer, according to Ayal Jedeikin, CEO and Founder of Cypator.

“Leading centralized exchanges are spinning off OTC desks to cater to institutional clients,” he adds. “This is non-custodial in nature and settled post-trade, hence reducing counterparty risk significantly.”

It must, though, be recognized that the crypto market is still relatively young, and many regulators have failed to determine what asset class it should be compared with.

There are already some similarities between the crypto and FX markets, such as the decentralized nature of trading and the ability of each asset class to be used for traditional purchases, observes Patrick Bärtschi, head of business development at Bittrex Global.

“However, I think it ultimately depends on whether crypto will be considered a security or a commodity or whether it will be regulated as a whole new asset class,” he says. “Once we have clarity on that, we may have more insight on what structures it may be able to adopt.”

Regulations Are Must

There is no question that crypto markets would benefit from both legal and regulatory definitions. Yet, so much of the ecosystem’s overall structure is derived from functionality that is baked into the core programming of its flagship networks.

Rich Evans, MD of Institutional Sales, Prime Liquidity at CEX.IO

That is the view of Rich Evans, the Managing Director of Institutional Sales, Prime Liquidity at CEX.IO, who observes that Bitcoin and Ethereum provided a blueprint and launch pad, respectively, for the vast majority of projects that came to populate the ecosystem.

“In turn, the development of automated market maker technology has accelerated the usage of decentralized exchanges that connect participants directly without third-party intermediaries – a phenomenon unique to the crypto space,” he says.

Though similarly decentralized and prone to volatility, the crypto ecosystem is conversely highly transparent relative to OTC markets through the constant production of on-chain data, adds Evans. “Coupled with crypto’s fast transaction times, it becomes clear that any attempt to force these markets into a pre-existing mold would only diminish these features and potentially weaken the space.”

In the second part of our two-part article on crypto market structures, Finance Magnates considers the likelihood of the crypto market eventually adopting the same structures as the FX OTC interdealer market.

The phrase ‘there is more that unites us than divides us’ has been used in various ways by many politicians over the years as they sought to heal divisions in their parties or nations. But, it could equally be applied to the FX and crypto markets, where fragmentation and the absence of a single regulatory authority are just some of the common factors.

The collapse of FTX highlighted shortcomings in the segregation of customer assets and measures to prevent firms from trading against their customers. Traditional financial market infrastructure (such as in the FX market) benefits from the compounding effects of both operational procedures and regulations that have been developed over time in response to different market failures. The concept of segregating trading and custody is one of the results of this evolution.

Segregation of Customer Funds

Tom Flanagan, Digital Assets Head of Platform Trading at TP ICAP

The crypto asset market would benefit greatly from embracing this model to provide new market participants with the necessary confidence, suggests Tom Flanagan, the Digital Assets Head of Platform Trading at TP ICAP.

“This segregated model is proven to mitigate conflicts of interest – and the single point of failure risk – that arise from co-mingling asset custody with trading,” he says.

Markets Should be Transparent

Another element of the FX market structure that Flanagan reckons crypto would benefit from is the transparency and liquidity analytics accessible within wholesale FX venues.

“Most crypto venues are anonymous with a lack of information detailing the type of flow and the market participants involved,” he says. “Statistics such as fill rates and round-trip time (along with more advanced analytics such as pre and post-trade mark-outs) provide clients with better information on the types of liquidity their firm is dealing against in an anonymous marketplace and whether it is a beneficial flow to them and their franchise.”

According to Flanagan, a global code of conduct akin to the FX Global Code would also help to level the playing field and provide a layer of transparency for how all institutional market participants should interact.

Christo de Wit, Country Manager at Luno South Africa

“Using a third-party custodial solution requires a degree of trust, but there are benefits in terms of convenience, and for many traders it would be more secure,” says Christo de Wit, the Country Manager at Luno South Africa. “Of course, it is important that customers understand how centralized custody and self-custody work and the risks and benefits associated with both before making a decision.”

Centralized Orderbooks Might Help

It has been suggested that the creation of a centralized settlement utility would increase the stability of the crypto market, although de Wit cautions that there could be negative as well as positive effects.
“A centralized settlement utility in the crypto market would enhance efficiency, mitigate counterparty risk, and streamline settlement processes,” he says. “However, it would also pose a systemic risk and introduce counterparty dependency.”

Typically, FX OTC is traded away from centralized markets. However, Deribit believes in the potential of centralized liquid order books where large sizes can be traded.

David Wells, CEO at Enclave Markets

“Crypto will use capital market models for addressing market structure issues such as separating custody from market making and capital allocation services,” suggests David Wells, the CEO at Enclave Markets.

He reckons the infrastructure used to run these systems will be crypto-native and much more efficient and stable than what exists in traditional financial markets, which rely on technology and code bases that are decades old.
Thomas Restout, CEO of EMEA at B2C2, says crypto will become OTC driven as exchanges become harder to trade on. “As the settlement and credit process improve, I see strong convergence with FX markets,” he adds.

Danny Bailey, Senior Institutional Sales Lead at Bitstamp

Crypto and FX markets have a similar base of trading 24/7, and therefore it is not surprising that a similar client-based crypto OTC offering has emerged in the last few years, suggests Danny Bailey, the Senior Institutional Sales Lead at Bitstamp.

“As more institutions trade crypto, there will be more of an interdealer appetite,” he adds, “Although this will take time and require a robust risk management and regulatory framework.”

It is a natural transition for institutional digital markets to move to an OTC-style trading model, cleared either bilaterally or through a central clearer, according to Ayal Jedeikin, CEO and Founder of Cypator.

“Leading centralized exchanges are spinning off OTC desks to cater to institutional clients,” he adds. “This is non-custodial in nature and settled post-trade, hence reducing counterparty risk significantly.”

It must, though, be recognized that the crypto market is still relatively young, and many regulators have failed to determine what asset class it should be compared with.

There are already some similarities between the crypto and FX markets, such as the decentralized nature of trading and the ability of each asset class to be used for traditional purchases, observes Patrick Bärtschi, head of business development at Bittrex Global.

“However, I think it ultimately depends on whether crypto will be considered a security or a commodity or whether it will be regulated as a whole new asset class,” he says. “Once we have clarity on that, we may have more insight on what structures it may be able to adopt.”

Regulations Are Must

There is no question that crypto markets would benefit from both legal and regulatory definitions. Yet, so much of the ecosystem’s overall structure is derived from functionality that is baked into the core programming of its flagship networks.

Rich Evans, MD of Institutional Sales, Prime Liquidity at CEX.IO

That is the view of Rich Evans, the Managing Director of Institutional Sales, Prime Liquidity at CEX.IO, who observes that Bitcoin and Ethereum provided a blueprint and launch pad, respectively, for the vast majority of projects that came to populate the ecosystem.

“In turn, the development of automated market maker technology has accelerated the usage of decentralized exchanges that connect participants directly without third-party intermediaries – a phenomenon unique to the crypto space,” he says.

Though similarly decentralized and prone to volatility, the crypto ecosystem is conversely highly transparent relative to OTC markets through the constant production of on-chain data, adds Evans. “Coupled with crypto’s fast transaction times, it becomes clear that any attempt to force these markets into a pre-existing mold would only diminish these features and potentially weaken the space.”

Bank Failures Leave US Crypto Businesses in the Cold

https://www.financemagnates.com/cryptocurrency/bank-failures-leave-us-crypto-businesses-in-the-cold/

There is often a perception that the events leading to the failure of a bank are complex and multi-faceted. However, the demise of both Silicon Valley Bank and Silvergate Bank can be traced back to two main factors: limited depositor diversification and excessive investment in long-dated assets such as US government bonds.

Bank Failures and US Crypto Business

Rising interest rates have reduced the value of these bonds, and as the post-pandemic technology spending boom slowed, Silicon Valley Bank’s customers started withdrawing cash to stay afloat. Selling its bonds for much less than it paid for them alarmed many depositors and once withdrawals accelerated the end was nigh, as it was at Silvergate Bank where the collapse of FTX in November sparked depositor panic.

The reasons behind the demise of Signature Bank are more difficult to unpick and speak about to the extent that cryptos continue to divide the traditional banking community.

Net Capital Outflows From Crypto Exchanges After US Banks Collapsed. Source: Glassnode.com

On the one hand, there is Barney Frank, the former Chairman of the House Financial Services Committee and a leading co-sponsor of the Dodd-Frank Act that was supposed to prevent financial crises.

Frank (who sat on the board of Signature Bank) told CNBC that it was shut down because regulators wanted to send a strong anti-crypto message and that “we became the poster boy because there was no insolvency based on the fundamentals.”

The New York State Department of Financial Services quickly denied this, stating that its decision to close the bank had “nothing to do with crypto” and was rather prompted by a “significant crisis of confidence in the bank’s leadership” and concerns over its ability to do business in a safe and sound manner.

Who Will Be Next?

Speculation has been rife about which bank might be next to fall. First Republic Bank started reducing its exposure to crypto last year but still got caught up in the negative sentiment. The bank sent an email to its customers last week reassuring them that its capital levels were ‘significantly higher than the regulatory requirements for being considered well capitalised’ and that it had access to more than $60 billion of unused borrowing capacity.

First Republic Banks Shares Fell 60% Last Week. Source: Tradingview.com

The failures of Silvergate Bank, Silicon Valley Bank and Signature Bank have piqued interest in Cross River Bank, the new automated settlement
Settlement

Settlement in finance refers to the process when a buyer makes payment and receives the agreed-upon services or goods. The term is used on exchanges such as New York Stock Exchange (NYSE) when security changes hands. When the asset is transferred and placed in the new buyer’s name, it is considered settled. This process could take a few hours or several days after a trade is made. It depends on the clearance process. In the United States, the settlement date for marketable stocks is usually 2

Settlement in finance refers to the process when a buyer makes payment and receives the agreed-upon services or goods. The term is used on exchanges such as New York Stock Exchange (NYSE) when security changes hands. When the asset is transferred and placed in the new buyer’s name, it is considered settled. This process could take a few hours or several days after a trade is made. It depends on the clearance process. In the United States, the settlement date for marketable stocks is usually 2
Read this Term
partner for USDC stablecoin issuer Circle.

In an interview with TechCrunch last year, the bank’s Founder, CEO and Chairman, Gilles Gade, said crypto was “front and centre” of its long-term strategy. He said Cross River Bank wanted to offer more crypto-related products and services and was gearing towards a crypto-first strategy.

Current and potential customers may be heartened by Gade’s observation that the bank wanted to be “judicious” about where the crypto market was headed.

However, two high-profile crypto observers, David Gerard and Amy Castor note that with the closure of Silvergate Bank and now Signature bank, crypto has been effectively shut out of the US banking system. They describe the Federal Deposit Insurance Corporation interventions as a warning shot to every other bank in the US to straighten up their books and not specialise in bad customer bases.

“Crypto is one such customer base,” they wrote. “Crypto customers were already strongly correlated with money laundering and crime and now crypto correlates with hot money that flows in and out by billions a day. That is a hazardous kind of customer for any bank to specialise in.”

“This is terrible news for crypto,” they continued. “Losing your banking rails is the worst thing that can happen to a crypto firm. Unless the crypto industry can find reliable US dollar payment rails that regulators will put up with, crypto in the US is dead as a financial product.”

As David Gerard put it, it is a good thing crypto is uncensorable and unstoppable and doesn’t need banking because it doesn’t have it any more. So, where do we go from here?

Markets Are Afraid of Lehman Brothers 2.0

Silicon Valley Bank was the biggest bank failure in the US since the global financial crisis, and the banking sector is supposedly a very different place than it was in 2007/8.

As the Bank for International Settlements’ committee on the global financial system noted in 2018, in the wake of the crisis markets supervisors placed increased emphasis on stronger capitalisation as being a key determinant of banks’ capacity to cope with adverse shocks.

Capital requirements for large banks are around ten times higher than in 2007 and excess leverage has been curbed. Banks are supposed to abide by a leverage ratio which stipulates how much high-quality capital they must hold against their assets and the new rules include much tougher liquidity
Liquidity

The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent

The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent
Read this Term
requirements.

One of the most significant consequences of the chaos that engulfed the banking sector 15 years ago is the Basel III framework, a key objective of which is to reduce excessive variability of risk-weighted assets. The framework took effect in January and will be phased in over the next five years.

But, John Cochrane, a Senior Fellow of the Hoover Institution at Stanford, concludes that the overall architecture allows large leverage, assuming regulators will spot risks and is inherently broken.

“If such good people are working in a system that cannot spot something so simple, the project is hopeless,” he writes in his latest blog. “After all, a portfolio of long term treasuries is about the safest thing on the planet unless it is financed by hot money deposits. Why do we have teams of regulators looking over the safest assets on the planet? And failing? Time to start over.”

It has been widely reported that the Federal Reserve is pondering tightening its scrutiny of mid-sized banks with possible actions including higher capital and liquidity requirements and more rigorous annual stress tests.

Crypto Regulation Push

Of course, no amount of regulation can prevent a bank from going under, and the recent turmoil has been concentrated in the US, opening up the possibility of US-based crypto businesses relocating to jurisdictions more favourably inclined towards digital assets.

For example, the EU is set to vote on its Markets in Crypto Assets regulation (MiCA) next month, and the UK is in the midst of a consultation on proposals for regulating crypto asset activities. A number of jurisdictions across the Middle East and Asia have made no secret of their desire to attract crypto business.

Josh Olszewicz, the Head of Research at Valkyrie Digital Asset Management told CoinTelegraph this week that 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.

But, at this moment, crypto businesses in the US, in particular, could be forgiven for thinking that ‘their money is no good here’.

There is often a perception that the events leading to the failure of a bank are complex and multi-faceted. However, the demise of both Silicon Valley Bank and Silvergate Bank can be traced back to two main factors: limited depositor diversification and excessive investment in long-dated assets such as US government bonds.

Bank Failures and US Crypto Business

Rising interest rates have reduced the value of these bonds, and as the post-pandemic technology spending boom slowed, Silicon Valley Bank’s customers started withdrawing cash to stay afloat. Selling its bonds for much less than it paid for them alarmed many depositors and once withdrawals accelerated the end was nigh, as it was at Silvergate Bank where the collapse of FTX in November sparked depositor panic.

The reasons behind the demise of Signature Bank are more difficult to unpick and speak about to the extent that cryptos continue to divide the traditional banking community.

Net Capital Outflows From Crypto Exchanges After US Banks Collapsed. Source: Glassnode.com

On the one hand, there is Barney Frank, the former Chairman of the House Financial Services Committee and a leading co-sponsor of the Dodd-Frank Act that was supposed to prevent financial crises.

Frank (who sat on the board of Signature Bank) told CNBC that it was shut down because regulators wanted to send a strong anti-crypto message and that “we became the poster boy because there was no insolvency based on the fundamentals.”

The New York State Department of Financial Services quickly denied this, stating that its decision to close the bank had “nothing to do with crypto” and was rather prompted by a “significant crisis of confidence in the bank’s leadership” and concerns over its ability to do business in a safe and sound manner.

Who Will Be Next?

Speculation has been rife about which bank might be next to fall. First Republic Bank started reducing its exposure to crypto last year but still got caught up in the negative sentiment. The bank sent an email to its customers last week reassuring them that its capital levels were ‘significantly higher than the regulatory requirements for being considered well capitalised’ and that it had access to more than $60 billion of unused borrowing capacity.

First Republic Banks Shares Fell 60% Last Week. Source: Tradingview.com

The failures of Silvergate Bank, Silicon Valley Bank and Signature Bank have piqued interest in Cross River Bank, the new automated settlement
Settlement

Settlement in finance refers to the process when a buyer makes payment and receives the agreed-upon services or goods. The term is used on exchanges such as New York Stock Exchange (NYSE) when security changes hands. When the asset is transferred and placed in the new buyer’s name, it is considered settled. This process could take a few hours or several days after a trade is made. It depends on the clearance process. In the United States, the settlement date for marketable stocks is usually 2

Settlement in finance refers to the process when a buyer makes payment and receives the agreed-upon services or goods. The term is used on exchanges such as New York Stock Exchange (NYSE) when security changes hands. When the asset is transferred and placed in the new buyer’s name, it is considered settled. This process could take a few hours or several days after a trade is made. It depends on the clearance process. In the United States, the settlement date for marketable stocks is usually 2
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partner for USDC stablecoin issuer Circle.

In an interview with TechCrunch last year, the bank’s Founder, CEO and Chairman, Gilles Gade, said crypto was “front and centre” of its long-term strategy. He said Cross River Bank wanted to offer more crypto-related products and services and was gearing towards a crypto-first strategy.

Current and potential customers may be heartened by Gade’s observation that the bank wanted to be “judicious” about where the crypto market was headed.

However, two high-profile crypto observers, David Gerard and Amy Castor note that with the closure of Silvergate Bank and now Signature bank, crypto has been effectively shut out of the US banking system. They describe the Federal Deposit Insurance Corporation interventions as a warning shot to every other bank in the US to straighten up their books and not specialise in bad customer bases.

“Crypto is one such customer base,” they wrote. “Crypto customers were already strongly correlated with money laundering and crime and now crypto correlates with hot money that flows in and out by billions a day. That is a hazardous kind of customer for any bank to specialise in.”

“This is terrible news for crypto,” they continued. “Losing your banking rails is the worst thing that can happen to a crypto firm. Unless the crypto industry can find reliable US dollar payment rails that regulators will put up with, crypto in the US is dead as a financial product.”

As David Gerard put it, it is a good thing crypto is uncensorable and unstoppable and doesn’t need banking because it doesn’t have it any more. So, where do we go from here?

Markets Are Afraid of Lehman Brothers 2.0

Silicon Valley Bank was the biggest bank failure in the US since the global financial crisis, and the banking sector is supposedly a very different place than it was in 2007/8.

As the Bank for International Settlements’ committee on the global financial system noted in 2018, in the wake of the crisis markets supervisors placed increased emphasis on stronger capitalisation as being a key determinant of banks’ capacity to cope with adverse shocks.

Capital requirements for large banks are around ten times higher than in 2007 and excess leverage has been curbed. Banks are supposed to abide by a leverage ratio which stipulates how much high-quality capital they must hold against their assets and the new rules include much tougher liquidity
Liquidity

The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent

The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent
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requirements.

One of the most significant consequences of the chaos that engulfed the banking sector 15 years ago is the Basel III framework, a key objective of which is to reduce excessive variability of risk-weighted assets. The framework took effect in January and will be phased in over the next five years.

But, John Cochrane, a Senior Fellow of the Hoover Institution at Stanford, concludes that the overall architecture allows large leverage, assuming regulators will spot risks and is inherently broken.

“If such good people are working in a system that cannot spot something so simple, the project is hopeless,” he writes in his latest blog. “After all, a portfolio of long term treasuries is about the safest thing on the planet unless it is financed by hot money deposits. Why do we have teams of regulators looking over the safest assets on the planet? And failing? Time to start over.”

It has been widely reported that the Federal Reserve is pondering tightening its scrutiny of mid-sized banks with possible actions including higher capital and liquidity requirements and more rigorous annual stress tests.

Crypto Regulation Push

Of course, no amount of regulation can prevent a bank from going under, and the recent turmoil has been concentrated in the US, opening up the possibility of US-based crypto businesses relocating to jurisdictions more favourably inclined towards digital assets.

For example, the EU is set to vote on its Markets in Crypto Assets regulation (MiCA) next month, and the UK is in the midst of a consultation on proposals for regulating crypto asset activities. A number of jurisdictions across the Middle East and Asia have made no secret of their desire to attract crypto business.

Josh Olszewicz, the Head of Research at Valkyrie Digital Asset Management told CoinTelegraph this week that 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.

But, at this moment, crypto businesses in the US, in particular, could be forgiven for thinking that ‘their money is no good here’.