Crypto-asset markets continued their bull run, with Bitcoin peaking at $41,940 mainly on strong institutional investor interest, before settling back to close the month at $33,839 (+16.6%). Ethereum and other altcoins had a strong month on continuing interest in decentralized finance (DeFi). Also supportive was the U.S. Office of the Comptroller of the Currency issuing regulations authorizing national banks to use distributed ledger technologies and related stablecoins to conduct payment activities. However, Tether continues to be dogged by controversy on questions regarding its reserves adequacy, and as stories about its possible role in Bitcoin pumping circulated.
Crypto-Asset Markets (see also Tables 1-3 below)
Crypto-asset market capitalization increased by about 31% from December 31 to $999 billion with the price of Bitcoin up 16.6% ($33,839). The main driver continued to be increasing institutional investor interest amid prospects of years of ultra-low interest rates and concerns about future inflation given expansionary monetary policies (Annex 1 below). Altcoin market capitalization was up 66%, with the price of Ethereum surging 85% on its major large role within decentralized finance (DeFi), and expectations related to upcoming technical upgrades aimed at making Ethereum more scalable. XRP also surged 90%, with some attributing it to it possibly being the next “Wall Street Bets” (WSB) target. The amount of crypto-assets on DeFi platforms increased 80% to $27.7 billion (from $15.4 billion on December 31).
Stablecoin market capitalizations continue to increase. Almost all are USD-pegged, and Tether remains dominant ($25.2 billion) despite the controversy that surrounds it (Annex 2 below). Tether is followed by USD Coin ($5.8 billion), Dai ($1.6 billion) and Binance USD ($1.5 billion). USD-pegged Empty Set Dollar (ESD) launched in September 2020 and one of the first algorithmic stablecoins to come to market, briefly held the #6 position. An algorithmic stablecoin adjusts its supply to maintain its peg. However, ESD broke its peg massively in January, trading down around $0.30 ($125 million) at end-January.
New U.S. Secretary of the Treasury Janet Yellen said that crypto-assets are “a particular concern” when it comes to criminal activity and terrorist financing, going on to say that they “are used, at least in a transaction sense, mainly for illicit financing.” In fact, laundering volumes through crypto-assets are tiny compared to the volumes of cash laundered through traditional methods. Chainalysis reported that criminal activity represented only about $21 billion (or 0.34% of all 2020 crypto-asset transaction volume versus 2.1% in 2019). By comparison, And the United Nations estimates that between $800 billion and $2 trillion is laundered every year. Yellen later offered a more nuanced assessment.
Privacy-focused messaging app Signal, which now has around 40 million users, is exploring the addition of payments into the app. Significant engineering resources have reportedly been devoted to integrating privacy-focused Stellar blockchain-based payment system MobileCoin into Signal. Adding credence to this story is that Signal CEO Moxie Marlinspike serves as a technical adviser to MobileCoin, although he played it down, saying that the company had only done some “design explorations” around the idea.
Crypto-related regulatory developments (see also Table 4 below)
The U.S. Office of the Comptroller of the Currency (OCC) clarified that national banks and federal savings associations may use stablecoins to conduct payment activities and other bank-permissible functions and participate in distributed ledger technology (DLT) networks. The OCC letter said DLT networks “may be more resilient than other payment networks” due to the large number of nodes needed to verify transactions, which can in turn limit tampering, but banks need to understand the risks associated with the underlying activity and conduct a legal analysis of the DLT network activity.
The OCC conditionally approved crypto-asset custodian Anchorage’s application for a national trust charter, and the creation of Anchorage Digital Bank. With a banking charter, Anchorage can provide sub-custody services — like holding assets for a main custodian — for any financial institution. Anchorage is the first crypto company to receive a federal charter, though Kraken and Avanti have both received state charters for digital banking services in Wyoming. While the Wyoming charter enables both Kraken and Avanti to operate nationally, it comes with certain limitations.
It will be interesting to see where the OCC goes from here with crypto-friendly Acting Comptroller of the Currency having stepped down on January 14, to be replaced by Chief Operating Officer Blake Paulson.
The U.S. Financial Crimes Enforcement Network (FinCEN) extended the comment period for its proposed rules regarding crypto-asset transfers to personal (unhosted) wallets. Under them, exchanges would have to collect personal information for such transactions greater than $3,000, and report to FinCEN transactions that add up to more than $10,000 during a day. According to the accompanying FAQ the proposed rules are like existing FinCEN Currency Transaction Report rules. The original comment period was 15 days, most of which were holidays, but stakeholders now have until March 29.
Other digital asset market developments (see also Table 5 below)
Decentralized exchanges (DEX) are on track to surpass previous all-time high volumes. They had already transferred more than $27 billion in transaction volume during the first half of January, the 2nd highest total since September 2020’s $29 billion. September 2019’s $29 billion total. DEX use smart contracts on blockchain networks like Ethereum to let users swap between digital assets without transferring tokens to an exchange wallet or verifying their identity. Decentralized finance (DeFi) apps Uniswap and Sushiswap are the most popular DEX.
In other DeFi-related news:
- The Acting Comptroller of the Currency argued that decentralized finance (DeFi) could pave the way for “self-driving banks” and national bank charters might one day be granted to DeFi protocols.
- Decentralized non-custodial crypto trading platform ShapeShift will start routing orders through DeFi applications to avoid complying with know-your-customer (KYC) requirements.
- Opium Finance launched a collateralized debt obligation product (CDO) product for Compound Finance’s automated lending markets.
Celo, a decentralized financial app, is adding a new stablecoin, backed by the Euro. The Euro stablecoin will be backed by a basket of cryptocurrencies that are algorithmically adjusted to maintain a stable price. The Celo Euro is the second stablecoin to launch on the platform after the Celo Dollar, launched in June 2020. e-Money is launching a suite of European-currency stablecoins on Avalanche’s Contract Chain, including digital Euros, Swiss Francs, Norwegian Krone, Swedish Krona, and Danish Krone.
CBDC developments (see also Table 6 below)
Most central banks are exploring CBDC according to the third annual Bank for International Settlements survey. Central banks collectively representing a fifth of the world’s population are likely to launch retail CBDCs in the next three years. 86% of the 65 central banks surveyed said they were at least considering the pros and cons of issuing CBDC (up from 80% last year). 60% of them are now conducting experiments or proof of concepts (versus 42%), while 14% are moving forward to development and pilots. Emerging market central banks are leading the way, citing financial inclusion and payments efficiency as top motivating forces.
The European Central Bank (ECB) concluded the digital euro public consultation that was launched in October 2020. 8,221 citizens, firms and industry associations submitted responses to an online questionnaire, a record for ECB public consultations. An initial analysis of raw data shows that privacy of payments ranked highest among the requested features of a potential digital euro (41% of replies), followed by security (17%) and pan-European reach (10%). The ECB will publish a comprehensive analysis of the public consultation in the spring. Also, the ECB and European Commission are jointly reviewing at the technical level a broad range of policy, legal and technical questions.
China’s government backed Blockchain Service Network (BSN) is building a universal digital payment network (UDPN) to integrate various countries’ central bank digital currencies (CBDC). The beta version of UDPN is expected to launch in the second half of 2021, and completion is expected in five years. The BSN aims to enable a standardized digital currency transfer method and payment procedure. The new system intends to bring together systems like banking, insurance, enterprise resource planning and mobile apps through APIs to provide a cost-effective global payment solution.
General fintech/bigtech developments (see also Table 7 below)
Ant Group and other bigtechs/fintechs coming under increasing pushback from authorities.
Ant Group has set up a working group to rectify its business practices under the close watch of Peoples’ Bank of China and other financial regulators. The regulators will tell Ant Group which parts of its fintech platform need to be regulated as financial institutions, and the portions of the business that need new operating licenses. The licensed financial services businesses will then be moved into a holding company and subjected to regulatory scrutiny. China’s State Council has laid out guidelines for establishing a financial holding and said companies must apply to the PBOC to do so by November 1, 2021.
The China Banking and Insurance Regulatory Commission and the People’s Bank of China jointly issued the “Notice on Regulating Commercial Banks to Carry Out Personal Deposit Business Through the Internet”. It clarified that commercial banks shall not carry out fixed deposit and fixed-activation deposit business through non-self-operated online platforms, including but not limited to non-self-operated online platforms to provide marketing promotion, product display, information transmission, purchase entrance, interest subsidy and other services.
Special purpose acquisition companies (SPACs) gain traction for fintechs seeking to go public.
Special purpose acquisition companies (SPACs) have gained traction among private companies looking to go public, as COVID-19 creates uncertainty in the initial public offering (IPO) market. A SPAC is a shell company dedicated to buying or merging with another company so it can be listed on the stock market, without going through an IPO’s expensive and lengthy (2-3 years for an IPO versus 3-4 months) process. SPACs represented nearly 50% of all capital raised by U.S. operating companies in 2020, with more than $70 billion in proceeds raised (Figure 2). Because SPACs are typically smaller than operating companies, they accounted for more than half of all new listings in 2020. And three weeks into 2021, 57 SPACs ($15.7 billion) had already floated on U.S. exchanges. And crypto platform Bakkt is set to merge with VPC Impact Acquisition Holdings, a deal expected to be valued at $2.1 billion.
The way it works is that investors give the SPAC money for up to two years while it looks for a merger target. In return, they get a unique right to withdraw their investment before a deal goes through that minimizes potential losses. The potential upside is huge if the SPAC shares rise because investors also get warrants giving them the right to buy more shares at a discounted price in the future. However, a recent study found that most SPAC share prices fell post-merger, and there are questions around incentive alignments between SPAC sponsors, target companies and investors.
Miscellaneous commentary and research (see also Table 8 below)
The Bank for International Settlements’ Innovation Hub (BISIH) set out its work program, focusing on six key areas: suptech and regtech, next-generation financial market infrastructures, central bank digital currency (CBDC), open finance, green finance, and cyber security. The CBDC theme will include a proof-of-concept platform using multiple wholesale CBDCs to explore the feasibility of faster and cheaper cross-border payments, and a technological research project and associated prototype(s) for tiered retail CBDC distribution architectures.
Projects are to be spread across the three existing Hub Centres and new locations coming online in 2021. Priorities to be supported by the BIS Innovation Network, a network of experts drawn from the BIS’s 63 member central banks. They are chaired by Susan Slocum (Reserve Bank of Australia, Suptech & Regtech), Siritida P Ayudhya (Bank of Thailand, Next Generation FMIs), Marius Jurgilas (Bank of Lithuania, CBDC), Aristides Andrade Cavalcante Neto (Central Bank of Brazil, Open Finance), Tomer Mizrahi (Bank of Israel, Cyber Security) and Sharon Donnery (Central Bank of Ireland, Green Finance).
Annex 1: Institutional Investors are Driving the Bull Market.
JP Morgan has attracted a lot of attention with its Bitcoin investment thesis based on it potentially replacing gold as an alternative store of value. They posit a maximum Bitcoin long-run price target of $146,000 to match the total private sector investment in gold via bars, coins and exchange-traded funds (about $2.7 trillion). But they caution that this scenario is conditional on Bitcoin volatility converging to that of gold, and that short-term price dynamics are very sensitive to institutional investment flows.
Most institutional investors participate through investment funds like Grayscale Investment’s closed-end crypto-asset trusts. As publicly traded trusts that report to the U.S. Securities and Exchange Commission, they relieve institutional investors to forget about storage, custody and security of their holdings. Grayscale is the dominant crypto fund manager in terms of assets under management ($26 billion).
As a result, for example, Grayscale Bitcoin Trust (GBT) has accumulated more than 3% of total Bitcoin supply, which is a much higher proportion of liquid supply. (Glassnode analysis found that only 22% of outstanding Bitcoin are currently in constant circulation and available for buying and selling, plus the market is very concentrated – about 2% of accounts control 95% of all Bitcoin supply.) Also, GBT’s unit price sometimes significantly exceeds its native asset value (NAV). It was 33 basis points in early January but it dropped briefly below 10 bps before closing January around 40 basis points.
Price premia over NAV occasionally appear on exchange-traded funds (ETF) but rarely surpass about 3%. When they do, authorized participants step in to arbitrage the gap away by creating or redeeming shares of the ETF. But GBT has a six-month lockup, and secondary offerings are only allowed directly for Bitcoin. Some institutional investors buy GBT this way, effectively at its NAV, with the intent of selling after the lockup expires to capitalize on that premium. Cynics say that the lockup allows Grayscale to profit if the fund trades at a discount. Grayscale could profit by buying its own stock at a discount.
Underscoring the importance of Grayscale in crypto markets, JP Morgan has suggested that there could be a significant market correction if Bitcoin’s price fails to break out above $40,000 soon, and they see daily flows into GBT of $100 million are needed for such a breakout to occur. So far that pace has been kept up. To January 29, GBT bought 40,000 Bitcoin versus the 26,000 that have been mined.
However, Grayscale competitors are popping up, like Osprey Bitcoin Trust that will launch with a 0.49% management fee (versus GBT’s 2%). Money-losing business intelligence firm MicroStrategy made Bitcoin its primary reserve asset and sold $650 million convertible notes to buy more Bitcoin (Morgan Stanley acquired 10.9% stake in the firm). SkyBridge, headed by ex-White House Communications Director Anthony Scaramucci, launched a Bitcoin Fund. Also, BlackRock is planning to add cash-settled Bitcoin futures as an eligible investment to three funds.
Annex 2: Controversy Continues to Dog Tether.
Tether has been accused of running a huge Bitcoin pumping scheme. Adding fuel to claims of shadowy motivations behind Tether issuance are suspicions that the stablecoin is not fully backed (see below). But according to Frances Coppola, Tether’s asymmetric mechanics both support and disprove this claim. An opposing theory says that what look like Bitcoin pumps are Tether reacting to Bitcoin price volatility by supplying more “lubrication” to crypto-asset markets. The idea stems from Tether’s key role as a “reserve asset” for unbanked crypto platforms. Bryce Weiner believes that this crypto-asset market dependency makes Tether too big to fail – i.e., if Tether collapses crypto-asset markets will crash.
Meanwhile, a lawsuit launched by the New York Office of the Attorney General (NYAG) against Tether’s parent iFinex in April 2019 continues to trundle along. It alleges that Bitfinex was dipping into Tether’s reserves to cover up $850 million in missing funds. Most recently, iFinex asked the New York Supreme Court to give it another 30 days to produce all the documents demanded by the NYAG. The original deadline was January 15, which itself was an extension on an original December 16 deadline, although Tether has claimed that, so far, more than 2.5 million documentation papers have been delivered.
Table 1: Crypto-Asset Market Capitalization ($billions)
|December 31, 2020||January 30, 2021||Change|
|Market Cap ($billions)||Price|
Table 3: Top Five Stablecoin (all USD) Capitalization (January 30, 2020)
|Market Capitalization ($billions)|
|USD Coin||$5.8 (+$2.1)|
|Binance USD||$1.5 (+$0.6)|
|Paxos Standard||$0.6 (+$0.3)|
Table 4. Other Crypto-Related Regulatory Developments
|The U.K. Financial Conduct Authority ban on the sale of crypto-referenced derivatives and exchange-traded notes to U.K. retail investors came into effect on January 6. Also, such products can no longer be included in individual savings accounts and self-invested personal pensions.|
|The National Bank of the Kyrgyz Republic completed the drafting of two bills designed to recognize and regulate the country’s crypto sector.|
|Serbia’s new Law on Digital Assets went into effect, and the Serbian parliament adopted a set of amendments to the tax regulations covering digital assets.|
|The Bangko Sentral ng Pilipinas released new guidelines for the virtual asset service providers operating in the Philippines, imposing new restrictions and mandating licenses for operations.|
|CoinMENA, a Bahrain-based soon-to-launch crypto exchange certified by the Shariyah Review Bureau, acquired a crypto-assets services company license from the Central Bank of Bahrain.|
Table 5. Other (Other) Digital Asset Market Developments
|Gemini is launching the Gemini Credit Card in the United States. Customers will earn up to 3% in crypto-asset rewards deposited into the user’s Gemini account. Meanwhile, Gemini Trust Company now has more than $10 billion in total crypto under custody.|
|Ripple introduced a detailed response that addressed allegations surrounding the U.S. Securities and Exchange Commission (SEC) lawsuit filed against the firm in December.|
|Visa CEO Al Kelly said his firm is in a position to make crypto-assets more “safe, useful and applicable” and may add them to its payments network.|
|BTCetc Bitcoin Exchange Traded Crypto (BTCE) recorded average daily trading of EUR57 million on the Deutsche Bourse in the first 11 days of January, including a record of $100 on January 4. BTCE has also surpassed $375 million assets under management (AuM).|
|The CoinShares Physical Bitcoin exchange-traded product (BITC) went live on January 19 and was listed on the SIX Swiss Exchange. BITC will be physically backed, meaning it will hold the underlying assets it is designed to track. Each unit of the product will be backed with 0.001 Bitcoin.|
|The bitcoin fund from Canada’s 3iq Corp, listed on the Toronto Stock Exchange, has reached over C$1 billion in market capitalization.|
|Circle rolled out a new application programming interface (API) that will allow for the seamless transfer of the USDC stablecoin to USD via automated clearinghouse (ACH) systems.|
|The Stock Exchange of Thailand will reportedly launch a digital asset trading platform in the second half of this year to allow trading on all types of digital token assets excluding cryptocurrencies.|
Table 6. Other CBDC Developments
|The Reserve Bank of India (RBI) is exploring the possibility as to whether there is a need for a digital version of fiat currency and in case there is, then how to operationalize it.|
|The Indian government will introduce a Bill during the next Lok Sabha session to create a “facilitative framework” for the RBI to issue CBDC, and ban most private crypto-assets.|
|The PBOC continued to give away digital yuan via “red envelope” lotteries, the latest in Shenzhen of 100,000 envelopes of 200 digital yuan to city residents. with another one planned for February. And Chengdu will reportedly roll out a 50 million digital yuan lottery pilot too.|
|ZhongAn Online P&C Insurance and China Construction Bank are issuing insurance policies paid for in digital yuan.|
|Ant Financial has reportedly quietly conducted a small-scale limited-time test of digital yuan via its AliPay mobile payment app in two tea stores at a shopping mall next to its Shanghai headquarters.|
|The PBOC called for wider acceptance of cash in economic activities and vowed to punish those who refuse to accept cash payments in the wake of a widening gap in access to digital services.|
|The Ministry of Digital Transformation of Ukraine and the Stellar Development Foundation signed a Memorandum of Understanding and Cooperation that included partnering on, among other projects, developing the National Bank of Ukraine’s digital currency (e-hryvnia).|
|The Banque de France successfully settled €2 million of simulated equity shares with French investment firm IZNES on a DLT-based wholesale CBDC platform provided by U.K.-based SETL.|
Table 7. Other General Fintech Developments
|Visa called off its deal to buy fintech start-up Plaid for $5.3bn after the US Department of Justice sued to block the transaction on antitrust grounds. Plaid makes software that allows banks and fintechs to plug into consumers’ various financial accounts.|
|The OCC approved LendingClub’s acquisition of Radius Bank, subject to certain conditions including a minimum $250 million capital contribution from LendingClub. This marks the end of LendingClub’s transition from its original P2P lending business model to a digital banking model.|
|Walmart is partnering with Ribbit Capital, an investor in stock-trading platform Robinhood, to “deliver tech-driven financial experiences tailored to Walmart’s customers and associates.|
|TransferWise is the first firm to pilot the Visa Cloud Connect platform, which provides a secure cloud-based connection to VisaNet, enabling TransferWise to expand its debit card program.|
|2020 was a big year for U.K. crowdfunded securities offerings according to Equity Crowd Expert. In total, £332 million was raised, led by Crowdcube and Seedrs, responsible for 90% of the offerings.|
|Bank Negara Malaysia’s new digital bank licensing framework will apply a simplified regulatory framework for the first three to five years on banks with no more than RM3 billion of assets.|
|The U.K. government published a consultative paper seeking views on how it can ensure its regulatory framework is equipped to harness the benefits of new technologies, supporting innovation and competition, while mitigating risks to consumers and stability.|
|JP Morgan is launching a digital bank to offer consumer banking services in the United Kingdom, and has already hired 400 people.|
|The Central Bank of Kenya outlined a digitalization plan to modernize the country’s domestic payment landscape, including defining open banking standards.|
|Saudi Arabia’s International Islamic Trade Finance Corporation partnered with the Bangladesh’s City Bank to execute the world’s first Shariah-compliant cross-border blockchain transaction.|
|The State Bank of Pakistan launched “Raast” (or “direct way”), a new instant digital payment system in a bid to boost financial inclusion and government revenue to culminate in early 2022.|
|The Central Bank of Nigeria released new guidelines for quick response code (QR) payments and a regulatory sandbox.|
|The NY Fed is looking for a Director of its NY Innovation Center. A principal function of the Center is will to collaborate with the Bank for International Settlements Innovation Hub.|
|The Reserve Bank of India is establishing a working group to study digital lending in the regulated and unregulated financial sectors so that an appropriate regulatory approach can be put in place.|
|Contactless was the preferred way to pay in the United Kingdom, accounting for nine-in-ten of all eligible card transactions in 2020, according to figures from Barclaycard.|
|The Bank of France will shut down 14 of its 37 cash handling centers by the end of 2022 as the Covid-19 pandemic accelerates a decline in the use of notes and coins.|
|Luxembourg has amended its legal framework to enable account keeping institutions such as banks to provide DLT-based dematerialized securities.|
Table 8. Other Miscellaneous Commentary and Research
|The OECD published a paper on asset tokenization; the digital representation of real (physical) assets on distributed ledgers, or the issuance of traditional asset classes in tokenized form.|
|A Bank for International Settlements paper found that e-commerce has ramped up during the pandemic. The growth has differed across sectors and over different stages of the pandemic.|
|A joint study by the German Federal Ministry of Finance and the Deutsche Bundesbank concluded that demand for programmable payments is rising in Germany.|
|A Bank of Canada paper analyzed the trade-offs between the safety and convenience of aggregating digital currency balances in addresses, electronic wallets and banks.|