Fintech perspectives from a bunch of policy wonks. The views expressed herein are those of the authors and should not be attributed to the International Monetary Fund, its Executive Board or its management.
The Kiffmeister is a former Senior Financial Sector Expert at the International Monetary Fund.
Central banks that have made the decision to explore retail central bank digital currency (CBDC) issuance are focusing on a common set of key design choices. These include the operating model, the technology platform (centralized versus decentralized database technology, or token-based), degree of anonymity/privacy, availability/limitations, and whether to pay interest. These design decisions are driven by country-specific factors and balance the need to achieve the policy objectives that launched the exploration process and be attractive to users and merchants. (For more detail on these factors and considerations see the 2020 IMF working paper on CBDC operational considerations.)
In this blog I want to talk about the technology platform decision, broadly speaking breaking down into those with centralized or decentralized ledger architectures, and ledger-less offline peer-to-peer stored value platforms. In a traditional centralized ledger (client-server model with no distributed components) transaction processing would entail the payor connecting to the central ledger keeper and initiating a funds transfer to the recipient’s account. The ledger would be updated after the payor has been confirmed as the account holder who has enough funds to carry out the transaction.
Alternatively, the ledger could be run on a distributed ledger technology (DLT) platform, in which the ledger is replicated and shared across several participants. With a DLT platform the central bank could have a centralized, decentralized or partially-decentralized authority for verifying and/or committing transactions. DLT platforms can be “public” (accessible by anyone) or restricted to a group of selected participants (“consortium” or “private”). Ledger integrity can be managed by a selected group of users (“permissioned”) or by all network participants (“permissionless”).
So far, central banks that have reached the proof of concept (PoC) and pilot stages of CBDC explorations have opted for private-permissioned (centralized authority) platforms (see table). These allow for control over platform access and participants, and role-based oversight and visibility of transactions. Private permissioned platforms also ensure that the central bank retains full control over money issuance and monetary policy. Permissionless (decentralized authority) platforms have tended to fall short on scalability, and settlement finality, and financial integrity risk management.
It has been generally believed that centralized platforms process transactions more quickly. VISA says their network can handle up to 65,000 transactions per second (TPS), while private DLT platforms have tended to be way slower (e.g., 10,000+ TPS). There is also the issue of “finality” – the point at which transferred funds become irrevocable. Some networks, like Bitcoin and R3 Corda, offer only what is called “probabilistic finality” which won’t cut it for a retail payment system.
Although all the pros and cons of DLT-based versus centralized ledger-based retail payment systems are out of scope of this post, it’s worth mentioning that DLT-based platforms may offer enhanced resiliency by reducing single points of failure. Also, potential data loss at one node can be recovered through replication of the ledger from other nodes when the network comes back online. But DLT-based platforms may experience attacks against the network layer, which includes the consensus mechanism by which database updates are approved, or smart contract exploits. (For more on such pros and cons, see Raphael Auer and Rainer Böhme’s Technology of Retail Central Bank Digital Currency article)
In the table below, I’ve listed what I believe to be the main players in the retail CBDC platform space. My main criterion for inclusion is that the platform has been used in a CBDC or sovereign digital currency pilot or proof of concept or has published something substantive to back up the claim that it offers a viable CBDC platform. I’ve tried to categorize them by whether they’re ledger- or token-based, and if they’re ledger-based, whether the ledger management is centralized or distributed. My plan is to make this a “live” table, and possibly add more columns based on your comments and suggestions. If you have platform suggestions that I’ve missed, please provide links to written material that supports the claim.
Tabulated below are all of the central bank and sovereign retail digital currency launches and pilots I know of that have revealed their technology partners and platforms. I didn’t include the South Korean pilot because they haven’t revealed their technology partners or platforms. Please keep in mind that this is just a first crack and comments and suggestions are welcome.
Crypto-asset prices spiked to new highs this month with Altcoins leading the way, although prices faded after Coinbase launched on April 14. Bitcoin finished down 3% on the month, and 11% off the all-time high price of $64,863 of April 14. By contrast, Altcoin market capitalization finished up 37% with XRP up 177%, Binance Coin 107% and Ethereum up 45%. The impetus continued to be continuing institutional investor interest in, and popularization of, crypto-assets. Meanwhile, central banks continued to advance their digital currency explorations, with the Bank of Japan launching its proof of concept (PoC) work and the Riksbank wrapping up its first round of PoC work.
Crypto-asset market capitalization increased about 14% from March 31 to $2,158 billion, although Bitcoin finished down 3% ($57,750) after hitting an all-time high of $64,863 into the mid-April Coinbase listing (see below). Altcoin markets led the way with capitalization up 37%, with Ethereum finishing up 45% possibly bolstered by the mid-April “Berlin” hard fork that reduced costs for certain transaction types, and introduced a new transaction envelope that will make it easier to package multiple transactions into a single transfer. It also paved the way for the “London” upgrade scheduled for the summer of 2021, that aims to reduce transaction costs (“gas fees”) on the network.
XRP continues to soar (+177% in April) after Ripple’s motion was granted to keep the financial records of CEO Brad Garlinghouse and his predecessor private from the U.S. Securities and Exchange Commission (SEC) in its lawsuit against the firm. The case hinges on the classification of XRP as a security (i.e., a financial asset from which the investor intends to profit), as opposed to a currency or medium of exchange. By failing to file a securities registration statement or seek special exemption, the SEC is accusing Ripple of violating multiple sections of the Securities Act of 1933. Ripple won another skirmish when it was granted permission to get access to the SEC’s documents related to its exemption of Bitcoin and Ethereum from being given “security” status. Emboldened by these wins, Ripple has filed a motion to dismiss the lawsuit entirely.
Moves towards “popularizing” crypto-assets continue. Venmo’s “Crypto on Venmo” started rolling out on April 20. The service will let its 70 million users buy, hold and sell crypto-assets (BTC, ETH, LTC and BCH) within its mobile app, using funds from their balance with Venmo, or a linked bank account or debit card. Also, Coinbase’s U.S. customers can now buy crypto on the exchange via debit cards and bank accounts linked to PayPal. Such purchases are limited to $25,000 per day.
Stablecoin market capitalizations continue to increase (see Annex). Almost all are USD-pegged, and Tether’s USDT remains dominant ($51.6 billion), followed by USDC ($14.7 billion), BUSD ($7.6 billion), DAI ($3.7 billion) and UST ($2.0 billion). Tether released another attestation that shows that its stablecoins are fully backed, to assuage rumors that it was not. However, the report still doesn’t describe how Tether’s reserves are invested. Coinbase started supporting Ethereum blockchain-based (ERC-20) USDT on its Pro platform. The ERC-20 variant comprises almost half of all outstanding USDT, although the TON-based variant is now larger.
Less than a week after the Fei protocol’s April 4 launch, Fei Labs found a vulnerability in the incentive calculation of the Ethereum-backed algorithmic stablecoin. The team patched the vulnerability on April 6, but it did not prevent the stablecoin from losing 30% off its peg. Fei uses a bonding curve to manage supply and demand based upon its collateralization levels and uses a system of ‘direct incentives’ to penalize the withdrawal of liquidity during periods of selling pressure. This caught many investors off-guard as they would have to take a hit when withdrawing their ETH collateral or the supposed dollar-pegged tokens it generated. However, by the end of the month it was closing back in on USD parity.
Coinbase reported first-quarter revenue that soared nearly 900% from $190.6 million in the same period last year, blowing past the $585 million nabbed in the fourth quarter. Meanwhile, the platform’s verified users (those with confirmed identities who are eligible to trade) swelled to 56 million at quarter’s end, compared to 34 million one year prior. Founded in June 2012, Coinbase debuted on Nasdaq on April 14, under the ticker COIN, the price spiking to $430 on opening day, but closing the month at $298.
The U.S. SEC has yet to approve a crypto-asset exchange-traded fund (ETF) although it extended its window to approve (or disapprove) VanEck’s Bitcoin ETF from May 3 to June 17. Also, investment manager Grayscale published a roadmap that implied it planned to convert two of its crypto-asset funds (GBTC and ETHE) into ETFs. Meanwhile, the Ontario Securities Commission has approved four Ethereum ETFs to trade on the Toronto Stock Exchange (TSE); 3iQ Corp, CI Global Asset Management, Purpose Investments, and Evolve Fund Group. And Horizons ETFs Management (Canada) launched the TSE-traded BetaPro Inverse Bitcoin ETF that will allow investors to take short positions on bitcoin futures.
According to Michael Morell, a former CIA acting director, the broad generalizations about the use of bitcoin in illicit finance are significantly overstated. This flies in the face of the false narratives spun by senior government officials, such as Treasury Secretary Janet Yellen, who issue public warnings about bitcoin’s alleged use by criminals. Morrell’s research concluded that there is probably less illicit activity in the bitcoin ecosystem than there is in the traditional banking system. Furthermore, he highlighted blockchain analysis as a highly effective crime fighting and intelligence gathering tool.
Crypto-related regulatory developments (see also Table 1 in the below-linked PDF)
Türkiye Cumhuriyet Merkez Bankasi has banned the direct and indirect use of crypto-assets for payments. According to its statement “payment service providers cannot develop business models in a way that crypto assets are used directly or indirectly in the provision of payment services and electronic money issuance and cannot provide any services related to such business models.” The regulation comes into force on April 30. Turkey ranks 29th out of the 154 countries on the Chainalysis’ Global Crypto Adoption Index, and number one in the Middle East.
A review of 16 leading crypto-asset exchanges, including the seven that contribute prices to the CME Bitcoin Reference Rate, found that just four were found to be subject to a significant level of trading-related regulation (itBit, eToroX, LMAX Digital, and Currency.com). Seven of the remaining exchanges, including Coinbase, operate as licensed Money Service Businesses (MSBs) or equivalent, but their trading activities are effectively unregulated. And three of the top exchanges appear not to be subject to any regulatory scrutiny whatsoever (Bittrex, Luno, and Bitfinex).
The U.S. House of Representatives passed the Eliminate Barriers to Innovation Act of 2021 (H.R. 1602) which includes a section on digital assets. The legislation seeks to set up a digital asset working group with representatives from the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC). The overarching goal is to clarify when the SEC has jurisdiction over digital assets, in the case of when they are deemed securities and when the CFTC has a final say, in the case of when digital assets are classified as commodities.
U.S. Securities and Exchange Commission (SEC) Commissioner Hester Peirce unveiled an updated version of her proposed three-year regulatory safe harbor for token sales. The update adds “semi-annual updates to the plan of development disclosure and a block explorer”; an “exit report requirement” that “would include either an analysis by outside counsel explaining why the network is decentralized or functional, or an announcement that the tokens will be registered under the Securities Exchange Act of 1934”; and that exit report requirement “provides guidance on what outside counsel’s analysis should address when explaining why the network is decentralized.”
Other digital asset market developments (see also Table 1 in the below-linked PDF)
Robinhood experienced on and off again issues executing users’ crypto-asset trades on April 16, blaming it on unprecedented demand for crypto services. At the same time, Robinhood continues to face headwinds from regulators. For example, the Massachusetts Securities Division published has accused Robinhood of a “pattern of aggressively inducing and enticing trading among its customers – including Massachusetts customers with little or no investment experience.” Subsequently, Robinhood filed a complaint and motion in the Massachusetts State Court to block the complaint.
The People’s Bank of China (PBOC) has ordered Ant Group to “cut off” the “improper connections” between its payment platform and its financial products. More specifically, told the PBOC told Ant to become a financial holding company that will be regulated more like a bank, eliminate unfair competition in its payments business, end its monopoly on information, improve its corporate governance, and better manage liquidity risks in its major fund products (including downsizing its Yu’ebao money-market fund).
Retail Central Bank Digital Currency (CBDC) developments (see also Table 2 in the below-linked PDF)
On April 5, 2021, the Bank of Japan (BoJ) began its Phase 1 central bank digital currency (CBDC) proof of concept (PoC) work. In PoC Phase 1, the Bank plans to develop a test environment for the CBDC system and conduct experiments on the basic functions that are core to CBDC as a payment instrument such as issuance, distribution, and redemption. This phase will be carried out through March 2022. The BoJ will then move to Phase 2 to test more detailed functions of CBDC, and then, if necessary, on to Phase 3, in which private businesses and end-users will participate in a pilot program.
The Riksbank concluded the first phase of its e-krona central bank digital currency (CBDC) proof of concept (PoC). Working with Accenture, the objective was to test a blockchain-based R3 Corda technical platform to increase the Riksbank’s knowledge of how an e-krona could function and be used as a complement to cash. The next phase of the PoC will test the platform’s capacity to manage retail payments on a large scale and will include potential distributors. It will also test offline functionality and integration with existing point-of-sale terminals, and different means of storing private keys to the tokens and the tokens containing e-kronor.
The Bank of Thailand has set its agenda for a retail central bank digital currency (CBDC) with preliminary testing protocols scheduled to begin in Q2 2022. As part of its plans, the central bank published a preliminary report detailing its CBDC thesis. The main motivations are increasing financial inclusion and reducing the risk of private stablecoins undermining the central bank’s “monetary sovereignty and financial stability.” The central bank will begin its CBDC developmental efforts by engaging with stakeholders followed by cost-benefit analysis to ascertain the opportunities, risks and challenges.
The European Central Bank (ECB) published in-depth results of their digital euro consultation. The survey, which ran from October 20, 2020 to January 12, 2021 and collected 8,221 responses, asked 18 questions pertaining to the benefits and challenges of issuing a digital euro and on its possible design. It found that privacy is the most demanded feature followed by security and usability. 47% of respondents were from Germany, which is notorious for its continuing high levels of cash usage, and most respondents (33%) come from the tech industry. More than two-thirds of respondents acknowledge the importance of intermediaries providing innovative services that allow access to a digital euro and indicate that it should be integrated into existing banking and payment systems. They would like additional services provided on top of basic digital euro payments.
The Bank of England and the U.K. Treasury announced the creation of a Central Bank Digital Currency (CBDC) Taskforce that will (i) coordinate exploration of CBDC objectives, use cases, opportunities and risks, (ii) guide evaluation of the design features, and (iii) support a rigorous, coherent and comprehensive assessment of the overall use case. Also, the Bank of England established a CBDC Unit, and created a CBDC Engagement Forum to engage senior stakeholders and gather strategic input on all non-technology aspects of CBDC, and a CBDC Technology Forum to gather input on all technology aspects of CBDC.
General Fintech Developments (see also Table 3 in the below-linked PDF)
The People’s Bank of China (PBOC) and four other regulatory agencies summoned 13 domestic internet platform companies including Tencent, JD Finance and ByteDance for talks on their financial businesses. The firms were urged to bring their online lending and deposit-taking businesses in line with regulatory requirements, and to to refocus on their payment service business, enhance their transaction transparency and break any information monopolies.
Paxos Trust Company completed a same-day settlement of US-listed equity trades in partnership with Instinet and Credit Suisse on its Paxos Settlement Service permissioned blockchain solution. Paxos said the project demonstrated its ability to enable same-day settlement for trades conducted throughout the day. In the current system, settlement can only occur the same day if trades are completed before 11 AM ET and therefore is rarely utilized. The platform is said to be interoperable with the legacy clearing system and can facilitate settlement on any time cycle.
The Bank of England unveiled a new type of omnibus account as part of its real-time gross settlement service. With it an operator of a payment system can hold funds in the omnibus account to fund their participants’ balances with central bank money. This account co-mingles funds from different entities for the purposes of wholesale settlement. Fnality sees these new accounts as supportive of the opportunity to use tokenized cash assets to enable on-chain wholesale exchange of value.
Fnality uses an Ethereum-based permissioned blockchain that will run on chain payment systems in multiple currencies in each jurisdiction. When a bank wants to make a payment, it transfers money from its central bank account to the Fnality omnibus account, which then tokenizes it. The bank then uses the tokens to make a payment, and the recipient bank can then opt to convert the received tokens back to central bank money, or it could use the tokens for further payments.
The Monetary Authority of Singapore and the Bank of Thailand launched the linkage of Singapore’s PayNow and Thailand’s PromptPay real-time retail payment systems. Customers of participating banks in Singapore and Thailand will be able to seamlessly and securely transfer funds of up to S$1,000 or THB25,000 daily across the two countries, using just a mobile number. The fees will be affordably priced and transparently displayed to senders prior to confirming their transfers.
The European Investment Bank (EIB) launched a €100 million two-year digital bond issuance on an Ethereum-based public blockchain platform. The EIB paid the three underwriters (Goldman Sachs, Santander and Societe Generale) using Banque de France-issued wholesale CBDC. Societe Generale – FORGE provided the end-to-end services to issue and manage the digital-native security tokens.
Miscellaneous commentary and research
A Bank of Canada paper proposed a framework to allow authorities to understand the defining characteristics of stablecoin arrangements, to be specific about any concerns they may have, and to be objective in their treatment from issuer to issuer. First, it classifies arrangements into three parts, coin structure, related transfer system(s) and related financial service(s), and then categorizes the attributes of each one. Secondly, it identifies specific risk scenarios that are relevant to the stablecoin arrangement, and thirdly, it quantifies the range of probable loss and possible frequency associated with the identified risk scenarios.
A BIS paper assessed emerging crypto-asset financial integrity regulatory approaches and supervisory practices and identifies policy priorities to address common challenges faced by financial authorities. It points to opportunities to adopt new approaches, like blockchain analytics, that take advantage of the inherently data-rich nature of the crypto-asset sector. Also, the inherently cross-border nature of crypto-assets, as well as the uneven global implementation of international standards in this area, make international cooperation a critical component for effective supervision.
The ECB published a report on the use of distributed ledger technology (DLT) in securities post-trade processes. It categorized securities issuance and post-trade processes into models depending on how DLT is used in each case, drawing implications for the use of DLT at different stages of the securities life cycle, from issuance to custody and settlement. It recommends that, to prevent market fragmentation, the adoption of DLT-based solutions should be based on common practices and standards that enable DLT systems to interact with both each other and conventional systems.
I’ve tabulated the key features of the two active central bank digital currency (#CBDC) projects in the Caribbean area. The Central Bank of the Bahamas (CBOB) went live with its Sand Dollar on October 21, 2020 after a ten month pilot, and the Eastern Caribbean Central Bank (ECCB) started a twelve month pilot of its DCash on March 31, 2021 on four of the eight island countries under its currency union. This is all based on publicly-available information – hence some of the question marks. If there are errors of omission or commission, please let me know in the comments! Also, see below for an updated version of the PDF version of the table that includes the Central Bank of Uruguay 2017-2018 e-Peso pilot.
System utilizes enhanced short-lived one-time web tokens
Smartphone & smart card
Initially no, but maybe yes later
None during pilot
Tier 1 requirements
Physical/email address, phone number and photo.
For “value-based“: Physical/email address, birth date/ place, phone number and photo.
Tier 1 transaction limit
EC$1,000/m or EC$2,700/m
Tier 1 holding limit
Tier 2 requirements
Tier 1 requirements plus govt.-issued photo identification
For “register-based“: Full name, address, phone number, and bank account
Tier 2 transaction limit
B$10,000/m or B$100,000/y
EC$3,000, EC$5,000, EC$20,000/d depending on risk profile
Tier 2 holding limit
Business license & VAT ID number
Business name, physical/email address, phone number
B$20,000/m or 1/8th of annual revenues whichever is greater.
EC$25,000/d to EC$300,000/d based on risk rating
B$8,000 or 1/20th of annual sales, up to an annual limit B$1 million.
Users can make a pre-set dollar value of payments when communications access to the Sand Dollar Network is disrupted. Wallets would update against the network once communications were re-established.
The party initiating the transfer (sender) must have an internet connection. If the receiver is offline the payment will still be processed, and they will see the change in their balance as soon as they are back online.
Transaction transparency to enable central bank monitor suspicious transactions and stop accounts. Pseudonyms ensure user anonymity. Central bank maintains ledger and server is encrypted
Central bank can see anonymized transaction data and outstanding stock of DCash in each digital wallet. Registered financial institutions can fully observe the identity of payers and payees and the purpose of transactions
The crypto-asset bull run continued, with Bitcoin hitting a new all-time high ($61,557) before settling back to close the month at $59,483 (+28%). The main drivers were moves by Visa and PayPal to bring crypto to the people, and continuing interest in decentralized finance (DeFi) reflected in the strong performance altcoins (market capitalization up +50%) although the Financial Action Task Force appears to be taking aim at DeFi applications. On the central bank digital currency front, the Eastern Caribbean Central Bank launched a 12-month pilot, and the Bank of Jamaica will launch an 8-month one in May.
Crypto-Asset Markets (see also the Annex in the PDF version)
Crypto-asset market capitalization increased by about 37% from February 28 to $1,972 billion with the price of Bitcoin finishing up 28% ($59,483) after hitting an all-time high of $61,557 (Figure 1). Altcoin markets led the way with capitalization up 50%. Providing overall impetus were moves by Visa and PayPal to bring crypto to the “people”.
Visa will allow the use of USD Coin stablecoins to settle transactions on its payment network. Visa piloted the program with payment/crypto platform Crypto.com and plans to offer the option to more partners later this year. It used the Ethereum blockchain and strips out the need to convert digital coin into traditional money for settlement. Crypto.com sent USDC to Visa’s Anchorage Ethereum address.
PayPal launched Checkout with Crypto that will allow U.S. PayPal Bitcoin, Litecoin, Ethereum or Bitcoin Cash holders to check out with crypto seamlessly within PayPal at millions of global online businesses. Customers pay no transaction fees, but a spread will be built into the conversion from crypto to USD. There are no additional integrations or fees required by the business. All transactions are settled in USD and converted to the applicable currency for the business at the standard PayPal conversion rates.
One of the hottest crypto-assets in March was Terra (LUNA) finishing at about $18.81 (+252% over the month) likely due to the launch of Anchor, a savings protocol on the Terra blockchain. Anchor offers a principal-protected stablecoin savings product that accepts TerraUSD deposits and pays a stable interest rate. According to its white paper, Terra combines the price stability and wide adoption of fiat currencies with Bitcoin’s censorship-resistance to offer fast and affordable settlements. This article presents an overview of the Terra ecosystem and where it’s heading.
Stablecoin market capitalizations continue to increase (see Annex). Almost all are USD-pegged, and Tether’s USDT remains dominant ($40.5 billion), followed by USDC ($10.8 billion), BUSD ($3.5 billion), DAI ($3.0 billion) and UST ($1.6 billion). Tether released an attestation dated February 28, 2021 and delivered by accounting firm Moore Cayman that shows that its stablecoins are fully backed, to assuage rumors that it was not. However, the report doesn’t describe how Tether’s reserves are held.
The Bank of Thailand (BOT) issued a warning against baht-denominated stablecoin Thai Baht Digital (THT), citing a sixty-year-old law, that makes the “creation, issuance, usage or circulation of any material or token for money is a violation of Section 9 of the Currency Act 1958.” The BOT will is also planning to introduce stablecoin regulations as soon as this year. They will only cover stablecoins, and not crypto-assets. However, the purview of the framework will not only include Thai baht-backed stablecoins, but also all digital currencies backed by foreign currencies and other assets.
Crypto-related regulatory developments
The Financial Action Task Force (FATF) is going after decentralized finance (DeFi) applications in its recent draft guidance. The FATF said its standards may not apply to the DeFi platform underlying software or technology, but entities involved with the decentralized application (DApp) such as owners or operators that may now be considered virtual asset service providers (VASPs). Virtual asset (VA) escrow services, including services involving smart contract technology, brokerage services, order-book exchange services, advanced trading services, and custody providers will all considered VASPs.
The upper chamber of Wyoming’s legislature reportedly passed a bill that, if approved, would clear the way for decentralized autonomous organizations (DAOs) to become incorporated under state law. The legislation would make it easier and cheaper to set up a DAO and give legitimacy to many crypto-asset projects. DAOs are entities that operate through smart contracts, with financial transactions and rules encoded on a blockchain, effectively removing the need for a central governing authority.
Other digital asset market developments (see also Table 1)
U.S. crypto-asset fund managers are applying with the U.S. Securities and Exchange Commission (SEC) to launch crypto-asset exchange-traded funds (ETFs). The SEC has until April 29 to deliver an initial decision on the VanEck Bitcoin ETF filing (45 days after the March 15 submission’s official publication on the SEC website on March 15). The Chicago Board Options Exchange filed with the SEC to list the Bitcoin ETF that Van Eck filed for SEC approval in January. Fidelity Investments has filed to list a new Bitcoin ETF. The Wise Origin Bitcoin Trust aims to track Bitcoin’s daily performance using the Fidelity Bitcoin Index PR, an index that is derived from several price feeds. Also, Grayscale Investments has posted at least nine ETF related positions to LinkedIn.
Meanwhile, the CI Galaxy Bitcoin ETF launched on the Toronto Stock Exchange (TSE). The new ETF will join the Purpose Bitcoin and Evolve Bitcoin ETFs, both of which launched in February. And less than two months after launching its Bitcoin trust, Canada’s Ninepoint Partners is planning to change its offering to an ETF on the TSE. Deutsche Borse’s electronic trading platform, Xetra launched its first Ethereum-based exchange-traded products (ETPs). The products are physically backed and listed on the Regulated Market of the Frankfurt Stock Exchange and cleared by Deutsche Börse Group’s Eurex Clearing.
Valkyrie Digital Assets filed with the U.S. SEC for a new ETF that would invest in companies that hold bitcoin on their balance sheets. And JPMorgan has filed a request with the U.S. SEC to approve a debt instrument linked to 11 firms that have all invested in Bitcoin and other crypto-assets. The debt instrument will enable investors to have direct exposure to a basket of cryptocurrency-focused firms.
Retail Central Bank Digital Currency (CBDC) developments (see also Table 2 in the PDF version)
The Eastern Caribbean Central Bank launched its DCash CBDC pilot on March 31. Consumers can sign up to use DCash through participating financial institutions and authorized DCash agents. The 12-month pilot will roll out initially in four countries; Saint Kitts and Nevis, Antigua and Barbuda, Grenada, and Saint Lucia.
The city of Chengdu launched China’s largest digital currency trial to date, following those already completed in Beijing, Suzhou and Shenzhen. Prior to Chengdu, there had been six trials of the “Digital Currency, Electronic Payment” (DCEP) project in China, with a total distribution of 120 million digital yuan. Chengdu’s trial, which will conclude March 19, is for an additional 40 million digital yuan.
The Bank of Jamaica will be piloting a retail CBDC from May to end December 2021, using eCurrency Mint’s centralized ledger technology platform. Issuance and distribution will be fully integrated with the Bank of Jamaica’s JamClear Real Time Gross Settlement System. It will be issued to deposit-taking institutions and authorized payment providers in the same manner that it issues cash. The Bank of Jamaica Act is to be amended, giving the central bank the sole authority to issue digital currency.
The Bank of Japan will start experimenting with retail CBDC, by first testing the technical feasibility of the core functions and features required for CBDC through proof of concepts (PoC). It has established a “Liaison and Coordination Committee on Central Bank Digital Currency” through which it will share details of and provide updates on the PoC with the private sector and the government and will seek consultation on future steps to facilitate smooth PoC implementation.
The Bank of Thailand provided a preliminary assessment of its exploration of the use of a CBDC and distributed ledger technology (DLT) for business-to-business invoice payments. The tests demonstrated that DLT can increase payment efficiency for businesses by allowing users to set various conditions on the CBDC (programmable money) to enhance flexibility in handling business activities. However, they encountered some limitations with their DLT set up, particularly in supporting large transaction volumes and preserving transaction privacy, but explorations will continue.
International Monetary Fund (IMF) staff concluded that the issuance of the sovereign digital currency (SDC) SOV by the Republic of the Marshall Islands (RMI) as a second legal tender would raise risks to macroeconomic and financial stability as well as financial integrity. Also, SOV issuance could jeopardize the RMI’s last US dollar corresponding banking relationship. This combined with anti-money laundering and combatting the financing of terrorism risks could disrupt external aid and other important financial flows, resulting in significant economic drag.
Ripple is piloting a private version of the public, open-source XRP Ledger to provide central banks with a secure, controlled, and flexible platform for issuing and managing digital currencies. Moving money on the CBDC Private Ledger will reportedly be cost-effective, reliable, and close to instantaneous. It will initially handle tens of thousands of transactions per second but can scale to hundreds of thousands.
Wholesale CBDC developments (see also Table 2 in the PDF version)
A Bank for International Settlements (BIS) paper explored how interoperating multi-central bank digital currency (mCBDC) arrangements could reduce cross-border payment inefficiencies. This could be especially relevant for emerging market economies poorly served by the existing correspondent banking arrangements. Yet competing priorities and history show that these benefits will be difficult to achieve unless central banks incorporate cross-border considerations in their CBDC development from the start and coordinate internationally to avoid the mistakes of the past.
General Fintech Developments (see also Table 3 in the PDF version)
State Street launched a peer-to-peer repo program for the buy-side that they say enables competitive financing costs across a broader range of collateral types and yield enhancement opportunities compared to traditional repo markets. State Street guarantees the payment obligations of cash borrowers to cash lenders within the program following a default, thus facilitating bilateral trading by counterparties with varying credit and capital strength. Program participants trade with one another pursuant to a common master repurchase agreement, negotiating trade terms with approved counterparties within the program’s broader requirements guidelines.
Banco Central do Brasil cleared the way for Facebook’s WhatsApp messaging service to let its users send each other funds using the Visa and Mastercard card networks, months after vetoing WhatsApp’s initial attempt. However, WhatsApp is only allowed to do peer-to-peer payments, not involving merchants, unlike the free Pix service, which can be used to pay businesses and individuals. Facebook is still seeking approval to operate with merchants.
The Bank of Thailand (BOT) and the State Bank of Vietnam (SBV) have deployed a retail payment connectivity system that makes use of an interoperable QR Code in order to simplify cross-border payments between the two countries.
SPAC issuance surpassed last year’s fundraising record just halfway through March. At that point SPACs had raised $79.4 billion globally since the start of the year (versus $79.3 billion over all of 2020), and 264 new SPACs have been launched (versus 256 over all of 2020). SPACs are listed shell companies that raise funds to acquire a private company with the purpose of taking it public, allowing targets to sidestep a traditional initial public offering. The U.S. SEC reportedly opened an inquiry into SPACs, asking banks to provide the information on deal fees, volumes, and what controls banks have in place to police the deals internally. Also, the U.K. Financial Conduct Authority will be consulting on amendments to its Listing Rules and related guidance to strengthen protections for SPAC investors.
Miscellaneous commentary and research (see also Table 4 in the PDF version)
The GSMA annual State of the Industry Report on Mobile Money revealed a dramatic acceleration in mobile transactions attributed to COVID-19 lockdown restrictions limiting access to cash and financial institutions. The number of registered accounts grew by 13% globally in 2020 to more than 1.2 billion. The fastest growth was in markets where governments provided significant pandemic relief to their citizens, value of government-to-person payments quadrupling during the pandemic.
The crypto-asset bull run continued, with Bitcoin hitting a new all-time high ($58,332) before settling back to close the month at $46,526 (+35.4%). The main driver continued to be increasing institutional investor interest, with some help from a few random Elon Musk tweets and the Tesla announcement that it had bought $1.5 billion of Bitcoin. Ethereum and other altcoins had a strong month on continuing interest in decentralized finance (DeFi). Bitfinex and Tether reached a $18.5 million settlement with the New York Attorney General over allegations that they hid the loss of commingled client and corporate funds and lied about Tether’s USDT reserves. India will reportedly go ahead with a complete ban on investment in crypto-assets, and the Central Bank of Nigeria banned all regulated financial institutions from providing services to crypto exchanges in the country.
Crypto-Asset Markets (see also the Annex in the PDF version)
Crypto-asset market capitalization increased by about 41% from January 30 to $1,389 billion with the price of Bitcoin finishing up 35.4% ($46,526) after hitting an all-time high of $58,332 (Figure 1). 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. For example, Tesla announced that it had invested $1.5 billion in Bitcoin and signaled its intent to begin accepting it as a form of payment. Also, new crypto-focused investment funds, including exchange-traded funds (ETFs), continue to pop up, something I discuss in a separate post. However, there were some signs that institutional investor interest was fading, as the Grayscale Bitcoin Trust premium turned negative, and Bitcoin “whales” were reported to be offloading. Altcoin market capitalization was up 45%, although Ethereum’s was up only 5% as its soaring “gas” fees turned attention to alternative tokens like Cardano (+260%), Binance Coin (+375%) and PolkaDot (+106%).
The amount of crypto-assets on decentralized finance (DeFi) platforms increased 26% to $34.8 billion (from $27.7 billion on January 30). January decentralized exchange (DEX) trading volume soared to set an all-time high of $56 billion, according to data from Dune Analytics. DEXs use smart contracts on blockchain networks to let users swap between digital assets without transferring tokens to an exchange wallet or verifying their identity. However, DeFi Money Market (DMM) ceased operations as a result of U.S. Securities and Exchange Commission (SEC) inquiries, raising concerns that other DeFi applications may be next.
Stablecoin market capitalizations continue to increase. Almost all are USD-pegged, and Tether’s USDT remains dominant ($34.8 billion) despite the controversy that surrounds it (see below). USDC is followed by USDC ($9.0 billion), Dai ($2.3 billion) and BUSD ($2.3 billion). Of note, Canada’s VersaBank Canadian dollar-pegged VCAD crypto-asset will become the world’s first bank-issued stablecoin.
The last Monthly Monitor talked about how 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 in the stablecoin league table. (An algorithmic stablecoin adjusts its supply to maintain its peg.) However, ESD broke its peg massively, and is now trading below $0.20 ($50 million market capitalization). However, there’s another very viable-looking USD-pegged stablecoin, TerraUSD which sits at #7 ($700 million market capitalization). I discuss it in a separate post.
Bitfinex and Tether reached a $18.5 million settlement with the New York Attorney General (NYAG) over allegations that they hid the loss of commingled client and corporate funds and lied about Tether’s USDT reserves. By May 18, 2021 and on a quarterly basis thereafter for two years, the firms will be required to publish reports on the composition of USDT reserves. Without admitting or denying any wrongdoing, Tether committed to publicly share these reports. Also earlier in the month, Ripple reported that the last $550 million of the loan at the center of the lawsuit was paid off. However, the lawsuit did not cover the rumored role of Tether in a huge BTC pumping scheme, which I discuss here.
Diem (formerly Libra) is reportedly preparing to launch a minimum viable project based around a U.S. dollar stablecoin in March. In that regard, crypto-asset custodian Fireblocks and payments platform First Digital Assets Group will be partnering with Diem to provide digital plumbing to allow financial service providers such as banks, exchanges, payment service providers and digital wallets to plug into Diem. In a move obviously with Diem in mind, in a legal opinion on the European Union rules, the European Central Bank said it should have the final word on whether a stablecoin should be allowed to launch in the euro zone, and that this binding for national authorities assessing applications to issue stablecoins.
Crypto-related regulatory developments
India will reportedly go ahead with a complete ban on investment in crypto-assets, while providing existing investors a three- to six-month transition period to exit their holdings. Also, the Central Bank of Nigeria (CBN) banned all regulated financial institutions from providing services to crypto exchanges in the country. The CBN warned of stiff penalties to financial institutions that fail to comply with the directive. As a result, the country’s Securities and Exchange Commission put plans to regulate crypto-assets on hold.
The U.S. SEC and Ripple said that there’s little chance of settlement ahead of the expected trial over alleged securities infractions. The SEC is accusing Ripple Labs and its lead executives of being in violation of securities laws with $1.3 billion generated from XRP sales. The SEC also amended its complaint to include allegations that Ripple purposely manipulated XRP’s price by increasing and decreasing XRP sales depending on market conditions.
Other digital asset market developments (see also Table 1 in the PDF version)
Incumbent financial institutions aren’t shrinking from fintech challenges. MasterCard announced plans to support crypto-assets in 2021, and said it is “actively engaging” with several major central banks to support CBDC initiatives. Visa is piloting a suite of application programming interfaces (APIs) to let banks connect to digital asset bank Anchorage’s infrastructure, to allow their customers to buy and sell digital assets. Visa is already working with crypto companies to issue bank cards and has partnered with 35 crypto firms to date, but this is the first time the company has offered crypto services to banks. Bank of New York Mellon announced plans to hold, transfer and issue Bitcoin and other crypto-assets as an asset manager on behalf of its clients.
Retail CBDC developments (see also Table 2 in the PDF version)
The IMF’s Sonja Davidovic posted the first topical piece on our new Global Fintech Intelligencer blog. As central banks advance their CBDC work, they are faced with questions on how to interoperate with other digital assets. To unravel the interoperability conundrum and provide a robust digital ecosystem for the economy, China has launched the Blockchain Service Network (BSN). Although in its early stages, the BSN remains a unique attempt to build a global interoperability network that connects digital assets both across borders and networks.
A Sveriges Riksbank staff memo argued that it would be misguided to expect cash-like features of a CBDC. For a CBDC to be cash-like, it would need to be both anonymous and usable off-line, but the memo claims that the technical construction of digital currencies requires that they be verified by a remote ledger, in order to avoid double spending. It dismisses the possibility of using tamperproof local devices that cannot be programmed so that a token cannot be spent more than once. However, Mondex used tamper-resistant hardware to do exactly what the memo says is impossible. It failed due to a flawed business model, and not any technical shortcomings.
A Swiss National Bank working paper proposed a double spending-resistant token-based CBDC system. It showed how earlier-deployed, software-only electronic cash can be improved upon to preserve transaction privacy, meet regulatory requirements, and offer quantum-resistant protection against systemic privacy risk. The proposed CBDC system is based on blind signatures and a two-tier architecture, that purportedly guarantees perfect, quantum-resistant transaction privacy and provides anti-money laundering and counter terrorism financing protections stronger than those of banknotes.
Canadian fintech firm Bidali has reportedly launched a pilot to test a digital Bermuda dollar with the support of the Bermuda government. Under the pilot program, popular local rum company Gosling’s Limited will be accepting digital Bermuda dollars through the Stellar network. From there it hopes to expand to other businesses in Bermuda. Bermuda is a British island territory that does not have a central bank and the Bermuda dollar is pegged one-to-one to the U.S. dollar – it is effectively a non-digital government-issued stablecoin with one USD in reserve for every Bermuda Dollar that’s issued. Also, since 2019, Bermudans have been able to pay taxes with USDC stablecoins.
Wholesale CBDC developments (see also Table 2 in the PDF version)
The Digital Currency Institute of the People’s Bank of China and the Central Bank of the United Arab Emirates joined the m-CBDC Bridge central bank digital currency (CBDC) project for cross-border foreign currency payments. The m-CBDC Bridge initiative is run in partnership with the BIS Innovation Hub (BISIH), the Hong Kong Monetary Authority and the Bank of Thailand. It will further explore the capabilities of distributed ledger technologies by developing a proof-of-concept prototype to support real-time cross-border foreign exchange payment-versus-payment transactions in multiple jurisdictions, operating 24/7. It will analyse business use cases in a cross-border context with both domestic and foreign currencies.
The South African Intergovernmental Fintech Working Group launched “Project Khokha 2” to explore the use of tokenized money, blockchains and wholesale central bank digital currency (CBDC) in South Africa. The CBDC will use R3’s Corda enterprise blockchain, and the settlement token and debenture will use a variant of Cosmos blockchain interoperability solution. Accenture will be responsible for tokenizing the wholesale CBDC on Corda. Block Markets Africa will help with distributed ledger technology, tokenizing the bonds and the wholesale payment token using its custom Cosmos-based solution. And Deloitte will document the insights. Other participants in the trials will include commercial banks Absa, FirstRand, Investec, Nedbank, and Standard Bank, the Johannesburg Stock Exchange (JSE), and Strate, South Africa’s central securities depository.
General Fintech Developments (see also Table 3 in the PDF version)
The People’s Bank of China (PBoC) China National Clearing Center (CNCC) and its Digital Currency Research Institute (DCRI) has partnered with SWIFT to launch a new financial payment service, Finance Gateway Information Service Limited. No further details on the functions or scope of the funding were offered on the registration document. SWIFT owns 55% of the incorporation contribution, CNCC owns 34%, DCRI 3%, CNCC’s subsidiary Cross-border Interbank Payments and Settlement Limited (5%), and the Clearing Association of China (3%).
The pandemic continued to drive consumers to PayPal and Venmo. Paypal added a record 72.7 million active accounts in 2020, with the addition of 16 million accounts in the fourth quarter. Venmo, PayPal’s peer-to-peer (P2P) service, processed $47 billion in payments, up 60% from a year earlier. Similarly, payment volumes and values at U.S. interbank retail P2P payment service Zelle increased 58% (to 1.2 billion transactions) and 62% ($307 billion sent) and 457 new financial institutions joined its network in 2020, bringing the total number to nearly 7,000. Also, according to Zelle research, more than 85% of consumers either use or plan to use P2P services.
Miscellaneous commentary and research (see also Table 4 in the PDF version)
A U.S. Fed paper identified high-level environmental preconditions that support a U.S. retail CBDC, aimed at sparking further inquiry. These preconditions were broadly grouped into five areas: clear policy objectives, broad stakeholder support, strong legal framework, robust technology, and market readiness. Within each area, detailed elements were discussed. It recognized that these areas and elements were not exhaustive because many systems, tools, processes, and structures will need to be in place for a CBDC. In addition, many of these elements are interconnected.
A Minneapolis Fed article found that “the benefits of a central bank digital currency (CBDC) in the United States are not immediately obvious. Largely due to the legal and regulatory framework supporting the payments infrastructure, an end user’s buying power and ability to trust in the integrity of a transaction are the same for banknotes and bank account balances. Because the banking sector facilitates the exchange of funds between parties, the absence of central bank-issued digital money for general purposes is not currently an issue for most Americans.” Also, this VoxEU article asked tough questions about the need for CBDC, and the high risk that a CBDC introduction could be a gigantic flop.
 DMM users were depositing DAI, USDC, USDT, or ETH to the DMM smart contract in exchange for DMM mTokens that offered over 6% interest rates on the real-world car loans that backed them. DMM runs off a custom-built Chainlink oracle. The SEC subpoena requested information about the mTokens, the DMG governance tokens, and other details surrounding DMM’s operations and governance.
There is a growing queue of crypto-asset exchange-traded fund (ETF) applications at the U.S. Securities and Exchange Commission (SEC). So far, the SEC hasn’t been friendly towards the concept, pointing to inadequate means to prevent market manipulation and illicit activities at the top exchanges, as it rejected Bitcoin (BTC) ETF applications starting in 2018.
With institutional and retail crypto-asset investment interest surging, three firms (Valkyrie Digital Assets, Vaneck, New York Digital Investment Group) have recently submitted BTC-based ETF filings with the SEC. However, the approval process will be a long slog, with late September being a best guess as to when it will be complete, if successful. Hopes are high this time around because of the new Presidential Administration and the possibility of longtime crypto advocate Gary Gensler as SEC chair.
Meanwhile, the Ontario Securities Commission (OSC) cleared the launch of the Purpose Bitcoin ETF, making it the first publicly-traded ETF to gain regulatory approval in North America. After about a week of trading on the Toronto Stock Exchange it had bought 10,064 Bitcoin (about $450 million at a BTC price of $45,000). Soon after, the OSC approved the Evolve Bitcoin ETF but it appears to be off to a slower start. Also, CI Global Asset Manager filed a preliminary prospectus for its CI Galaxy Bitcoin ETF.
Alternatively, there is the Grayscale Bitcoin Trust and other similar closed-end trust products coming down the pipeline. Osprey Fund’s Bitcoin Trust is now available on a private-placement basis to retail investors. Bitwise Asset Management is seeking Financial Industry Regulatory Authority approval to trade shares of its Bitwise Bitcoin Fund on New York-based OTCQX over-the-counter (OTC) marketplace. BlockFi registered its new Bitcoin Trust with the SEC late last month. Bitwise launched a DeFi Crypto Index Fund that will track companies and securities involved in decentralized finance (DeFi).
Also, tech company MicroStrategy has been selling zero-coupon convertible senior notes with the intention to use the net proceeds to buy BTC. In December 2020 they sold $650 million of notes, and then another $1,050 million in February. However, a Gartner Finance poll of finance managers found that a majority of them are not planning to hold BTC as a corporate asset. In their responses, most of the 77 finance leaders interviewed cited BTC’s volatility as “extremely difficult to mitigate.”
The last Monthly Monitor talked about how USD-pegged Empty Set Dollar (ESD) briefly held the #6 position in the stablecoin league table. The ESD launched in September 2020 and was one of the first algorithmic stablecoins to come to market. (An algorithmic stablecoin adjusts its supply to maintain its peg.) However, ESD broke its peg massively in January 2021, and is now trading down around $0.13 resulting in a drop down to #14.
However, there’s another very viable-looking USD-pegged stablecoin, TerraUSD which sits at #7 ($590 million market capitalization). The peg isn’t absolutely perfect, as it has occasionally spiked down to nearly $0.96 and up to $1.04, but since it has launched in October 2019 it has spent most of its time within a $0.98 – $1.02 band, which is better than any other algorithmic USD-pegged stablecoin I’ve seen. TerraUSD is also part of the Terra family of products that seem to be seeing real use cases (see below).
Terra is a delegated proof of stake system that uses the LUNA token as collateral for the stablecoins it issues, and it has several active use cases underway:
The South Korean CHAI decentralized app-based mobile payments system runs on Terra’s payment rail. The rail is built on two the native stablecoin of Terra for funds across the networks and the Luna token for small transaction fees for miners. CHAI has partnered with 15+ major local banks to facilitate convenient fiat on/off ramps, recently crossed 2 million monthly active users. Terra’s network also integrates with MemePay, a Mongolian e-wallet utilized by 1.5% of the online population.
Terra’s Mirror synthetic assets protocol tracks the price of U.S. stocks, futures, exchange-traded funds, and other traditional assets. The Mirror Wallet kicked off with 12 of the top American technology stocks. The target market is users outside of the United States who seek 24/7 exposure to and fractional ownership of synthetic assets.
FYI besides TerraUSD there are eleven other Terra-based stablecoins (AUD, CAD, CHF, CNY, EUR, GBP, INR, JPY, HKD, KRW, and SGD).
Bitfinex and Tether reached a $18.5 million settlement with the New York Attorney General (NYAG) over allegations that they hid the loss of commingled client and corporate funds and misrepresented the truth about the reserves backing Tether’s USDT stablecoin. The two firms also agreed to provide to the NYAG quarterly reports on the composition of Tether reserves over the next two years, starting within ninety days of the February 18, 2021 effective date of the settlement. Without admitting or denying any wrongdoing, Tether committed to publicly share these reports. However, the lawsuit did not cover the rumored role of Tether in a huge BTC pumping scheme.
According to the Financial Stability Board, stablecoins are crypto-assets that aim to maintain a stable value relative to a specified asset, or a pool or basket of assets. U.S. dollar pegged USDT is the biggest stablecoin by market capitalization.
Although USDT’s market capitalization is a small fraction of BTC’s ($35 billion versus $940 billion on February 24, 2020) in terms of trading volume it is by far number one. USDT’s main use case appears to be as a crypto-asset trading on-ramp for residents of countries where there are crypto-asset trading bans and/or capital controls, and as a “reserve currency” for unbanked exchanges.
Is USDT fully backed U.S. dollar assets?
Tether claims that USDT is always 100% backed by currency and cash equivalents, plus “other assets and receivables from loans made by Tether to third parties, which may include affiliated entities.” In an ongoing lawsuit launched in 2019 by the New York Attorney General (NYAG) against Tether parent iFinex, it came to light that Tether had loaned $850 million of USDT’s reserves to its sister company Bitfinex. Since then, Tether has been dogged by suspicions that USTD is not 100% backed by U.S. dollar assets, although Tether claims that the Bitfinex loan has been paid off.
Tether has not helped its cause with its opacity regarding USDT’s reserve holdings. Although not audited, other stablecoin issuers at least publish monthly attestations that they are fully backed. However, attestations remain very vague about what comprises the reserves. The last time Tether published anything like an attestation for USDT was in 2017., but claim full details will be released later in 2021.
What kinds of assets back USDT?
But even if USDT’s are fully backed, questions remain around what they are invested in, although the other stablecoin issuers are not paragons of transparency. The USDC attestation report only tells us the reserves are held in segregated accounts at US federally insured depository institutions and in approved investments. The BUSD and PAX reports are equally vague, telling us that the reserves are held at US depository institutions sometimes in amounts backed by debt instruments expressly guaranteed by the full faith and credit of the US Government. Gemini’s attestations seem more transparent and imply that all of the reserves are invested in US Treasury securities.
The perception that Tether’s investments aren’t exactly top-tier, is not contradicted by the redemption restrictions: “Tether reserves the right to delay the redemption or withdrawal of Tether Tokens if such delay is necessitated by the illiquidity or unavailability or loss of any Reserves held by Tether to back the Tether Tokens, and Tether reserves the right to redeem Tether Tokens by in-kind redemptions of securities and other assets held in the Reserves.” (Crypto traders get around this by buying BTC with USDTs on an exchange that trades the BTC/USDT pair, transferring them to an exchange that trades the BTC/USD pair, and cashing them out.)
Is Tether part of a Bitcoin pumping scheme?
Some claim that USDT issuance is part of a BTC price pumping scheme. For example, a 2019 paper found that Bitcoin purchases with Tether “are timed following market downturns and result in sizable increases in Bitcoin prices. Rather than demand from cash investors, these patterns are most consistent with the supply-based hypothesis of unbacked digital money inflating cryptocurrency prices.” See also David Gerard’s succinct description of the process in this Twitter thread.
But according to Frances Coppola, USDT’s asymmetric mechanics both support and disprove this claim. An opposing theory says that what look like BTC pumps are merely Tether reacting to BTC price volatility by supplying more “lubrication” to markets. The “lubrication” idea stems from Tether’s key role as a “reserve asset” for unbanked crypto platforms. Also, a recent paper used USDT deviations from its fiat currency peg to show that USDT acts as a “safe haven” for crypto-asset investors. They found evidence of significant premiums over parity during the crash in non-stable crypto-assets in early 2018 and during the March 2020 COVID-19 crisis. Discounts were found to derive from liquidity effects and collateral concerns. For example, USTD spiked to as low as around $0.90 in April 2017 when doubts were raging about the sufficiency of Tether’s reserves.
So, if BTC’s price is falling, investors wanting to cash out is likely to increase demand for USDT, which will in turn raise its price. In normal circumstances, arbitrage is probably sufficient to maintain the peg. But when BTC is experiencing high volatility – in either direction – demand for USDT can increase far faster than arbitrageurs can bring it down. To prevent the dollar peg breaking, therefore, Tether must respond to this extra demand by issuing more USDT. And issuing more USDT increases exchange liquidity, making it easier to purchase or sell BTC and therefore feeding the price movement. So wild swings in BTC’s price might not be triggered by USDT issuance, but they… can be fed by it.
If Bitfinex and Tether follow through on their commitment to be more transparent about Tether’s reserves, rumors about USDT being backed by flaky assets may be put to bed, although questions remain around possible Tether BTC pumping. Also, it is a big if! However, the NYAG settlement does reduce a major crypto market black swan risk if, as Bryce Weiner believes, the market plumbing absolutely depends on USDT, making it effectively too big to fail.
Most institutional investors participate in crypto-asset markets through investment funds like Grayscale Investment’s closed-end trusts. As publicly traded trusts that report to the U.S. Securities and Exchange Commission, they relieve investors of concerns about storage, custody and security of their holdings. Grayscale is the dominant crypto fund manager with over $37 billion assets under management. This blog explores some of the market dynamics associated with the Grayscale Bitcoin Trust (GBTC).
Although accredited investors can buy GBTC directly from Grayscale at NAV, many institutional investors cannot take this route because GBTC shares have a six-month lock up period. (According to SEC Rule 144, restricted securities issued by an SEC reporting company like GBTC are subject to a minimum holding period of 6 months.) Hence, these investors are forced to buy the shares at a premium over the native asset value (NAV) in the secondary market, and these premia can be significant:
Price premia over NAV occasionally appear on exchange-traded funds (ETFs) but they rarely exceed about 3%. When they do, authorized participants step in to arbitrage the gap away by creating or redeeming shares of the ETF.
However, some have pointed to a scheme by which the premium could be arbitraged. It involves buying GBTC directly from Grayscale at NAV and shorting free-trading GBTC. Six months later, the two positions net out leaving a risk-free profit. This glosses over risks like not being able to borrow and fund GBTC for up to six months. JP Morgan analysts have estimated the cost of this premium monetization trade at 10-15% per annum. The GBTC long position could also be hedged with BTC futures contracts. However, the fact that the premium continues to exist, implies that such arbitrage is not consistently taking place.
That same JP Morgan analysis concluded that the introduction of a U.S. Bitcoin ETF would be positive for Bitcoin over the longer term but could be short-term negative. It would erode GBTC’s effective monopoly status and could cause a cascade of GBTC outflows and a collapse of its premium. This could have negative near-term implications for Bitcoin given the flow and signaling important of GBTC. And some think that the chances of the SEC giving the green light to a Bitcoin ETF is looking good.
Meanwhile, Grayscale competitors are sprouting up. Osprey Bitcoin Trustlaunched with a 0.49% management fee (versus GBTC’s 2%). BlockFi and Bitwise have followed suit with similar offerings. However, the business models of Grayscale and all such funds hang on whether the SEC will continue to push back on crypto-asset ETFs.