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 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.
There is a perception that decentralized finance (DeFi) and central banks are worlds apart. However, these two worlds should explore common ground that can unlock the best possible solution for the end-consumer – the transparency and efficiency of the DeFi space paired with safe and reliable liquidity and reduced compliance burden provided by central banks. After all, it should be about working towards one common goal – to provide the safest, most efficient, and reliable user experience in payments.
A lot of existing and prospective initiatives are looking into enabling faster, cheaper, more transparent and more inclusive cross-border payment services, while maintaining their safety and security. Improved cross-border payments translate into widespread benefits such as supporting economic growth, international trade, global development and financial inclusion. Cross-border payments are particularly relevant for emerging and developing economies given the central role of remittances and the large number of unbanked citizens in these countries.
The emergence of distributed ledger technology (DLT) has added new momentum to efforts to improve cross-border payments initiated both by the private and public sector. While the private sector has focused on developing decentralized peer-to-peer (P2P) solutions in the retail domain, the public sector has aimed at enabling direct exchanges between participating financial institutions through centrally operated DLT-based networks in the wholesale domain.
For the private sector, the use of DLT eliminates the need for trusted third parties and intermediaries like commercial banks for processing, clearing and settlement. DLT has spurred the growth of DeFi that recreates traditional functions of financial systems using smart contracts in place of middlemen. DeFi operates via decentralized, permissionless DLT-enabled applications called DApps. Currently, the primary DeFi platform is Ethereum, but in principle these ideas can be implemented on any smart contract platform. The main building blocks of DeFi are fiat currency-pegged stablecoins that can be exchanged seamlessly and most DApps are designed to fully interoperate with each other.
Public sector activity in the cross-border domain has focused on exploring DLT-enabled private permissioned wholesale CBDC networks as an alternative to existing real-time gross settlement (RTGS) systems. The broadcast of transactions in real-time across the network of participants eliminates the need for reconciliation or intermediation, allowing designated financial institutions to transact directly without relying on correspondent banks. The Inthanon-LionRock research project carried out in collaboration between the Hong-Kong Monetary Authority and the Bank of Thailand in 2019 created a Thai Bhat and Hong-Kong Dollar cross-border corridor network prototype, which allowed participating banks in Hong Kong and Thailand to conduct funds transfers and foreign exchange transactions on a P2P basis reducing settlement layers.
At a first glance, these two types of initiatives appear worlds apart. But the potential convergence holds promises for the best of two worlds in cross-border payments – a robust solution leveraging the competitive advantage of both. For example, DeFi relies on liquidity pools to meet its liquidity needs. Liquidity pools are crypto-assets that facilitate trading on decentralized exchanges. The tokens are locked into smart contracts and serve to provide liquidity in decentralized exchanges. Those exchange typically make use of an automatic market maker, which obviates the need for an order book and a counterparty in the traditional sense. For the buyer to compete a transaction, there does not need to be an available seller, only sufficient liquidity in the pool against which the trade is executed.
However, these pools can put the deposited funds at serious risk such as impermanent losses, smart contract exploits or malicious actions by pool administrators. Given their decentralized nature, there is no recourse when funds or data is lost as the counterparty is not easily identifiable. Instead of relying on crypto-assets in the liquidity pool, stablecoin providers could purchase central bank reserves issued “on-chain”. These reserves can be used to back the issuance of their coins in different currencies. Another advantage of linking up with central banks is that it could ease the regulatory and compliance burden of DeFi providers and participants which can be particularly heavy when working across different sectors and jurisdictions. Central banks, on the other hand, would have more regulatory oversight over DeFi providers holding their reserves.
Also, rather than having to venture out in the retail space to operate and manage their own networks, which can be time and resource intensive, central banks could benefit from the continuous enhancements of decentralized public networks. In addition, central banks would not need to run consumer-facing operations, like hosting wallets, handling consumer complaints, maintaining superior user experience and integrating with other functional applications beyond payments, which are traditionally outside their mandates. Plus, central banks would have real-time insights into how DeFi providers are using these on-chain reserves and whether they are achieving desired policy goals.
The oracle middleware of decentralized data systems provides a unique opportunity for central banks (or international regulatory and standard setting bodies) to impose technical and regulatory standards that govern the interaction with external DeFi providers. Oracles are third-party services that enable data and transaction sharing between disparate environments in a secure and authoritative manner. Information shared by oracles is digitally signed and hence is considered non‑repudiable (assurance that the signature cannot be denied by the party who signed it). For example, only parties that have completed required financial integrity checks would be authorized to purchase the central bank liability discussed above. Oracles can transmit real-time exchange rate data for DeFi cross-border payments systems and continuously validate and monitor data usage in the downstream applications. Oracles can also be used to achieve interoperability with private enterprise blockchain networks and existing legacy payment systems.
The marriage of the decentralized P2P solutions and centrally governed and organized networks can catalyze mutual benefits beyond cross-border payments. Linking central platforms with decentralized marketplaces would allow for a better integration of the retail and wholesale domains thereby unlocking a variety of use cases for DeFi providers that could be aligned with a country’s strategic policy objectives such as expanding financial inclusion. At the same time, central banks can rely on the continuous improvement of the public networks underlying DeFi while ensuring access to liquidity and regulatory compliance.
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.
As central banks advance their work on central bank digital currency (CBDC), they are faced with questions on how to ensure interoperability 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.
Many central banks are exploring central bank digital currency (CBDC), but China is at the cutting edge of exploring interoperating their e-CNY with other digital currencies and payment systems. The Blockchain Service Network (BSN) is a government-backed infrastructure network that bridges various distributed ledger technology-based networks. It was founded in April 2020 by Red Date Technology, a Beijing-based software company, and six other private and public sector agencies, including China UnionPay, China Mobile and the State Information Center. For regulatory compliance purposes, the governance of the BSN was split up into BSN China (for private permissioned blockchains) and BSN International (for public permissionless networks) while preserving a certain level of interoperability.
BSN China is expected to serve as a domestic public infrastructure network that will facilitate the development, deployment, operations, maintenance, and regulation of low-cost consortium blockchain applications. (Consortium blockchains grant assess only to selected participants, whereas private blockchains keep write permissions to one entity, although read permissions may be more open, whereas with public blockchains, access and interaction with the network is unrestricted and the identity of its participants is semi-anonymous.)
Rather than starting from scratch, developers can leverage the BSN to build their applications efficiently by choosing desired components from a broad menu of integrated systems. Developers would be able to deploy their distributed applications (dapps) with a single private key across different networks, while servers running on the BSN are designed to be compatible with the blockchains of any participating member.
A network of public city nodes that are linked via the internet form a nationwide (and in the future, worldwide) physical city node blockchain service network. In effect, public city nodes serve as BSN data servers that developers can deploy their applications to using a dedicated channel for transaction processing, data communication, and storage. These disparate channels are supposed to ensure “absolute privacy” of each application while allowing data allocations across multiple channels. Participants and end-users can access those applications at no cost. Currently, the BSN spans various cloud environments and portals, including 108 public city nodes, connecting over 80 cities across mainland China and eight public city nodes in other countries around the world.
Through the hub users can tap into data generated by outside applications while getting cross-chain services between blockchains adapted in the network. For example, an Ethereum-based dapp would be authorized to access real-time logistics data generated by a dapp built on Hyperledger and processed through the Interchain Hub. The BSN envisions this becoming a standard protocol for dapps from different blockchains, allowing them to call each other with just a few lines of code.
This aim of this collaboration was to provide developers outside China with a standardized development environment to build and run dapps on public blockchains. The public blockchains are supposed to be adapted to the Chinese market with public blockchain nodes that are installed on top of the BSN, so that Chinese developers can access all nodes from all public blockchains via one gateway and one simple monthly plan.
In the localized version for the Chinese market, the network will convert the decentralized public blockchains into permissioned ones, while replacing their native tokens with direct payment by the Chinese currency renminbi to cover transaction fees on these blockchains. This is considered to be the most direct and effective way to ensure regulatory and supervisory compliance and encourage adoption among users within China. Unlike the localized version, the global version of the BSN will allow public decentralized blockchains.
According to industry experts, the BSN is supposed to serve as the backbone of China’s Digital Silk Road ambitions. Others argue that the BSN will encourage the development of digital currencies, stimulate internationalization of digital assets, and expand Chinese developers’ access to the global crypto industry. Regardless of the underlying motivation, thus far, the BSN is the only large-scale network that aims for seamless interoperability between international digital assets and applications across public and private blockchain networks.
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.
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).
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 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.