Kiffmeister’s Global Central Bank Digital Currency and Stablecoin Monthly Monitor (June 2021)

According to my real-time tabulation, 55 central banks are exploring or have recently explored retail central bank digital currency (CBDC) and the pace of development is accelerating. The Monetary Authority of Singapore launched a Global CBDC Challenge, to seek innovative retail CBDC solutions to enhance payment efficiencies and promote financial inclusion, partnering with the International Monetary Fund and World Bank, among others. Stablecoin market capitalizations continue to increase although not at the torrid pace of recent months.

Retail Central Bank Digital Currency (CBDC) developments (see also Table 1 below)

Before jumping into the latest retail central bank digital currency (CBDC) developments, let’s summarize where things currently stand. First, of the 65 central banks that responded to the Bank for International Settlements (BIS) annual survey carried out in the last quarter of 2020, 50 are actively engaging in retail CBDC work. According to my real-time tabulation, 55 central banks are exploring or have recently explored retail CBDC, and I count 20 that the BIS didn’t survey, so the real number may be at least 70. Now we have that trivia out of the way, here are June’s retail CBDC developments.

BTW during the month, I set out my definition of what is and isn’t a retail CBDC just so I could be clear that we’re all on the same page. I started with a BIS definition that I adhere to: a broadly available general purpose digital payment instrument, denominated in the jurisdiction’s unit of account, that is a direct liability of the jurisdiction’s monetary authority. There was some discussion on LinkedIn that has led me to propose adding: subject to the same rules and regulations as imposed on the jurisdiction’s other units of account. Furthermore, what do people think of adding something like usable for peer-to-peer transactions to the necessary conditions?

G7 Finance Ministers and Central Bank Governors remain focused on CBDC. They committed to work together on their wider public policy implications, noting that CBDCs could act as both a liquid, safe settlement asset and as an anchor for the payments system. Their objective is to ensure that CBDCs are grounded in long-standing public sector commitments to transparency, the rule of law and sound economic governance. CBDCs should be resilient and energy-efficient; support innovation, competition, inclusion, and could enhance cross-border payments; they should operate within appropriate privacy frameworks and minimize spillovers. G7 authorities will work towards common principles and publish conclusions later in the year.

The Monetary Authority of Singapore (MAS) launched the Global CBDC Challenge, to seek innovative retail CBDC solutions to enhance payment efficiencies and promote financial inclusion. Partners include the International Monetary Fund, World Bank, and the Organisation for Economic Co-operation and Development. Firms around the world are invited to submit innovative solutions that can address 12 problem statements centered on the CBDC instrument, distribution; and infrastructure.  Finalists will pitch their solutions at November’s Singapore FinTech Festival , and up to three winners will be selected, with each receiving $50,000 in prize money. The deadline for application submissions is July 23.

The Bank of England published the feedback it received on the “Central Bank Digital Currency: Opportunities, Challenges and Design” discussion paper that was published in March 2020. In short, the feedback is encouraging the Bank to continue examining the case for a CBDC. But at the same time, it received clear feedback that the use case for a CBDC, which might justify its introduction, needed further research, refinement, and articulation, to inform a comprehensive assessment of the pros and cons of what would be a major decision. Additionally, some respondents expressed doubt that a CBDC was needed at all, given they considered that the intended benefits could be achieved through other forms of payments innovation.

US Fed Vice Chair Quarles made it clear that he is not a big fan of a digital dollar: “First, the U.S. dollar payment system is very good, and it is getting better. Second, the potential benefits of a Federal Reserve central bank digital currency are unclear. Third, developing a CBDC could pose considerable risks.”

The People’s Bank of China (PBOC) revealed the holding and transaction limit structures being applied to the wallets currently being used in its eCNY pilots. There are anonymous wallets that can be registered with only a mobile phone number, with maximum holding limits of 10,000 yuan, single transaction limits of 2,000 yuan, and daily cumulative payment limits of 5,000 yuan. And then there are less anonymous wallets with holding limits of 500,000 yuan, single transaction limits of 50,0000 yuan, and daily cumulative payment limits of 100,000 yuan, requiring that the users link the wallets to a bank account and meet full know-your-customer (KYC) requirements. Also, users can open sub-wallets to limit payments, set up conditional payments, and control information sharing.

The Bank of Thailand has hired Giesecke+Devrient (G+D) for a CBDC proof of concept project.  G+D’s Filia platform is multi-tiered. The central bank creates and issues the data files that represent monetary value, while distribution is carried out by commercial banks or other payment service providers. Filia can be used through various forms of digital wallets, such as smartphones, smartwatches and smart cards, without a bank account or disclosure of private data. It also allows for consecutive offline payments. 

For more CBDC developments, please see the Table 1 below. There is also a Table 2 that summarizes the month’s many CBDC-related research reports (see end of post).

Stablecoin Developments

Stablecoin market capitalizations continue to increase although not at the torrid pace of recent months. Almost all are USD-pegged, and Tether’s USDT remains dominant ($63.1 billion, up $11.5 billion from end-April), followed by USDC ($25.2 billion, up $10.5 billion), BUSD ($10.2 billion, up $2.6 billion), DAI ($5.2 billion, up $1.5 billion) and UST ($1.9 billion, down $0.1 billion). According to Tether CTO Paolo Ardoino, USDT’s demand has been impacted by a significant decrease in open interest for bitcoin futures. USDT is the dominant stablecoin on most crypto derivatives exchanges.

G7 authorities committed to international cooperation to ensure common global stablecoin standards, They continued to support the Financial Stability Board’s (FSB’s) ongoing work in reviewing regulatory, supervisory and oversight challenges to the implementation of its high level recommendations for global stablecoin arrangements. They continued to support the implementation of the G20 Roadmap to enhance cross–border payments and welcomed the publication of the FSB consultation on targets for addressing the four challenges of cross-border payments

The Basel Committee on Banking Supervision issued a public consultation on preliminary proposals for the prudential treatment of banks’ crypto-asset exposures. It divides crypto-assets into two groups. Group 1 is comprised of those eligible for treatment under the existing Basel Framework with some modifications (e.g., certain tokenized traditional assets and stablecoins). Group 2 is comprised of “other” crypto-assets, such as bitcoin, that do not fulfil the classification conditions. Banks would have to hold risk-based capital at least equal in value to their Group 2 crypto-asset exposures (i.e., the maximum of their long and short positions) to absorb a full write-off of the crypto-asset exposures.

The Bank of England published a discussion paper that set out its emerging thoughts on new forms of digital money, including systemic stablecoins. It builds on the Bank’s previous discussion paper on CBDC published in March 2020 and the Financial Policy Committee’s expectations for stablecoins set out in the December 2019 Financial Stability Report. Broadly speaking, the paper proposes that stablecoins should meet equivalent standards to those imposed on commercial banks.

According to Coinmetrics, none of the major stablecoins became seriously unpegged during the May 19 crypto flash crash. As prices drop, investors often rush to trade their crypto-assets into stablecoins, while the liquidations can cause stablecoins being used as collateral to be sold. This sudden shift in supply and demand can potentially knock stablecoin prices from their peg and threaten their stability. Although I and some others observed some USD stablecoins below 90 cents on some trading screens, apparently none actually traded there (see figure below). 

Wholesale CBDC developments

The Bank for International Settlements (BIS) Innovation Hub, Banque de France and Swiss National Bank launched Project Jura that, together with a private sector consortium led by Accenture, will conduct an experiment using wholesale CBDC (wCBDC) for cross-border settlement on a distributed ledger technology (DLT) platform. The private sector consortium includes Credit Suisse, Natixis, R3, SIX Digital Exchange and UBS. It will involve the exchange of financial instruments against a euro wCBDC through a delivery versus payment (DvP) settlement mechanism and the exchange of a euro wCBDC against a Swiss franc wCBDC through a payment versus payment (PvP) settlement mechanism. These transactions will be settled between banks domiciled in France and in Switzerland, respectively. 

On June 18, the Banque de France successfully conducted a wholesale CBDC experiment with SEBA Bank, as part of the experimental program launched in March 2020. The CBDC was used to simulate the settlement of listed securities and trigger their delivery in the TARGET2-Securities (T2S) test environment, using T2S’s conditional securities delivery (CoSD) feature. The Banque de France simulated CBDC issuance on a public blockchain, preserving control and confidentiality of transactions using a dedicated smart contract. 


Table 1: Other Central Bank Digital Currency (CBDC) Developments
The PBOC continued to roll out more e-CNY pilots. The Beijing Local Financial Supervision and Administration Bureau is gave away 40 million yuan via 200,000 red envelopes, through apps of the Bank of China and the Industrial and Commercial Bank of China. The city of Shanghai handed out 19.25 million yuan via 350,000 digital red envelopes. And more than 200 vendors at and around the venues for the 2022 games in Shijingshan are now supporting payments made using e-CNY. 
The Bank of Russia announced the establishment of the first pilot group for testing the digital ruble, bringing together 12 Russian banks. The Bank also reaffirmed its plans to complete a prototype digital ruble platform by the end of 2021 and roll out testing in January 2022.
The Bank of Ghana is in the advanced stages of introducing a retail CBDC. The e-cedi will go through three phases before it goes into circulation. The first phase, which is now underway, is focused on the design of the CBDC, and the second phase will look at implementation. In the final stage, a pilot would determine whether the digital currency will be feasible before it goes into circulation. 
The Central Bank of Nigeria (CBN) is reportedly planning to launch a CBDC by the end of 2021. The CBN has been exploring CBDC for the last two years. One of the reasons the CBN is exploring CBDC is to make remittances travel easier from abroad to Nigeria.
The Banco Central do Brasil (BCB) is reportedly pushing for more time on the rollout of its central bank digital currency (CBDC). BCB told CoinDesk that “according to the current BCB assessment, the conditions for the adoption of a Brazilian CBDC will be achieved in two to three years.” 
The National Bank of Rwanda is reportedly studying the possibilities of issuing CBDC, according to John Karamuka, the Director of Payment Systems at the central bank.
The Bank of Israel has reportedly conducted a pilot test of a digital shekel. However, a more recent Bloomberg report implies that it’s actually an Ethereum-based proof of concept test.  
The Palestinian Monetary Authority is reportedly studying the possible issuance of a CBDC. Palestine does not have a currency of its own. Instead, the Israeli shekel serves as the de facto currency, alongside the Jordanian dinar and the U.S. dollar.

The Marshall Islands SOV Deconstructed

In 2018, the Republic of Marshall Islands (RMI) parliament passed the Sovereign Currency Act 2018 (the SOV Act), which established the digital currency Sovereign (SOV) as second legal tender in addition to the US dollar based. As legal tender, the SOV would be able to be used for any purchases as well as all payments of debt and tax obligations. Pursuant to this law, the SOV would be issued by the Ministry of Finance and would be non-redeemable. It was to be introduced via an initial coin offering (ICO), which the appointed organizer – SFB Technologies was tasked to perform. The law also requires transparency over the identity of the SOV users. The SOV would be issued on the Algorand blockchain.

One main purpose of the SOV is to generate revenue for the government. Additional motivations expand financial inclusion and improve RMI’s access to the global digital financial system.

After the initial issuance through an ICO, the number of SOV units would grow by 4 percent per year coded into the blockchain independently of the demand for the currency. Half of the revenue from the initial issuance (24 million SOVs) would be allocated to SFB Technologies and the other half to the RMI government. SFB technologies is tasked with developing and implementing the SOV and would bear all the necessary costs to issue the SOV and perform the ICO.

SFB technologies was planning on organizing a pre-sale of rights to future SOV units, with an eye to “test the markets and technology” and to gather additional information that could inform the government’s decision whether to proceed with the launch of the SOV. The pre-sale as currently conceived is independent of the RMI government and is designed as a private sale.

At a first glance, this arrangement sounds great, but a closer look reveals that it sounds too good to be true. Let us deconstruct the statements above to figure out where the SOV’s fatal flaws lie.

First, introducing the SOV would imply that the RMI would move to a dual currency system. In the absence of a monetary policy framework and a central bank this would impose significant risks to macroeconomic, monetary, and financial stability. The fixed annual growth rate of 4 percent irrespective of the demand for the currency would lead to large fluctuations in the value of the SOV against other currencies, including the U.S. dollar, the primary legal tender. These fluctuations, in turn, could create incentives for households, firms, and visitors to hoard the more stable/appreciating legal tender, while discharging debts and other obligations, including tax obligations, in the depreciating legal tender. This could have serious adverse consequences for the RMI’s public finances. Also, given that the RMI does not have a central bank, the country would effectively outsource its monetary policy to a private sector party creating a strong dependency.

Second, SFB technologies is foreign start-up with limited financial sector experience. The company’s intention was to seek financial support from potential investors to finalize the design of the SOV highlighting the immaturity of their technical concept. Also, SFB technologies’ dual role of issuer and private investor may create the appearance of a conflict of interest.

Third, based on the SOV’s issuance through an ICO as a way of raising revenue can be considered a securities offering. As there is no securities regulation governing either the pre-sale or the actual issuance, the RMI exposes itself to a regulatory vacuum unable to thwart or respond to potential fraud and manipulation.

Fourth, the identity of SOV users is expected to be verified through licensed international exchanges. However, licensing exchanges that will list the SOV is a mammoth task that may exceed this small country’s existing regulatory capacities. Moreover, although the exchanges are responsible for identity verification and establishing white and black lists for financial integrity purposes, the RMI government would still have to manage those lists as well as monitor and enforce compliance. Given the weakness of the country’s anti-money laundering (AML) and counter-terrorism financing (CFT) regime and capacity constraints within the regulatory and supervisory agencies, it remains questionable whether financial integrity risks can be mitigated adequately. The Digital Economic Zone for the exchange of virtual assets would only exacerbate the financial integrity issues.   

Fifth, the stated goal behind the SOV is to raise revenue for the government to offset the fallout from revenue from the reduction of the U.S. Compact grants after 2023. However, there is no indication how much revenue the SOV issuance would generate. For revenue to be sizeable, there would need to be strong demand for SOV by foreigners. This seems difficult given the strong competition from existing crypto assets. In addition, through the SOV issuance, the small economy’s revenues would be subject to global crypto market price volatility.

Finally, the country’s frequent power and network outages could hamper the issuance and wide-spread use of the SOV, obstructing the goal to achieve financial inclusion and impeding the country’s access to the global digital financial system. More importantly, the SOV issuance could jeopardize the country’s last U.S. corresponding banking relationship with First Hawaiian Bank exacerbating the RMI’s access to global financial networks.

It is easy to get blinded by the promise of enormous revenue from a state-backed crypto-asset like the SOV especially considering impending revenue fallouts. But issuing, managing and sustainably maintaining a crypto-asset designated as legal tender is a complex endeavor and requires important prerequisites such as an adequate legal and regulatory framework, sufficient capacity to supervise and regulate the SOV as well as the security of the underlying system and a viable digital infrastructure. Rather than embarking on a project of this magnitude and complexity, the Marshallese could consider other options such as rationalizing public spending which is the highest in the Pacific region to unlock extra revenue, lean on regulated stablecoin or e-money providers to expand access to finance, work with development partners such as the World Bank or the Asian Development Bank to expand the country’s core infrastructure and request technical assistance to enhance the country’s legal and regulatory regime.

The government is now considering to repeal the SOV Act and a bill on establishing a Digital Economic Zone was submitted to the Parliament recently.

Central Bank Digital Currency (CBDC) Privacy and Transparency: Not So Black and White

In designing central bank digital currency (CBDC), central banks face a trade-off between satisfying legitimate user preferences for privacy and mitigating financial integrity risk. Physical cash protects privacy because it is anonymous, but it also facilitates criminal financial transactions such as money laundering, financing of terrorism, corruption, and tax evasion.

A CBDC that gives authorities access to user identity and their transaction data would provide obvious financial integrity oversight benefits. However, such fully transparent CBDC might raise concerns around digital surveillance with CBDC potentially being instrumentalized against users, especially in jurisdictions where trust in public institutions is low. Also, such CBDC might disadvantage those without access to identification, which could impair financial inclusion efforts.

On the other hand, a fully opaque CBDC that hides users and their transactions from authorities, could introduce significant financial integrity risks, notably due to the ease and speed with which transactions can be performed and their potential global reach. Privacy preferences are not driven only by the desire to conduct illicit transactions but also to mitigate spamming and identity theft, and of being stalked or robbed (Kahn and others, 2005).

But there are many dimensions of anonymity and privacy with different CBDC design implications.

Dimensions of CBDC Anonymity and Privacy

Brookings (2020) and R3 (2021) specify two dimensions of privacy – anonymity and transaction privacy. Anonymity means that it is impossible to link transactions or activity to the sender or recipient. Under the EU General Data Protection Regulation (GDPR) identity data is considered personal data, i.e., any piece of information that relates to an identifiable person. This can range from pseudonymous keys or metadata (e.g., location data or online identifier) to personally identifiable information, like government ID numbers. A transaction is private if related metadata (e.g., whether it occurred, its amount, between who and when, whether the two parties have transacted before) is not revealed.

Then there is the question of who and how identity and transaction data is shared with. Bech and Garratt (2017) specify two types of financial anonymity – counterparty and third-party anonymity. Counterparty anonymity means that a payor need not reveal their identity to the recipient. Third-party anonymity means that the payor’s identity is invisible to all other parties, including the operator of the payment system.

Digital Currency Design Considerations

The Financial Action Task Force (FATF) has issued standards that countries should implement to prevent money laundering and terrorist financing that will impact CBDC design considerations. In most instances, to comply with FATF standards, some information on CBDC users and transactions would need to be collected and, on a when-necessary basis, made available to competent authorities. However, some form of proportionality could be applied to reduce data requirements on low value transactions to foster adoption and usability, provide a more ubiquitous access to CBDC, and assuage data privacy concerns. For example:

  • Brookings (2020) suggests that the central bank could delegate account and identity management to one or more payment service providers (PSPs) who verify and record specific identity information, while the central bank sees only pseudonymous public keys. In this business model, individuals are at least pseudonymous with respect to the central bank and the transactions it processes if the PSPs adequately protect this identity information. However, the PSP can disclose the identity associated with a suspicious account to address regulatory compliance and anti-money laundering. See the table below for three examples of this type of business model in action.
  • The European Central Bank tested out “anonymity vouchers” in a proof of concept (ECB, 2019). These non-transferrable vouchers allow users to anonymously transfer a limited amount of CBDC over a defined period whereby a user’s identity and transaction history cannot be seen by the central bank or counterparties other than those chosen by the user. Hence, anonymous CBDC transfers can be enforced without recording the amount of CBDC that a user has spent, thereby protecting users’ privacy.
  • China’s eCNY design includes “controllable anonymity” in its design. Although the central bank will be privy to the identity of its users and their transaction data, users will have the ability to control what information they expose to counterparties (Qian, 2018). It aims to keep the degree of anonymity within a controllable range by requiring the disclosure of transaction data only to the central bank (Fan, 2020).
  • A stored value CBDC hardware solution that takes the form of a card or a mobile wallet app on which prepaid values are stored locally opens the possibility of almost complete anonymity. Such a wallet could conceivably be as anonymous and private as physical cash, although the central bank may require identification to enforce a one wallet per person policy or holding and/or transaction size limits to mitigate financial integrity risk. A couple of vendors (BitMint and WhisperCash) offer this CBDC platform option.
Holding/Transaction Limit StructuresData Access
Central Bank of the Bahamas Sand DollarPhysical/email address, phone number and photo for low-limit access (B$500 holding and B$1,500/month transaction). Plus, government-issued photo ID for higher limits (B$5,000 holding and B$10,000/month and B$100,000/year transaction).Transaction transparency to enable CB to monitor suspicious transactions and stop accounts. Pseudonyms ensure user anonymity. CB maintains ledger and server is encrypted.
Eastern Caribbean Central Bank DCashPhysical/email address, phone number, photo and birth date/place for low limit access (EC$1,000 to EC$2,700/month transaction depending on risk profile). Plus, full name and bank account for higher limits (EC$3,000 to EC$20,000/day).CB can see anonymized transaction data and outstanding CBDC in each digital wallet. Registered financial institutions can fully observe the identity of payers and payees and the purpose of transactions.
Central Bank of Uruguay e-PesoPhysical/email address, SIM card and national ID for low limit access (UYU30,000 wallet maximum). No higher limits except for businesses (UYU200,000).User data is segregated across different databases. Transaction data per (anonymous) digital wallet can be decrypted to reveal the user’s identity under very restrictive conditions – e.g., a competent authority prosecuting someone that has probable cause to access the transaction data.
People’s Bank of China eCNYSIM card for low limit access (¥10,000 holding,  ¥2,000/transaction and ¥5,000/day). Plus, full name, address, phone number and bank account for higher limits (¥500,000 holding, ¥50,000/transaction and ¥100,000/day).Controllable anonymity: The PBOC will be privy to the identity of its users as they are required to provide their real identities when they first sign up. However, users will have the ability to control what information they expose to counterparties

Digital currency privacy tradeoffs have sparked intense debate with seemingly irreconcilable differences of opinion. On the one hand, authorities do not want to allow anonymous CBDC because of potential financial integrity risks. Others don’t believe it’s possible to design a fully anonymous currency that’s resistant to double spending attacks. On the other hand, law-abiding users consider privacy an intrinsic non-negotiable right and nobody should have full oversight over their transactions. However, the choice between user anonymity and transparency doesn’t need to be black and white. For example, the recent digital euro public consultation found that, although potential users place a high value on transaction privacy, they don’t support full anonymity. Ultimate design choices will depend on the motivation for CBDC issuance, country specific circumstances and user preferences.

This post was co-written by Sonja Davidovic and the Kiffmeister

Kiffmeister’s Global Fintech Monthly Monitor (April 2021)

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 Markets

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.

Source: https://coin.dance/stats/marketcaphistorical

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.

Kiffmeister’s Global Fintech Monthly Monitor (March 2021)

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.

Source: https://coin.dance/stats/marketcaphistorical

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.

Why All the Fuss About Tether?

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.

Conclusions

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.

What’s the deal with the Grayscale Crypto Investment Trusts?

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).

For example, Grayscale Bitcoin Trust (GBTC) has accumulated more than 3% of total Bitcoin supply, and an even higher proportion of liquid supply.  (Glassnode analysis found that only 22% of outstanding Bitcoin are considered liquid, i.e., currently in constant circulation and available for trading.)  Grayscale also runs eight other single-asset crypto trusts and recently incorporated twelve more such trusts although they have yet to launch. However in this post we’ll focus on 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:

Source: https://ycharts.com/companies/GBTC/discount_or_premium_to_nav

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.

There are  two active Bitcoin ETF filings with the SEC: VanEck Bitcoin Trust (submitted in December) and Valkyrie Bitcoin Funding (January 22). In the past, there have been many unsuccessful attempts, all of which were rejected by the SEC on the grounds that the underlying crypto-assets are too subject to market manipulation and liquidity is insufficient. However, some are heartened that SEC Director of the Division of Investment Management Dalia Blass, who oversaw the rejections, is stepping down, and Gary Gensler, President Biden’s nomination as SEC Chairman, is known as very crypto savvy.

Meanwhile, Grayscale competitors are sprouting up. Osprey Bitcoin Trust launched 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.