2018 March 19 - Volume.2 Issue.11
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This Week's Headlines:
Cryptocurrency Exchange Listing Success Markedly Vary
Looming Regulatory, Banking Hurdles Face Crypto Exchanges
Wyoming Passes Utility Tokens Law as New Asset Class
Central Bank Digital Currency to Impede on Bank Profitability
Binance CEO Changpeng Zhao tells Diar that vigorous review of teams and ICO projects are part of the exchange's modus operandi which has seen the young operation list tokens that have retained their gains, even in today's bear market. We crunch some numbers for tokens that have been trading since 2017 to date to see just how well crypto exchange listings have faired.
Despite the regulatory uncertainty regarding whether the ICO tokens are considered securities, there are seven large exchanges that are actively trading ICO tokens. In a U.S. Senate hearing in February, the Securities and Exchange Commission (SEC) chairman Jay Clayton stated that he believes that every ICO he has seen is a security. The SEC released an official announcement in March saying that a number of the exchanges are allowing trading of assets that meet the definition of a "security" under the federal securities laws and that the exchanges may be participating in the unregistered offer and sale of securities.
Bittrex is is the only U.S.-based exchange that is actively listing new ICO tokens. The exchange responded by saying that "Bittrex uses a robust digital token review process to ensure the tokens listed on the exchange are compliant with U.S. law and are not considered securities." Every new token that gets listed on Bittrex must go through a compliance review where the applicant is required to provide a legal memorandum or opinion from its U.S.-qualified outside counsel.But legal counsel in the whole cryptocurrency space seems to be doling out of very bad advice according to Mr Clayton.
Bittrex also considers a number of other factors before listing on an exchange mostly focused on the quality of the project and whether it is sustainable.
While Bittrex is the largest U.S-based exchange for trading ICOs, Binance is the largest exchange in terms of volume, making it markedly more liquid for trading tokens. Speaking to Diar, Binance CEO Changpeng Zhao, highlighted the thought process that Binance takes in listing of new coins as extremely seriously.
Bittrex, Binance Show Inverse Success Ratio vs. Other Exchanges
Methodology: Diar looked at all coins that started trading in 2017/18 on the exchanges and took prices from the start of trading of those tokens. The data does not account for delisted coins, but only coins that are currently traded.
Binance has a team that is dedicated exclusively to reviewing applications for new tokens. Mr Zhao stressed that the sustainability of the project is very important to Binance as they review the teams behind the project and their working history. Much like Bittrex, before listing new tokens, Binance consults lawyers to determine whether the asset is a security. The token must pass their due diligence test that checks whether the project has an innovative use case.
Diar data crunching shows that the due diligence process of listing new coins can be an indicator for traders - or at the very least, for exchange performance. The data looked at every coin that started trading in 2017 or 2018 and analyzed whether its price increased since being listed on an exchange. In the current falling rate environment, it is a good indication of quality if the coins were able to retain some of their value from recent All-Time Highs.
As the focus on cryptocurrency regulation pick up pace worldwide, exchanges could be the next target of the watchdogs. While the largest exchanges have already implemented necessary Know-Your-Client (KYC) and Anti-Money Laundering (AML) procedures, many still remain unregulated. Four of the largest exchanges by trading volume do not support any fiat currencies natively, but instead have bypassed the banking problem by using the currently contentious US Dollar pegged stablecoin, Tether. And if banking wasn't enough of a problem, the legality of trading some of the ICO tokens that could be considered securities is also uncertain.
With the surge of cryptocurrency trading in 2017, the demand for reliable exchanges grew becoming major revenue-generating business. Binance, which only launched last July, is the largest exchange by traded volume, a mere 7 months on. The popular exchange went from revenues of $7.5Mn in the first quarter to more than $200Mn in revenues in the second quarter and boasts 6 million users on its trading platform.
Unlike traditional financial markets, cryptocurrency exchanges are open 24/7, not location restrictive and have low barriers to entry. And with the potential of quite large audience with trades earning approximately 0.1% in fees, exchanges are certainly cash-cows.
|| HEAVY IS THE HEAD THAT WEARS THE CROWN
Of course, there is a huge responsibility and risk for exchanges to be reliable and safe as cryptocurrencies now represent the largest bounty hunt in the world attracting the attention of hackers en masse.
Diar found that an eye-balling $1.1Bn have been stolen off cryptocurrency exchanges – 60% of which has taken place in 2018 alone (Diar, 12 February). Bitfinex, which is currently the third most popular exchange by traded volume, has been hacked twice in 2015 and 2016 for a total amount of $68Mn. After two years, Bitfinex announced that it reimbursed the stolen funds in full. Japanese exchange Coincheck, whose hack in January represented the largest digital heist in history to the tune of close to $500Mn, has also reimbursed its users (Diar, 29 January).
And in early March, Binance has successfully prevented a hack, which was detected by an automatic risk management system and ultimately resulted in hackers losing their own funds. After the failed hack attempt, the company announced that it will offer a $250,000 bounty for details of the hackers and it started a $10Mn fund for future bounty awards.
|| AUTHORITIES GUNNING
Exchanges must comply with regulatory requirements from competent authorities. In November 2017, China shut down the country's exchanges citing a focus on preventing capital flight. China's largest exchanges Huobi and OKEx were forced to relocate to Singapore and Hong Kong respectively. In January, South Korean authorities also stepped in and prohibited anonymous trading at their exchanges. The ones that were unable to comply with the new KYC requirements were ordered to halt operations.
Following the U.S. Securities and Exchange Commission's (SEC) investigation of initial coin offerings (ICO) and the conclusion that some tokens might be considered securities, Bitfinex promptly announced that it will no longer allow U.S. investors to trade on the exchange. In a statement, Bitfinex said that a dramatically outsized portion of their resources goes into regulatory compliance while the revenues from the U.S. customers are limited. Binance, Huobi, HitBTC, Bit-Z, Bittrex and Poloniex still support trading of ICO tokens for US persons (see table). However, notably, none of these platforms support fiat currencies natively as all of them are using Tether as a substitute addressing their banking woes.
Tether has served as a financial market utility that acts as an efficient vehicle for arbitrage trading across exchanges. But either the reluctance or inability of Tether to release a professional audit and the lack of transparency is possibly posing a systematic risk to the whole cryptocurrency space (Diar, 29 January).
Binance User Distribution by Country/Region
Notes: *Excluding Japan (8,6%) Total Asia: 21.2% Source: Binance
Should Tether not have the corresponding reserves, the collapse would erase all of the customers' Tether deposits that are held on the exchange as it would become worthless. The exchanges that support fiat currencies natively are Coinbase/GDAX, Kraken, Gemini, Bithumb, Bitstamp, Quoine, bitFlyer, itBit and Upbit (see table). Exchanges with US banking have limited thus far their cryptocurrency offerings to the majors only – Bitcoin, Ethereum and Litecoin.
Most of the international exchanges remain unregulated. OKEx, HitBTC and Bit-Z are registered in Hong Kong, which has historically been praised for being a regulatory friendly region for cryptocurrency startups because of its predictable non-interventionist nature. Hong Kong's Securities and Futures Commission (SFC) has stepped in twice in the last year and issued warnings to exchanges that are selling Bitcoin futures or trading tokens with the characteristics of securities. iFinex, the company operating both Bitfinex and Tether, is incorporated in the British Virgin Islands while Binance is based in Cayman Islands.
US based exchanges have needed be register as a Money Services Business (MSB) and must also comply with the Bank Secrecy Act (BSA) and the USA Patriot Act. In order for exchanges to operate in New York, a special license called BitLicense is required. The application for BitLicense alone is an expensive and difficult process estimated to cost approximately $100,000 in legal and compliance fees. Kraken and Poloniex don't operate in New York because they don't have the required license, neither they applied for one (see table). And while Binance does not yet have any mechanism to block users from New York, they do state clearly users should follow their local laws and regulations. And over ¼ of their user base comes from the US (see chart). Kraken is the only U.S.-based exchange that is unregulated but partners with Munich-based Fidor Bank, which is regulated by the German Financial Supervisory Agency BaFin. As far as Diar could understand, Kraken is not registered with FinCEN as a MSB.
|| COINBASE ON POINT
Coinbase, who holds 38 licenses in the US, recently received an e-money license from the UK's Financial Conduct Authority (FCA) and partnered with Barclays to gain access to the UK's Faster Payments Scheme. Most of the banks are reluctant to work with cryptocurrency exchanges due to compliance processes and non-regulatory nature. Wells Fargo notoriously cut all baking ties with Bitfinex last year and the exchange relied on Poland's Bank Spoldzielczy. Coinbase's UK head Zeeshan Feroz said that becoming the first exchange to open a UK bank account is a result of exchange's compliance and the KYC processes.
While the regulatory scrutiny continues to pick up in 2018, it is already clear that the spoils will goto the exchanges that cooperate and comply with the necessary requirements. The recent purchase of Poloniex by Circle (a Goldman-Sachs backed started), who relaunched their cryptocurrency business in 46 states last week, indicates that some clarity by the SEC will be given in terms of token classifications, sooner, rather than later.
Cryptocurrency Exchanges Remain Largely Unregulated (By Traded Volume)
wdt_ID
# of coins
Allowed in US
1 Binance None Yes 116 Yes Cayman Islands Unregulated
2 Huobi None Yes 98 Yes Singapore Unregulated
3 Bitfinex None Yes 38 No British Virgin Islands Unregulated
4 OKEx None Yes 90 No Hong Kong Unregulated
5 Upbit KRW Yes 126 No South Korea FSC (Korea) requires KYC
6 Bithumb KRW No 12 No South Korea FSC (Korea) requires KYC
7 Bitstamp USD, EUR No 5 Yes Luxembourg EU licensed, regulated by CSSF
8 Quoine JPY, USD, SGD, EUR, AUD, HKD No 53 No Japan/Singapore JFSA
9 bitFlyer JPY, USD, EUR No 3 Yes Japan JFSA, NY BitLicense, EU licensed
10 HitBTC None Yes 303 Yes Hong Kong Unregulated
US Based Cryptocurrency Exchanges
Supported fiat
Uses Tether
Not allowed in
1 Coinbase/GDAX USD, EUR, GBP 4 No WY, HI, MN Regulated, NY BitLicense, FCA license
2 Kraken USD, EUR, GBP, CAD, JPY 17 Yes* NY Unregulated, Partnership with Fidor Bank (German BaFin Oversight)
3 Bittrex None 199 Yes - Regulated, Applied for NY BitLicence
4 Poloniex None 68 Yes NH, NY, WA Registered as MSB with FinCEN, Now Requires KYC
5 Gemini USD 2 No HI, AZ NYDFS regulated, NY BitLicense
6 itBit USD, SGD 1 No - NYDFS regulated
While the institutions of old flock to Delaware, Wyoming is aiming to be the home of the next generation of companies by passing into law 5 bills that define cryptocurrencies and Blockchain initiatives.Wyoming House Bill 70, dubbed as the "Utility Token Bill" was signed into legislation last week marking a new legal option for developers wishing to raise funds through an Initial Coin Offering.
The Utility Token Bill defines cryptocurrencies as a new asset class – one that intends to exempt developers from securities, commodities and money transmitter laws.By classing the cryptocurrencies as property, the purview would fall under the state. The preconditions for developers are straight-forward – the token must neither be marketed as an investment, and must a vehicle for exchange.
Wyoming House Bill Details
House Bill Text
1 HB0019 The Wyoming Money Transmitter Act "Virtual currency" means any type of digital representation of value that: (A) Is used as a medium of exchange, unit of account or store of value; and (B) Is not recognized as legal tender by the United States government.
2 HB0070 Open Blockchain Tokens-Exemptions The Utility Token Bill seperates convertible digital currencies such as Bitcoin that have been defined as a commodity, and tokens that have been marketed as investment vehicles. Utility Tokens will be exempt of other regulatory hurdles should they provide
3 HB0101 Electronic Corporate Records Blockchain record keeping of company shareholders management and votes.
4 HB0126 Limited Liability Companies-Series Decentralized Governance Protocols for Limited Liability Companies
5 SF0111 Property Taxation-Digital Currencies Property tax exemption for cryptocurrencies
Source: State of Wyoming, ETHNews
The Bank for International Settlement (BIS), the financial organization owned by 60 central banks published a report outlining the pros and cons of a possible Central Bank Digital Currency (CBDC) last week. With various options on the design and features of a possible CBDC, the BIS echoed its concerns that commercial banks will find difficulty sustaining deposits and maintaining income streams from payments. The possibility of competing with Central Banks could also be a reality should the design of the CBDC be interest-bearing, leaving banks no other options than to increase their customers returns to maintain deposits, resulting in dwindling profits.
The BIS Committee on Payments and Market Infrastructures highlighted the recent interest of central banks studying the possible issuance of a CBDC. The rapid growth of use with cards and mobile payments have spurred central banks to address a critical question – with a future where cash is seldom used and the public having access only to commercial bank money, what would be considered legal tender?
Digital money usage growth is seemingly inevitable due to technological advances and user preferences – a reality that Sweden is already facing (see graph). Riksbank, the Swedish central bank, has been studying the possibility of issuing the e-Krona (Diar, 20 Novevmber 2017). The Scandinavians have taken to cards, as well as the use of bank-led consortium apps, notably Swish, which has effectively left the retail payment system of the whole nation at the helm of a few corporations. The report says that proponents of a CBDC find that "should payments in private sector infrastructures be disrupted…because a bank providing credit transfers was under stress, households and businesses could still make digital payments via CBDC, something especially important if cash had (largely) disappeared."
|| DESIGN FEATURE VARIANTS
Earlier this year, the Bank of England (BoE), who also has a dedicated team conducting research on digital currencies, said that "if a central bank were to issue a digital currency, everyone, including businesses, households and financial institutions other than banks, could store value and make payments in electronic central bank" (Diar, 8 January).
The transfer mechanism currently preferred by the BoE importantly marks a feature of a CBDC – one of four listed by the BIS report (see table). A "CBDC may be transferred either on a peer-to-peer basis or through an intermediary." However, the use of intermediaries for CBDC would make for a redundant exercise as the public already has access to such forms of electronic payments today through banking facilities.
Here lies the first risk to commercial banks – "the issuance of CBDC would have implications for the structure of payment markets. To the extent that a CBDC would further open up payments to non-banks, commercial banks would stand to see their payment-related income streams eroded by increased competition." But an Op-Ed published in the Financial Times by Reza Moghadam, Vice Chairman of Morgan Stanley's Global Markets, believes the concerns may be overblown, sighting banks have already been losing their market share to the likes of PayPal.
|| NO NEED FOR NOW….BUT…..EH…BITCOIN
The BIS study is of the camp that a CBDC is yet to be of much use to most jurisdictions, but cautioned that "one could also consider the implications of not issuing CBDC. One is the potential for private digital tokens to more widely displace central bank money in transactions." And while Bitcoin price volatility makes it a difficult store of value to date, the features of the cryptocurrency resemble cash more than a CBDC (see table).
|| EARN INTEREST!
Central banks will also find the use of passing monetary policy directly through a CBDC to be an effective tool. The possible feature of an interest-bearing CBDC could make for an attractive safe asset akin to short-term government maturity bills. And should households get jittery about the health of the banking sector, they may seek refuge by sitting on the liabilities of the Central Bank hindering banking deposits.
Some Central Banks Have Voiced Their Positions on Digital Currency
Comments/Position
1 Riksbank Studying eKrona
2 Bank of England There is also growing interest in time banking and non-monetary based exchanges. And we have even considered whether there might be a Bank of England issued digital currency, but do not envisage this in the foreseeable future
3 Danmarks Nationalbank A central bank digital currency would be a solution to a non-existing problem in a country with an efficient payment system
4 US Federal Reserve Private-sector products and systems already exist or are being developed that will fulfill demands that central-bank-issued digital currencies might otherwise seek to meet
5 European Central Bank What might be a boon for savers in search of safety might be a bane for banks, as this makes a bank run potentially even easier
6 Bank of Japan At this juncture, the Bank of Japan does not have any concrete plan to introduce CBDC
7 People's Bank of China The development of digital economy needs central bank-issued electronic currency more than ever. It's crucial to speed up the research and issuance
8 Bank of Russia Studying CryptoRubles – "If we do not, then after two months our neighbors in the Eurasian Economic Union will."
Swedish Preferred Method of Payment - Cash Dwindling (%)
Source: Sveriges Riksbank
China Forecast: Non-Cash Payments Volume to Hit Trillions (USD)
Source: FT, Forrester Research
But, even this Reza Moghadam believes to be an exaggerated risk as "only checking accounts are likely to move, not other deposits offering higher interest rates; that is hardly the end of banking as we know it." And the BIS has indeed proposed a lower interest rate on CBDC holdings that are above the insured deposit amount to minimize the potential outflows.
||…AND NEGATIVE INTEREST TOO!
While the verdict is still out on how deep negative interest rates on the money supply might work in practice, the principle option is there. "In principle, negative rates on central bank liabilities could provide the monetary stimulus needed in extreme circumstances."
Key Features of Digital Currency According to the Bank for International Settlement
✓ Existing Feature - (✓) Possible Feature - ✖ Not Typical or Possible Feature
Key Features of Digital Currency
Central Bank Reserves
CBDC Token
CBDC Account
CBDC Wholesale-Only Token
1 24/7 Availability ✓ ✓ ✖ ✓ (✓) (✓)
2 Anonymity ✓ ✓ ✖ (✓) ✖ (✓)
3 Peer-to-Peer Transfer ✓ ✓ ✖ (✓) ✖ (✓)
4 Interest-Bearing ✖ ✖ (✓) (✓) (✓) (✓)
5 Limits/Caps ✖ ✖ ✖ (✓) (✓) (✓)
PwC Introduce Blockchain Audit
PricewaterhouseCoopers (PwC) revealed its blockchain auditing solution. The solution will monitor the transactions and provide an independent validation that the technology is functioning as intended. PwC hopes that the enterprise solution will encourage companies to adopt the technology.
France Looks to Embrace ICOs
French Ministry for the Economy and Finance is working on a legislation that would make France one of the most friendly jurisdiction for ICOs. The planned legislation aims to create a flexible regulatory framework that provides legal certainty. The unlicensed ICOs will be allowed to operate.
Mastercard Open to CBDC
Ari Sarker, a senior executive at MasterCard, said that the company would very happy to look at facilitating the use of central bank digital currency (CBDC). Mr Sarker said that for Mastercard to get involved, the digital currency would have to be tied to an identity, fulfill all the regulatory requirements and be backed by a regulator. (See story above)
Lightning Launched on Bitcoin Mainnet
Lightning Labs released the first beta release for the live bitcoin network. Lightning Labs also announced the completion of a seed financing round worth $2.5Mn. The investors that participated include DCG, Square and Twitter CEO,former PayPal COO and Robinhood co-founder.
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