This month in crypto: regulators, mount up!

First of all, congrats if you get the regulate reference. What an all-time classic.

But even if you didn’t get the reference, the theme of this month’s issue is probably already obvious. Crypto regulation is happening in a big way.

US regulations have been grabbing all the headlines, but there have also been big things happening over here in the UK.

So, for a change, let’s start with the UK and move on to America after that.

The Bank of England is planning to launch a UK Central Bank Digital Currency by 2030

Ever since Facebook kicked the hornets’ nest with its failed Libra crypto project back in 2019, governments around the world have been planning to make their own cryptocurrencies.

Of course, they don’t call them cryptocurrencies, they call them Central Bank Digital Currencies (CBDCs).

And I wrote an explainer on them a while back, which you can read here: Everything you need to know about Central Bank Digital Currencies, if you haven’t already.

China has had its own CBDC for a while now, the e-CNY or digital yuan, which passed 100 billion yuan ($14 billion) in transactions back in August.

And since the start of this year, China is even including it in its official currency circulation data.

If you read my CBDCs explainer – or any commentary on CBDCs – you’ll know that CBDCs are an absolute dream for dictators, totalitarian regimes, police states, or any government that wants compete control of its citizens.

There are also potential benefits for citizens that involve cutting the banking industry out of the distribution of currency, so the money goes directly to said citizens.

From the Bank for International Settlements:

CBDCs could bypass many of the vested commercial interests that have cropped up around payment systems and contributed to inefficiencies and costs for users. They could also lower costs by removing the credit and liquidity risks inherent in other forms of digital money. …

There are also benefits for social policies. For example, governments could use CBDCs to channel financial support to low-income households, which would deepen longer-term inclusion and act as another gateway to other financial services.

If you read the article that excerpt comes from, you’ll probably notice it fails to mention any of the downsides or dangers of CBDCs, which I guess you would expect from a piece titled “CBDCs for the people” written by the general manager of the Bank for International Settlements.

So, for balance, let’s list some of those potential dangers the Bank for International Settlements overlooks.

A CBDC would enable a government to:

• Track and trace every transaction of every citizen.
• Blacklist any citizen it chooses from using money.
• Blacklist any type of transaction – say gambling, buying alcohol, etc.
• Set limits on how much of anything anyone can buy – for example limiting the number of fizzy drinks or sugary products you can buy in x number of days, months, years.
• Limit problem citizens’ access to certain goods and services – for example stopping political activists paying for a mobile phone contract.
• Automatically taking fines, fees, taxes etc. out of your savings without your say so.
• Enact negative interest rates so you’re forced to spend your money to boost GDP.

The list is essentially endless. You just have to use your imagination. A CBDC is basically the government taking complete control of your bank account.

For citizens, it is kind of like being a child again and having a parent keep hold of your money for you – for your own good.

Anyway, with that in mind, our trustworthy UK government is planning to launch its own CBDC before the decade is out.

From Bloomberg:

The Bank of England and the UK Treasury stepped up work on creating a digital currency to sit alongside physical banknotes and sought to allay concerns that the work could threaten the stability of banks.

Officials at the two institutions said a central bank digital currency, or CBDC, which has been unofficially dubbed “Britcoin,” could present significant opportunities for UK consumers and businesses after it’s rolled out as early as the second half of this decade.

The moves are part of an effort by central banks around the world to adapt to new forms of payment that work more quickly and smoothly in online transactions. It also is aimed at keeping the government involved in supplying money as consumers shift to card payments backed by companies and not the government.

“While cash is here to stay, a digital pound issued and backed by the Bank of England could be a new way to pay that’s trusted, accessible and easy to use,” Chancellor of the Exchequer Jeremy Hunt said.

It’s also interesting to note that, as Bloomberg points out towards the end of that article:

While the Treasury insisted that the CBDC would be “subject to rigorous standards of privacy and data protection,” and neither the government nor the bank would have access to a person’s data, it would not be anonymous.

So, “No one will have access to a person’s data, but it would not be anonymous.” Isn’t that a contradiction?

Meanwhile…

The Treasury has set out its plans to regulate crypto

On the 1^st of February, the Treasury released its latest consultation on crypto regulation.

The consultation will run from now until the end of April, and it notes that:

The government’s proposed measures have been informed by recent market events – including the failure of FTX – which reinforce the case for effective regulation and sector engagement.

You can read the whole 82-page proposal here.

Or you can read this handy summary from the block below:

Crypto exchanges in the UK will need to beef up their compliance departments, as operating a crypto exchange will become an activity regulated by the Financial Conduct Authority beyond its current anti-money laundering provisions.

Prospective exchanges will need to supply details of their operations, risk management processes and financial resources, among other requirements. They will be responsible for designing control systems to detect and disrupt market abuse. Crypto lenders will also need FCA authorization, and the proposed rules spell out the operational remit for crypto custodians too.

Tokens traded on a UK crypto exchange will be subject to traditional finance market abuse rules. This covers offences like insider dealing, market manipulation and unlawful disclosure of inside information. Plus, those offering crypto trading services will need to follow the European Union’s financial market trading rules. This includes obtaining the best result when executing client orders.

Stablecoins, which are addressed in the Financial Services and Markets Bill working its way through Parliament, are not the main priority for the new regime. However, the Treasury considers that “activities relating to so-called algorithmic stablecoins should be subject to the same requirements as for unbacked crypto assets.”

When it comes to initial coin offerings, the proposed guidelines likely stamp them as security offerings. It will be up to the crypto exchanges to do due diligence on the token and ensure necessary admission and disclosure documents are filed correctly. The more complicated prospectus documents that companies file when doing an initial public offering will not be necessary in an ICO.

I guess it’s a good thing that the government is really taking crypto seriously, and, as I’ve said before, if it gets the regulation right it might just achieve its dream of making the UK a “crypto hub”.

But if it’s too heavy handed then it will simply push the crypto industry out of the UK once and for all.

The government certainly sounds like it wants to foster a thriving UK crypto industry… but then you look at what’s actually happening and it makes you wonder.

Case in point…

The Financial Conduct Authority effectively makes it illegal to buy anything with crypto

This month, regulators on both sides of the pond have stepped up their game. Like I said, we’ll get to what the US is doing in a minute. But here in the UK the FCA has found a way to effectively ban crypto without actually banning crypto.

Have a read of this story from the (notoriously anti-crypto) Guardian:

Authorities have raided several sites around Leeds as part of what is believed to be the UK’s first crackdown on illegally operated crypto ATMs.

Evidence was gathered from multiple sites around the city that were suspected to be hosting machines allowing customers to buy or convert traditional currencies into cryptoassets including bitcoin.

Why were the crypto ATMs illegal? Because they haven’t been approved by the Financial Conduct Authority (FCA)…

The article continues:

While the FCA does not regulate cryptoassets, it does require all firms dealing in crypto to register and prove they have effective anti-money laundering and terrorist financing controls.

There are no crypto ATMs registered with the FCA, meaning any crypto ATM operating in the UK is doing so illegally. …

“We will continue to identify and disrupt unregistered crypto businesses operating in the UK,” Mark Steward, the FCA’s director in charge of enforcement and market oversight, said.

On the surface, this might seem like one small town cracking down on crypto “crime”. But when you think about it, it’s a lot more than that.

Because of the new FCA rules, any business dealing with crypto must get approval from the FCA to do business, and prove that it has anti-money laundering and anti-terrorism controls in place.

So, what that means is that any business that wants to take crypto payments for anything must be registered with the FCA and prove it has these controls in place. This is not an easy thing to do – even for huge businesses like Revolut.

Remember that last year 80% of firms that tried to register eventually withdrew their applications because it was too difficult.

So it’s not like your local corner shop or your small online business will be able to get approved… which means the FCA has come up with a very clever way to effectively stop nearly all crypto-related business in the UK.

The genius part of this is, as the Guardian points out, the FCA doesn’t have the jurisdiction to regulate crypto. But it’s found a way to do it anyway. Well, to ban it anyway.

And over in the US, the Securities and Exchange Commission (SEC) is making a similar 4D chess move against crypto of its own…

Over in America, the Securities and Exchange Commission is gunning for staking and stablecoins

You’ve probably heard about the SEC cracking down on staking this month.

It sued the Kraken exchange, fined it $30 million and ordered it to stop letting its US customers stake their crypto.

Kraken is second only to Coinbase in terms of the most trusted exchange around the world, so this is a big blow for the industry.

Here’s what Kraken said in its press release:

Today, two Kraken subsidiaries announced a settlement with the U.S. Securities and Exchange Commission (SEC) concerning Kraken’s on-chain staking program. Because of this settlement, Kraken has agreed to end its on-chain staking services for U.S. clients.

Starting today, Kraken will automatically unstake all U.S. client assets enrolled in the on-chain staking program. These assets will no longer earn staking rewards. This applies to all staked assets except for staked ether (ETH), which will be unstaked after the Shanghai upgrade. U.S. clients will not be able to stake any additional assets, including ETH.

This of course led to panic in the cryptosphere and arguments from other crypto companies about how their staking products couldn’t possibly be considered securities and forced to shut down.

Here’s Coinbase’s argument: “Coinbase’s staking services are not securities. And here's why.”

And Coinbase’s CEO, Brian Armstrong, said Coinbase would be willing to defend its position in court:

But then, let’s not forget that the last time the SEC told Coinbase not to do something (release a lending product), Coinbase simply rolled over. So, I wouldn’t put too much stock in Armstrong’s tweet.

It’s worth noting here that the SEC is (currently) only going after centralised staking solutions, and it’s yet to try shut down something decentralised like rocket pool. But you can bet it’s also trying to think of ways to shut those down, too.

Oh, and then, as if it hadn’t dealt crypto a big enough blow with its Kraken demands, the SEC then announced it was going after Paxos – Binance’s stablecoin provider of choice.

From the Wall Street Journal:

The Securities and Exchange Commission has told crypto firm Paxos Trust Co. that it plans to sue the company for violating investor protection laws, according to people familiar with the matter, the latest move in the agency’s escalating campaign in crypto enforcement. …

The notice alleges that Binance USD, a digital asset that Paxos issues and lists, is an unregistered security.

Wow. It’s one thing gunning for exchanges. But if the SEC decides stablecoins are actually unregistered securities all bets are off.

This could be major.

And Paxos immediately agreed to shut down its BUSD stablecoin. However, since the SEC is only currently going after Paxos BUSD stablecoin, it’s just swapping them all for its Pax Dollar stablecoin.

From Paxos:

[Paxos] will end its relationship with Binance for the branded stablecoin BUSD.

Effective February 21, Paxos will cease issuance of new BUSD tokens as directed by and working in close coordination with the New York Department of Financial Services. …

BUSD will remain fully supported by Paxos and redeemable to onboarded customers through at least February 2024. New and existing Paxos customers will be able to redeem their funds in US dollars or convert their BUSD tokens to Pax Dollar (USDP), a regulated US dollar-backed stablecoin also issued by Paxos Trust.

And it then issued a further statement saying:

Paxos categorically disagrees with the SEC staff because BUSD is not a security under the federal securities laws.

This SEC Wells notice pertains only to BUSD.

To be clear, there are unequivocally no other allegations against Paxos. Paxos has always prioritized the safety of its customers’ assets. BUSD issued by Paxos is always backed 1:1 with US dollar-denominated reserves, fully segregated and held in bankruptcy remote accounts.

We will engage with the SEC staff on this issue and are prepared to vigorously litigate if necessary.

Needless to say, the outcome of that court case would have huge implications for the entire crypto industry going forward.

Oh, but that’s not all.

The SEC has also pulled an FCA (or did the FCA pull an SEC?) and managed to ban a major branch of crypto business without technically having the authority to do so.

The SEC proposed a new set of rules for funds managed by registered investment advisers.

Here’s the important part of the proposal, from the SEC:

The proposed rules would exercise Commission authority under section 411 of the Dodd-Frank Act by broadening the application of the current investment adviser custody rule beyond client funds and securities to include any client assets in an investment adviser’s possession or when an investment adviser has authority to obtain possession of client assets. Like the current rule, the proposed rule would entrust safekeeping of client assets to qualified custodians, including, for example, certain banks or broker-dealers.

And here’s SEC chair Gary Gensler’s statement about his statement:

Make no mistake: Today’s rule, the 2009 rule, covers a significant amount of crypto assets. As the release states, “most crypto assets are likely to be funds or crypto asset securities covered by the current rule.” Further, though some crypto trading and lending platforms may claim to custody investors’ crypto, that does not mean they are qualified custodians. Rather than properly segregating investors’ crypto, these platforms have commingled those assets with their own crypto or other investors’ crypto. When these platforms go bankrupt—something we’ve seen time and again recently—investors’ assets often have become property of the failed company, leaving investors in line at the bankruptcy court.

Make no mistake: Based upon how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians.

Further, today’s proposal, in covering all asset classes, would cover all crypto assets—including those that currently are covered as funds and securities and those that are not funds or securities.

Honestly, this is genius. It would allow the SEC to regulate (well, basically ban a lot of) crypto without technically having jurisdiction over it.

And to explain the whole thing much better than I ever could, here’s everyone’s favourite financial columnist, Matt Levine’s take on this master stroke:

One more point I’d like to make is about the SEC’s creativity. The SEC does not “regulate crypto.” In US law, at least some cryptocurrencies — the big ones, like Bitcoin and Ether — are classified as commodities not subject to SEC jurisdiction. But the SEC has launched a pretty comprehensive offensive to take over crypto regulation:

The SEC argues that when a crypto project issues tokens to fund its development, those tokens are almost always securities: Other than a few grandfathered tokens like Bitcoin and Ether, most tokens are going to be securities subject to SEC jurisdiction.

The SEC argues that interest-bearing crypto accounts — lending and staking products — are always securities; if a crypto exchange holds your Bitcoin for you and pays you interest, that’s a security subject to SEC jurisdiction.

The SEC here is using its authority to regulate investment advisers to indirectly regulate crypto: Investment funds are subject to SEC regulation, so the SEC will tell them what to do with their crypto, even if that crypto is not a security.

A general theme of financial regulation is that regulators write rules, and then creative financial-industry lawyers find ways around them. The industry lawyers tend to have advantages over the regulators: They are better paid, for one thing, but also the regulators have to write general public rules that account for all cases and then the industry lawyers get to poke holes in them at their leisure. …

And that is the stereotype: The industry is ruthless and creative about exploiting the rules, and the regulators are constantly playing catch-up.

I just want to say that in crypto right now the SEC is being ruthless and creative about exploiting legal provisions to expand its powers, and the industry seems to be playing catch-up. Just an unusual situation!

And yet…

For some reason crypto prices are on a tear… go figure

Over the past seven days (as I write this on Friday the 17^th of February):

• Bitcoin is up 10.3%.
• Ethereum is up 8.1%.

And many smaller projects are up even more than that.

That’s despite all this major regulation news and, as the Financial Times writes, “the release of new batches of data showing the US economy is not cooling off as rapidly as hoped.”

It just goes to show that, as the crypto kids like to say, “no one knows sh—” actually, probably better I don’t use that phrase here… even if it is apt.

If you know it, you know it.

And if you don’t, it basically says no one knows anything about anything. But you swap out the “anythings” for popular swear words.

So why is crypto up this week, despite the bad news? It’s most likely they new ordinal NFT craze on Bitcoin.

From decrypt:

Ordinals are the new thing taking Bitcoin by storm. On Monday, February 13, Inscriptions using Ordinals passed 100,000 as users flooded the network with images, video games, and other content.

Ordinal Inscriptions, similar to NFTs, are digital assets inscribed on a satoshi, the lowest denomination of a Bitcoin (BTC).

If it keeps growing at the rate it has done, I’ll probably cover it in more detail next month.

Okay, that’s all for this week.

Thanks for reading.

Harry

Full disclosure: At time of writing, I held the following cryptos: Ethereum, IOTA, Radix, Mina Protocol, Aleph Zero.

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