Crypto Industry Report #14
Balzers (LI), 08 January 2020
We start the year with a review of the crypto year 2019:
Our weekly Crypto Industry Report news ticker provides you with the latest information on the global crypto industry – picked and analysed by our blockchain experts.
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Bitcoin’s price and technical developments
At the start of 2019, bitcoin’s price was below $4k and trading within the range $4k to $3.4k, following a major price drop towards the end of 2018. However, in April the price started to gradually recover above $5k and it continued increasing in May crossing $8k.
Then, there was a major rally in June with the price reaching levels over $13k. The announcement of the Libra project by Facebook in June contributed to bitcoin’s price rally.
Following the significant gains achieved in June, the price then started to drop gradually to around $7.5k by the end of October. Then, after the positive comments made by the Chinese president, Xi Jinping, about the blockchain technology and its potential use cases, bitcoin’s price suddenly increased with an over 40% daily gain, which was the third largest daily gain on its history and it brought the price again above $10k at the end of October.
After this sudden increase, the price corrected to $6.6k by the middle of December and it then recovered above $7k by the end of the year. The next halving event of bitcoin will happen in May 2020, and the block rewards for miners will be reduced from 12.5 to 6.25 BTC.
In 2019, several institutional developments for bitcoin were announced such as the launch by Bakkt of both physically-delivered bitcoin futures and the first regulated bitcoin options based on its bitcoin futures as the benchmark.
In addition, bitcoin custody solutions for institutionals significantly improved, both regarding the technical infrastructure as well as other required services like insurance. The gradual professionalisation of bitcoin as an alternative asset class may soon lead some large asset managers to decide allocating a certain percentage of their portfolio to bitcoin.
Regarding technical developments, since the beginning of 2019 the number of lightning network nodes and open channels has been gradually increasing from around 2.3k nodes in January to close to 11k nodes in December.
There are also over 35k channels in the network. Another development was the support added by Bitfinex for deposits and withdrawals via the lightning network and other exchanges are expected to also add support soon.
In addition, Bitfinex is collaborating with developers to launch a stablecoin on the lightning network, which could reduce the volatility risks and facilitate instant and low cost stablecoin payments. The lightning network allows efficient bitcoin micropayments with low fees, but there are limitations for large payments.
Another development for bitcoin is the Liquid sidechain, which is a payment and settlement network for international financial institutions including exchanges, market makers and brokers. Schnorr signatures is another potential improvement for bitcoin that it is being discussed but it has not been implemented yet.
Through Schnorr signatures, it would be possible to aggregate signature data required for bitcoin transactions and it is expected that a significant improvement could be provided for the capacity and the scalability of the bitcoin network. In addition, Schnorr signatures could provide additional privacy both for regular and multisignature transactions.
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Ethereum hard fork updates and the growing staking trend
At the beginning of 2019, ethereum’s price was trading at around $140 and then it corrected to $100 in early February. The price then followed bitcoin’s rally reaching a peak near $350 at the end of June, and then it dropped to levels around $170 towards the end of August.
There was a short recovery to $220 at the end of September, and the price then oscillated between $150-$200 until mid-November, which was followed by a sudden drop to $140 and then close to $120 by mid-December. This price level around $120 was the lowest observed since February 2019, but by the end of the year ethereum’s price recovered above $130.
The Ethereum network was upgraded in February with the Constantinople hard fork, which included also another hard fork at the same block height to disable one of the Ethereum Improvement Proposals (EIPs) that had one identified bug.
The second hard fork called Istanbul was activated in December and shortly afterwards another hard fork, Muir Glacier, was announced for the end of December. The reason for the Muir Glacier hard fork was to better prepare the shift to ethereum 2.0 and to adjust the network so that ethereum 1.0 remains useful and efficient until 2021 when ethereum 2.0 is expected to be fully operational.
As part of the transition to ethereum 2.0, several scalability improvements, both on-chain and off-chain, are being developed such as plasma, state channels, sharding or eWasm.
In 2019, several major exchanges and wallets added staking support for some leading proof of stake (PoS) networks. In addition, several new PoS networks were launched and there seems to be a growing shift from proof of work (PoW) to PoS. Ethereum 2.0, which will be based on PoS, is expected to lead the growing PoS trend.
Moreover, ethereum also led the growth of decentralised finance (defi) in 2019 with the number of defi protocols, users, amount of locked value and cross-protocol activity increasing significantly. Defi is separated into several categories like lending, decentralised exchanges, derivatives, payments or assets.
Lending is the main category in terms of locked assets, in particular with MakerDAO, which reached in 2019 over $300 million in locked assets and it represents a major dominance percentage among all the defi projects. The growing defi trend and the amount of locked value is expected to continue increasing next year.
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International blockchain regulatory developments
Liechtenstein - Blockchain Act
In 2019, the Liechtenstein parliament unanimously approved the Law on Tokens and TT Service Providers (Blockchain Act or TVTG), which came into force on January 1, 2020. The Blockchain Act is the first comprehensive blockchain regulations globally covering the whole token economy and service providers, thus making Liechtenstein a pioneer and leader.
Unlike the blockchain regulations in other countries, the Blockchain Act is not focused on some specific areas of the blockchain industry and instead it regulates all the defined service providers and the representation of any rights and their transfer through tokens, thus establishing a comprehensive legal framework.
Moreover, the Blockchain Act requires obligatory registration of the service providers and it regulates any token generated by registered service providers, unlike in other countries in which registrations are generally optional.
The TVTG defines several key terms like Trustworthy Technologies or TT Systems, the ten TT Service Provider roles and it requires obligatory registration with the Financial Market Authority (FMA).
In addition, it introduces certain requirements like minimum capital, internal control mechanisms, storage of records, supervisory taxes, reporting and publication obligations, segregation of assets and other compliance requirements.
Certain Liechtenstein laws have also been amended following the introduction of the Blockchain Act, like the Due Diligence Act (SPG), the Financial Market Supervision Act (FMAG), the Persons and Companies Act (PGR) and the Business Act (GewG).
In the Blockchain Act, a token container model is introduced in which any type of rights can be tokenised, instead of defining certain categories of tokens. The TVTG aims to provide regulatory clarity within the blockchain industry in Liechtenstein, to protect users and also to encourage and facilitate continuous innovation.
The Blockchain Act may attract blockchain startups or established businesses to Liechtenstein that are looking for regulatory clarity. Therefore, the new legal framework is likely to impact positively Liechtenstein by accelerating the growth of its blockchain industry. In addition, the Blockchain Act could contribute to professionalising and providing additional credibility to crypto assets and the blockchain technology.
5th EU Anti-Money Laundering Directive (AMLD 5) transposition by Germany and the Netherlands
The AMLD 5 led some European countries in 2019, in particular Germany and the Netherlands, to increase the regulatory requirements for crypto related companies, which may need to establish subsidiaries, get a licence or comply with other requirements in order to serve clients based on these countries that are complying with AMLD 5.
Germany for example introduced a government bill for the transposition of the AMLD 5. The bill is introducing amendments to the German Banking Act (KWG) in order to establish crypto assets as financial instruments and also to define crypto asset custody as a new financial service that will require authorisation from the Federal Financial Supervisory Authority (BaFin).
Following some adjustments to the initial bill, crypto asset custody providers will be able to offer other financial services in the same entity. Also, those crypto custodians that are not providing any other services will benefit from reduced capital requirements.
Crypto firms serving the Netherlands will need to register with the Dutch central bank in order to comply with AMLD 5, which will go into effect on January 10, 2020. Self-registration will be required of companies or persons involved in the conversion of crypto to fiat currencies or offering crypto deposit services, including firms that are not based in the Netherlands but that are serving Dutch nationals.
Blockchain regulatory developments in other countries
In France, with the Pacte Law, non-security token issuers and digital asset service providers will have the opportunity to provide more trust to clients through an optional licence. However, in order to comply with anti-money laundering (AML) concerns as indicated in the AMLD 5, the licence registration will not be optional for custodians of crypto assets and those providing services related to the purchase or sale of digital currencies against fiat.
The financial regulator in Hong Kong published a new licensing scheme for crypto exchanges, however the licence is required only if the exchanges trade securities. It was also defined that products can be offered only to professional investors and that a maximum of 2% of the total funds can be kept in hot wallets. In addition, regulations for crypto fund managers were published, requiring an independent custodian and minimum levels of liquid capital.
In the US, the New York Department of Financial Services (NYDFS) announced the upcoming update of its virtual currency licence (BitLicense), with comments being accepted. This would be the first BitLicense update since five years.
The Indian government did not finally consider a crypto draft bill called ‘Banning of Cryptocurrency & Regulation of Official Digital Currencies’ during the winter session of Parliament, which was welcomed by the crypto community in India.
In Singapore, a consultation paper could lead the derivatives that include payment tokens such as bitcoin as underlying assets to fall under the Monetary Authority of Singapore (MAS) regulatory scope. However, it was indicated that MAS will only regulate the payment token derivatives that are offered by approved exchanges. In addition, MAS is aiming to introduce certain measures to protect and discourage retail investors from trading crypto derivative products.
The National Policy Committee of the National Assembly in South Korea passed a bill that will provide a legal framework for crypto currencies by classifying them as digital assets and it will establish the rules for financial transactions. In addition, the bill will require crypto related companies to prevent money laundering. However, before coming into force, the bill still needs to be approved and reviewed by the Legislation and Judiciary Committee and signed by the President.
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Bank Frick becomes a pioneer in blockchain tokenisation
In 2019, the Financial Market Authority (FMA) in Liechtenstein approved the first regulated alternative investment fund (AIF) in Europe to issue tokenised fund units.
Bank Frick became a pioneer by being part of this project since previous attempts to tokenise funds were focused on intermediary steps with the tokenisation of Special Purpose Vehicles (SPVs) and not the funds themselves, while in this project the token reflects the fund share directly.
Blockchain tokenisation is a growing trend with an important potential, especially for illiquid assets such as real estate, which could benefit from several advantages like a liquidity premium, fractional ownership, access to a global pool of investors and more efficient transactions leading to innovative investment opportunities.
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Announcements of Facebook’s Libra global stablecoin and central bank digital currency (CBDC) projects
Facebook announced its Libra global stablecoin project in June, which contributed to bitcoin’s price rally. The Libra Foundation was also established in Geneva with members including large global corporations.
However, shortly after the announcement of the project, international regulators identified several important risks of such a global stablecoin. In particular, if Libra becomes widely used worldwide for payments in the future then it could be a threat to the US Dollar and other national fiat currencies.
In addition, regulators had concerns about the privacy of Libra users and how Facebook will process or access the large amount of data involving Libra transactions.
Following warnings from some US senators and negative comments from several EU countries claiming that they would not allow Libra to launch in Europe, key Libra association members like Paypal, Visa or Mastercard announced that they were leaving the Libra association.
In addition, Facebook’s founder and CEO, Mark Zuckerberg, and David Marcus, the head of the Libra project, had to testify in court for several hours regarding the Libra project. Therefore, while the technical development of the project is progressing, it is not clear when or if Libra will be finally allowed to launch, in particular due to the risks related to the large Facebook user base of several billions. If those billions of Facebook users quickly start using the Libra stablecoin for international payments, then several risks could happen including those related to financial stability and the sovereignty of central banks and national fiat currencies.
In 2019, several major central banks and the Bank for International Settlements (BIS) started to research in detail central bank digital currencies (CBDCs). In particular, some countries like France, China or Sweden announced pilot projects and testing of CBDCs for next year. However, the focus will be CBDCs within financial institutions since a CBDC for the general public could introduce additional risks and it would require additional supervision.
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Launch of Bakkt’s bitcoin trading and custody products and other institutional developments
In 2019, Bakkt launched its physically-delivered bitcoin futures. Although the trading volume was initially low, it gradually kept increasing.
In December, Bakkt also launched cash-settled bitcoin futures and the first regulated bitcoin options based on its physically-settled bitcoin futures. Moreover, Bakkt obtained regulatory approval from the New York State Department of Financial Services (NYDFS) to accept any institution in the Bakkt Warehouse custody solution, which offers institutional level insurance.
Furthermore, during 2019 the institutional custody infrastructure of bitcoin improved significantly, not only with the Bakkt Warehouse, but also with other regulated custodians like Fidelity Digital Assets (FDAS) and institutional custody solutions like the Ledger vault introducing large insurance cover as well for clients.
In addition, Bakkt’s CEO was appointed for a seat at the US Senate and therefore she had to leave her role as CEO. For next year, Bakkt also announced the upcoming launch of a consumer app to facilitate payments in bitcoin with Starbucks already confirmed as a partner.
Furthermore, CBOE stopped its bitcoin futures and CME announced that they will also launch bitcoin options in 2020. Regarding Bitcoin ETFs, all the applications in 2019 were either rejected or withdrawn in order to improve them before further consideration by the regulators.
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Growth of crypto banks and increased demand for crypto banking products and services
The first crypto focused banks received banking licences in 2019. Sygnum obtained licences in both Switzerland and Singapore and SEBA Bank in Switzerland. Moreover, the US crypto friendly bank Silvergate successfully did an IPO on the New York Stock Exchange (NYSE) to further expand its crypto services.
There is a growing demand for crypto products and services and a bridge between traditional and crypto banking. This demand led some Swiss banks for example to announce that they will start providing crypto services.
This trend is expected to continue next year with the professionalisation of the industry, the likely launch of additional crypto focused banks and also with more traditional banks starting to offer crypto services.
Traditional and crypto banking may gradually be combined and eventually banks might offer all services to clients without the separation of traditional and crypto banking.
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Lawsuits involving Tether, Bitfinex and related companies
Bitfinex, Tether and other related companies like Crypto Capital were involved in 2019 in several lawsuits being accused of fraud and manipulation of the crypto markets. The main lawsuit is claiming over $1.4 trillion in damages and it is being represented by a prestigious law firm, which was previously successful in other important crypto related lawsuits.
The law firm claims that each Tether (USDT) is not actually backed by one US dollar and therefore crypto prices were manipulated. Tether and Bitfinex are closely connected since Bitfinex is the gateway for Tether to introduce USDT in the crypto markets.
Bitfinex was accused of using funds from Tether’s reserve to cover a shortfall of $850 million and, in addition, an attorney for Bitfinex admitted in court that Tether had invested in instruments beyond cash for the reserve, including bitcoin.
Since the USDT trading volume is significant, the outcome of the different lawsuits or whether Tether holds enough reserves could have an important impact in the crypto markets. The influence of Bitfinex is also relevant since it managed to raise $1 billion efficiently through an Initial Exchange Offering (IEO) in order to cover $850 million in funds that were inaccessible and held with Crypto Capital. The funds were not accessible because Crypto Capital was accused of money laundering and its founder was arrested.
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The Chinese president commented positively and other major governments and central banks became aware about the advantages and use cases of the blockchain technology
The Chinese president, Xi Jinping, made in 2019 his first positive comments about the blockchain technology and its potential applications in China. He claimed that blockchain could be applied in several areas in China including education, employment or food and medicine safety among others.
Following these comments, bitcoin’s price had the third largest daily gain in its history, although Xi Jinping positive comments were about the blockchain technology, not bitcoin or crypto currencies. Following the large over 40% daily BTC gain, China clarified that they are supportive of blockchain but not crypto speculation, which then contributed to a correction of bitcoin’s price.
Xi Jinping said that China should clarify the direction, the investments and accelerate the development of the blockchain technology. In addition, it was announced that the Chinese central bank is developing a digital yuan and tests are expected next year.
The US president commented in 2019 about bitcoin and cryptocurrencies through Twitter. His comments were negative, mentioning several risks and also claiming that if Facebook wants to become a bank with the Libra project then it would need to obtain the required licences and comply with banking regulations.
In addition, the Federal Reserve chairman claimed that while there are no plans for a central bank digital currency (CBDC), the idea is being researched and analysed in detail and the progress in other countries is being monitored.
The Bank for International Settlements (BIS) also developed a positive attitude towards CBDCs in 2019 with the launch of the BIS Innovation Hub, which will research and test CBDCs. Moreover, the European Central Bank (ECB) president claimed that the ECB should be ahead of the curve regarding stablecoins, due to a clear demand. Furthermore, the G7 group delivered an assessment report about the challenges and opportunities regarding global stablecoins.
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