The Breakdown - China Completes "Top-Level" Digital Currency Design

Episode Date: January 10, 2020

China’s digital currency project continues to move ahead aggressively, with a new paper from the People’s Bank of China suggesting that a core design is complete. Whatever stage of development the currency actually is, it’s clear that China wants the world to see it as ahead of the curve in the digital currency race.  In other parts of the world, crypto companies face a never-ending game of regulatory arbitrage. Derebit has moved from the Netherlands to Panama, citing a new burden from AMLD5 compliance. In the U.S., New York wants to give its crypto regulators (even) more teeth while Illinois recognizes the legality of blockchain-based contracts.

Welcome back to The Breakdown, an everyday analysis breaking down the most important stories in Bitcoin, crypto, and beyond, with your host, NLW. The Breakdown is distributed by CoinDesk. Welcome back to The Breakdown. What's going on, guys? It is Friday, January 10th. And today we're going to be talking about what I think is probably the most significant shaping factor in our entire industry, which is the role of governments, in the crypto industry, and in particular, China and the rest of the world responding to China getting into the digital currency game. So we're going to talk a little bit about the latest news from China around its digital currency project.

Then we're going to look at some new regulations going into effect in Europe and what they might mean and what they're actually doing vis-a-vis crypto companies. And then third and finally, we're going to look at a couple different examples of U.S. regulatory arbitrage within different states and how state-level regulation is impacted. acting crypto companies as well. But first, let's start with China. In my estimation, the most significant narrative or story of last year of 2019 was the combination of Libra and China's response to Libra. I think that if Libra had just happened as it is, it would have gotten a lot of governments to pay attention more to this industry. Certainly the U.S. government, for example,

perked up in a huge way in a way that Bitcoin or ICOs even hadn't been able to make them do. Because of, I think, two things. One, Zuckerberg's clear track record of not particularly caring what U.S. regulators thought. And two, the fact that he was bringing two billion people to the digital currency party. That got them thinking about digital currency in a whole different way. That got them treating Libra as a threat in a whole different way. However, what really set the trigger of the rest of the world, I think, was the additional impact of China's response to Libra

and how China almost immediately started talking about how they had accelerated efforts on their digital yuan project that had started in a research and development capacity more than five years ago in 2014 and how they were talking then, and this was the middle part of last year, about how they might even be testing as early as the winter of this year. So the latest is that a new paper that has been released

from the People's Bank of China, says that, quote, the top-level design of the digital currency has been completed. It was reported on a bunch of Chinese news sites, and then it was picked up by the block. It was picked up by a couple of the folks like Matthew Graham, who are crypto-twitter denizens in the U.S. but are based in China. And so basically the paper said that the top-level design, standard formulation, functional research, and development has been completed. And the next steps are basically more testing, following the principles of science. stability, security, and control. And this was all from the head of the digital currency research Institute at the PBOC. So basically, everything is progressing smoothly. What does this actually mean?

Well, one, we still don't have a date for when it actually launches. But two, it suggests to me that China is trying to show that they are ahead of the curve when it comes to this whole blockchain thing. They are moving more quickly than anyone else out there, that they are progressing in a way that no one else can claim to be, and that they are going to be the leader, they are going to put their stamp on this. I actually took to Twitter to ask a question about what people thought about this. Now, admittedly, Twitter is not full of China experts. It's not even really full of crypto experts necessarily. It's full of a lot of people who have a lot of passion, a lot of strong feelings, who are working their butts off to learn, right? So take that with a grain of salt.

But I asked people basically, and this was quoting Matthew Graham, who I mentioned earlier, no global power takes blockchain more seriously than China. And I said, agree or disagree? And by and large, most people were agreeing. However, there was one comment from a friend of mine, actually a college friend of mine, who I started a magazine with back in 2003, named Graham Webster, who's a China expert. He runs a China project for Yale and Stanford.

And he wrote, there's an element of recognizing it is a something and trying to make sure that something supports rather than undermines the current system. So basically he's saying, China clearly thinks there's something here and they want to direct it towards what's good for them, right? So they want to co-opt it towards their own ends. Secondly, he says, this leads to loud propaganda and a few initiatives, but hard to say if there's any, quote, serious engagement beyond vague control efforts. Now, I think a lot of folks would point to headlines about hundreds of millions of dollars

or tens of millions of dollars being spent on a provincial level around blockchain initiatives and those seem like serious efforts, but maybe they are really just about this idea of controlling the narrative and controlling the space, and this is just part of a larger geopolitical game. Either way, I still believe that it's impossible to argue that when it comes to world powers, anyone is moving as rapidly and as quickly and certainly as loudly as China when it comes to digital currencies. I continue to think that this will be the key story for this year and potentially beyond. And of course, one aspect of that story will be what U.S. regulators actually allow Libra to do, whether they actually allow Libra to go forward. Now, interestingly, on that front,

another little bit of news, Mark Zuckerberg has just unveiled a 10-year vision plan for Facebook. And it says a ton about financial services. It talks a lot about the opportunity to, quote, decentralized finance and business. Here's a quote directly from the post about it. Over the next we hope to build the commerce and payments tools so that every small business has easy access to the same technology that previously only big companies had. Zuckerberg says he hopes his company's efforts will, quote, go a long way towards creating more opportunity around the world. What he doesn't mention is Libra. Libra is nowhere in this. Really interesting, no matter what, but I think that there's two possible explanations. First one is that they are playing a strategic

game where a central part of their argument to regulators is that Facebook and Libra are separate, that Facebook was the initiator of Libra, but Libra is the Libra Association, and that Facebook's involvement in Libra going forward will be Calibra, the subsidiary, that builds tools for the Libra cryptocurrency. So in this estimation, the point about not including Libra is a strategic decision that's part of ongoing attempts to get regulatory support and an argument that Facebook and Zuckerberg in particular himself have distance from the project. The perhaps more cynical take is that they're hedging and that Zuckerberg wants to give himself outs to basically fold and wrap up that project or let it kind of go by the wayside. And this is something I've talked about on this

podcast before. And I certainly don't think this is the case with the people who are working on Libra for Facebook, the David Marcuses and Morgan Bellers of the world. I think they're all in it and pushing their little faces off. But it's not impossible to envision a world in which Libra ends up being a sacrificial lamb, let's call it, for larger policy objectives as it relates to Facebook, right? There are still lots of outstanding questions around Facebook, around antitrust, and many other issues that are separate from Libra and potentially threaten their core business. And you can, without too much imagination, I think, see a world in which the barriers to get Libra pushed forward are so high that they actually use it as a way to basically say, look, you know,

we're willing to play ball. In fact, you know, we're willing to kill this project, which we've invested a lot of time and resources into because we couldn't get you comfortable with it. And look at us. We're turning over a new leaf and being the type of company that you want to work with. So we'll have to see, but I certainly think that this new 10-year vision and this 2030 vision is pretty interesting as a piece of evidence one way or another. So speaking of Facebook, let's turn to another topic that relates to the kind of the global game of coins and this global regulatory arbitrage game that crypto companies have to play. We're going to be talking about a new piece of legislation called AMLD5, but first I think we have to look back at the last

major European regulatory experiment called GDPR. So GDPR was a data protection act. It was intended to basically make people's data safer. And what has happened in point of fact is that it has created an entirely new compliance burden that totally benefits large companies over startups. So Antonio Garcia-Martinez, who's the author of Chaos Monkeys, he's written for Wired and many others, and his deep experience at Silicon Valley wrote, GDPR is working exactly as everyone who knew the first thing about ads thought it would. GDPR kills upstart competition by making the compliance onus even greater, which startups generally don't have the resources to deal with. This is borne out in a chart that he was tweeting about that shows that Facebook and Google have each grown 80 billion over the last four years while the rest of the online ad marketplace has shrunk.

The cost of compliance is so high that it actually forces competition out. It benefits rather than just burdens the largest companies because they can afford to pay to deal with the burden. They can hire people to deal with the new compliance challenge. AMLD5 is a different type of registration. It is the fifth anti-money laundering directive, or AMLD-5. It's a European Union statute. And in the context of crypto, the challenge is that it basically requires exchanges and any custodial service providers to do a lot more, right?

They have to register with a local regulator. They have to demonstrate compliance, go deep on KYC and AML procedures. And it gives basically all of the authorities and powers that be much greater power to get involved, it gives law enforcement much greater power. Let's talk first about what could be good about this. In the long run, the companies that are able to abide by this and actually participate with it, it does bring them into the financial mainstream in a more major way. It allows potentially other financial institutions in Europe to have a higher grade of trust and so on and so forth. Anytime that I think it's more regulated, there's some portion of the market for whom trust will

increase in those entities that are now better regulated. The challenge is basically the same as GDPR in terms of who can actually pay to play, right? Who can actually deal with the new burden? An article on CoinDesk today showed that this seems to already be having an impact. So most notably is the derivative exchange derivet has moved from the Netherlands, where it was based in Amsterdam, to Panama. It's basically picked up and moved from Europe. to get out of the way of these regulations. And basically they're saying, quote, if Deribit falls under these new regulations, this would mean we have to demand an extensive amount of information from our current and future customers. We believe that crypto markets should be freely available to most,

and the new regulations would put two high barriers for the majority of traders, both regulatory and cost-wise. It's not new to see crypto companies playing this regulatory arbitrage game where they move away from major jurisdictions to places that have more crypto-friendly policies. Obviously, finance has been on a continuous rock-skipping journey around the world. A circle left the U.S. last year. So this isn't new, but it just is another indication that we're going to continue to see crypto companies, one, be willing to move when there's regulatory issues, and two, basically have to move.

it's dramatic only in the context of seeing on the one hand, you know, these governments that are putting so much emphasis on blockchain, you know, whatever that means, while others are effectively trying to strangle this nascent industry in its bed through regulation. Now, of course, most regulators wouldn't say that they're doing that. They're just trying to, you know, ensure that this industry isn't used for nefarious purposes. However, it amounts to effectively the same thing. Now, the last thing I wanted to talk about today is the fact that this isn't just an issue of nation states. It is, in the context of U.S., also a state-level regulatory issue. If you've ever tried to use a crypto product, for example, in the state of New York, you've

probably been geofenced and geoblocked based on where your IP address is. And that has a lot to do with the New York Department of Financial Services, NYDFS, which created a notoriously difficult license called the Bit License, which forced many companies, notably and famously, exchanges like Cracken, to leave New York because it was just so burdensome. The latest out of New York is that the governor, Andrew Cuomo, wants to give NYDFS even more power in regulating certain types of license entities, including crypto companies. Basically, they feel that there are certain loopholes in terms of having to pay for assessments and oversight requirements that companies are using to get around and they want to close those loopholes. And, you know, on the one hand,

this is fine. Every state has its own prerogatives. They get to decide what types of businesses they want in their, in their jurisdictions or not. But it is starkly contrasted with the approach of other states. For example, obviously, there's everything that's been going on in Wyoming, which has been working very hard to be the state-level pioneer of what pro-business, pro-crypto policies look like. But in other places, too, it's not just in Wyoming. Just today, news broke that Illinois had legalized blockchain contracts. They were recognizing smart contracts and other blockchain-based records as legitimate legal tools, basically. This is a area where there's obviously a little bit of a difference between smart contracts and blockchain-based contracts

and cryptocurrency businesses, on the other hand. I'm not trying to smash and minimize these different distinctions. However, it shows, I think, the just different attitudes of policymakers and the fact that this is still such a fragmented landscape when it comes to regulatory consensus, even in the context of the U.S. The summation of all of this is that we still have a highly dynamic global regulatory environment when it comes to crypto, crypto assets, digital assets, and blockchain. And obviously, these distinctions mean something when it comes to regulatory action, when it comes to regulatory attitudes. You know, China is very clearly pro-blockchain, whatever that means, but very anti-crypto. They're very interested in their own digital currency

that uses some of the same tools while making it useful for them from a control and surveillance perspective. In Europe, they're focused on things like data and consumer protections that are running into challenges when it comes to crypto companies coming online. They're obviously antagonistic towards not only Libra-style corporate coin, but also to Chinese digital currencies and are looking into their own digital currencies at a European or national level. You have other jurisdictions around the world that are taking advantage of the big global powers antagonism towards these digital assets to create friendlier pro-crypto environments. Obviously, Malta has been one, but Panama's on the scene now, as we see from Deribit.

So the global game of coins is going to continue. It's going to continue to be dynamic. And I think that for crypto companies, honestly, they just have to be prepared to pick up and move shop, which, if nothing else, is a very strong argument. for remote work. Anyways, that's it for this week. That's the breakdown for today. I'm interested to see what you think.

Do you think that China is the most aggressively involved in blockchain government in the world? Do you think that China's approach to blockchain is inherently antagonistic towards Bitcoin and the principles of Bitcoin? Do you think that they are ideologically opposed in mortal enemies in some way? Let me know what you think on Twitter at NLW.

And as always, thanks for listening. this week, guys, and I will catch you on Monday.