The Breakdown - Crypto’s Center of Gravity Is Shifting Away from the U.S.

Episode Date: March 5, 2023

On this “Long Reads Sunday,” NLW reads: The Future of Crypto Markets Will Be Driven by Developments in the East - Noelle Acheson Keep Crypto in America - Emily Parker  - “The Breakdown” is written, produced and narrated by Nathaniel Whittemore aka NLW, with editing by Michele Musso and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: Nataliia Nesterenko/ Getty Images, modified by CoinDesk.  Join the discussion at discord.gg/VrKRrfKCz8.   Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26-28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com.  

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is produced and distributed by CoinDess. What's going on, guys? It is Sunday, March 5th, and that means it's time for Long Reads Sunday. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the breakers discord. You can find a link in the show notes or go to bit.ly slash breakdown pod.

All right, guys, well, today we have an interesting theme, and we're going to spread this out over a couple of pieces, and I think a good way to kick it off is to point to a tweet which really deserves the visual, but it's from Brian Quintends, a former CFTC commissioner who's now at Andresen Horowitz, and he shared a chart put together by Electric Capital that is the percentage of all of the world's crypto developers who are in the U.S. The proportion of the developers in the U.S. has steadily declined year over year. In 2017, it was around 42%. In 2018, it was around 39%.

In 2019, it was around 36%. In 2020, it was around 33%. In 2021, it was around 31%. And in 2022, it was around 28%. Now, I don't think there's anything wrong with developers coming from all over the world. And the best way to read this chart, or the most hopeful way to read this chart, would be that other developers from other places got in the game. However, I think, as you'll see from our topic today, that there might be something else going on,

and certainly that was the point that Brian was trying to make. The comment that he added to the chart was this. For Gary Gensler, this is what success looks like. The point, of course, is that the U.S. seems to be determined to push crypto offshore, and that is the theme of the conversation today. So we're going to start with a piece by Noel Atchison, who used to be the head of research at CoinDesk and Genesis Trading, that's called The Future of Crypto Markets, will be driven by developments

in the East. Crypto investors need to keep an eye on geopolitical shifts playing out on the regulatory landscape, specifically some upcoming changes in Asia. Noel writes, as political experts focus on the diplomatic dance and building tensions between the United States and China, punctuated by some balloon-shaped comic relief that might end up not being so funny after all, a more benign battle is brewing in the halls of financial regulators. While local for now, nothing stays local for long in global markets. The potential ramifications go well beyond crypto markets, potentially shaping economic influence that in this changing landscape is more geostrategically important than ever. Earlier this week, Hong Kong Securities and Futures Commission, or SFC,

published the proposed text of its upcoming crypto regulation, slated to go into effect on June 1st, and opened it up for public comment. Its scope includes the licensing for crypto asset service platforms, which were originally only going to be allowed to service accredited investors. The SFC is now seeking input on whether or not retail investors should also be allowed to participate, and what types of protection should be in place.

Also open for discussion is the range of quote-unquote approved assets, which in principle would only include a limited selection of the most liquid tokens. So far, this seems like yet another example of a jurisdiction way ahead of the United States in terms of regulatory clarity and willingness to engage with the public on the topic. Yet lifting the little little, it is so much more. It is also an example of the East-West strategy divide, the power of retail, and the importance of watching the flows. Not that long ago, Hong Kong was not exactly welcoming to crypto businesses.

But nor was it overly antagonistic. It seemed to regard them as largely inconsequential, in contrast to China's building antagonism. In 2020, Hong Kong announced plans to introduce a new licensing regime to directly regulate all crypto platforms and to limit their reach to accredited investors. This recent move seems not only to clarify those promises, but also to broaden the scope and take into account what the regulators see as growing retail interest. Yet, it's about more than licensing. Hong Kong has also budgeted around 50 million Hong Kong dollars or around 6.4 million U.S.

for crypto asset development, including education efforts for individuals and businesses. And Hong Kong's financial secretary, Paul Chan, announced the launch of a task force composed of policy and industry representatives to explore crypto asset integration. This feels much broader and longer term than just crypto service provider insight. In part, it's about laying some groundwork for the economic growth of the region. Hong Kong's economy depends largely on financial services and tourism from the mainland, both of which were hit hard by the strict COVID-19 pandemic lockdowns. It recently reported its fourth consecutive quarterly GDP contraction, and the region's chief executive, John Lee, has vowed to prioritize attracting foreign talent. Most crypto firms based in Hong Kong

left as China's 2021 crypto trading and mining ban cast a cloud of operational uncertainty. Now several have announced they will be applying to return. It's also about more than just Hong Kong and its 7 million residents. Hong Kong is obviously closely affiliated with China. The two jurisdictions operate under the constitutional principle of one country, two systems, which separates Hong Kong's economic administration from that of its much larger parent. But events leading up to and during the recent protests made clear to the world that China holds the reins and that nothing happens in Hong Kong without China's approval. Here's where it gets particularly interesting.

China seems to approve of Hong Kong's crypto moves. Earlier last week, Bloomberg reported that Chinese officials had been seen at Hong Kong crypto events. They were not undercover. In January, Huang Yu Ping, a former member of the Monetary Policy Committee of China's Central Bank, said in a public speech the country should reconsider its crypto ban. He was not speaking on behalf of the central bank, but it is extremely unlikely his speech would have become public without official approval. None of this necessarily means that mainland China will be opening up to crypto markets

anytime soon. But it could be that China is watching Hong Kong's move with a view to relaxing its stance and eventually supporting the integration of global crypto assets into its economy. This matters in part because of size. There are no small numbers in China, and the sheer scale of the potential participant pool could dwarf virtually any more. market. The country reportedly has 212 million retail investors. Comparison, the entire population of the United States is approximately 330 million. Many of these investors have withdrawn from the

stock market given the economic uncertainty during the dark lockdown period, but with the improving outlook, some of the buildup of pandemic savings could be looking for high returns. What's more, Chinese retail investors tend to be less risk-averse than their U.S. counterparts. In general, they prefer momentum chasing to steady yields, which, in part, explains their enthusiasm for crypto markets a few years ago, and why the potential risk of a wipeout grew to the stage where the government felt the need to close off access. It did not manage to completely stamp out crypto activity, however. Around 8% of FTX's creditors are mainland-based, according to the filings. And China-based miners could account for approximately 20% of global hash rate,

according to the most recent study of Bitcoin mining published by Cambridge. Also, China is one of the few regions of the world actively easing money supply. Earlier this month, the central bank ramped up liquidity injections while keeping the monetary policy rate steady. But analysts expect the committee to continue to cut rates in the second quarter. The number of new loans extended by Chinese banks more than tripled between December and January. Most of us don't have to cast our memories too far back to remember what monetary easing can do for risk assets. China versus the U.S., two different styles of gamesmanship. It also matters in part because of geopolitics. It is no secret that China would like to see a weakening of the dollar's

international role without actually hurting the dollar, and it seems to understand that the role of U.S. capital markets is a key factor in global trade. For a few years now, financial regulators have been working to encourage more activity on Chinese markets, such as opening them up more to foreign investors, enabling more hedging, streamlining offshore listing requirements, and boosting trade settled in yuan. Allowing the opening of crypto markets could, of course, encourage more flows out of the yuan, which the Chinese authorities would understandably prefer to avoid. But if crypto assets and the innovation they bring are going to be key to the development of the financial markets of tomorrow, then China would obviously want some influence. Furthermore, China

is probably watching with interest to building antagonism towards crypto from Washington, D.C. If the U.S. sees crypto markets as a threat, it could be a threat worth exploring. This is representative of the typical strategic approach of the two economic superpowers. I once heard someone compare the relative philosophies to board games popular in each region. In the U.S., they play chess, where you win by killing your opponent's leader. In China, they prefer Go, where you win by conquering and holding onto territory. It could be that Chinese leaders see crypto assets as a territory play, with global financial markets as the playing field.

rather than an enemy to be weakened, crypto markets could be a strategic pillar of a new world order, or at the very least, an opportunity to attract global capital, talent, and prestige. So far this year, analysts have been focused on macro factors as the main driver of crypto market performance, with evolving use cases and technical speculation, also a feature of the recovery. It could be that a more significant driver is slowly building on the global strategy stage,

specifically in the geopolitical rivers of the east. All right, thanks to Noel for that great piece. If you guys have been listening to my show, you know that this is a thesis that I am quite intrigued by and is something that I'm watching closely. I don't really have that much more to add from what Noel has put here. I think that it is extremely notable that Chinese officials seem to be watching what's going on in Hong Kong and the loosening there and viewing it with openness. I don't think that any real decision has been made about whether crypto is a strategic asset in this geopolitical competition, but I do think it's

worth continuing to ask that question. Join CoinDesk's Consensus 2023. The most important conversation in crypto and Web 3, happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web 3, and the Metaverse yourself in all that blockchain technology has to offer creators, builders, founders, founders, brand leaders, entrepreneurs, and more. Use code Breakdown to get 15% off your paths. Visit Consensus.coindex.com or check the link in the show notes. Next up, we turn to CoinDesk's Emily Parker.

She published a piece this week called Keep Crypto in America. If the SEC is serious about U.S. investor protection, it should want crypto to stay in the United States. Emily writes, the SEC has been cracking down on crypto, setting off warning bells in the U.S. One fear is that regulatory uncertainty will push crypto industry players to avoid doing business in the country. And there are some signs that this isn't mere alarmism. Crypto lender Nexo announced late last year that it was leaving the U.S. after more than 18 months of, quote, good faith dialogue with U.S. state and federal regulators came to a dead end.

Jeff Dorman, chief investment officer at ARCA, told Bloomberg that the new companies that his firm is exploring are not even bothering with the U.S. Binance, which is the world's largest crypto exchange by trading volume, is reportedly looking to end some relationships with U.S. business partners and is taking another look at its U.S. venture capital investments. Jason Gottlieb, partner and chairman of the digital assets department at the law firm Morrison Cohen, LLP, said, I have been advising a number of projects to bubble off the United States. Don't sell tokens to U.S. users. Don't allow U.S. users to access the site or take

advantage of all of its functionality. Don't market in the U.S., etc. Boyd-Cohen, CEO and co-founder Lomob wrote, I can tell you from firsthand experience as a crypto founder myself, every single lawyer we have met with has advised us against considering the U.S. due to the regulatory uncertainty. There's no jurisdiction in the U.S. that would make sense for us to consider, concluded Cohen, who is himself an American. It's not clear if top regulators are concerned about this, But they should be. Because even if much of the crypto industry left the U.S., crypto won't. According to a new survey of U.S. adults by Crypto Exchange Coinbase,

20% of Americans own crypto. Even if this number isn't completely accurate, it's clear that crypto is something that U.S. regulators can't ignore. As long as crypto continues to exist, ordinary Americans will find ways to buy and trade it. Venture capitalists will invest in it, and entrepreneurs will build projects around it. If the U.S. can't get its act together,

domestic crypto projects will just operate in a gray area, and Americans will turn to offshore entities with potentially weaker safeguards. In other words, if the SEC is serious about U.S. investor protection, it would make more sense to keep crypto businesses at home. The problem isn't that the SEC is too strict. It's that it's too confusing. Crypto advocates have long argued that the SEC punishes select projects through regulation by enforcement instead of laying out clear rules and guidelines.

As a result, bad actors can slip through the cracks, while those who just want to play by the rules don't have a clear path to do so. And it's not just the SEC. industry insiders have described the situation in Washington as a crackdown or Operation Chokepoint 2.0. There's been too much regulatory activity to sum up briefly here, but among the more controversial moves were a pending SEC lawsuit against Paxos on its BUSD stablecoin, and its shutting down of a crypto exchange Cracken's staking program. The case of BUSD left many wondering why that stable coin was targeted instead of others, and how exactly a stable coin would be deemed a security.

As for Cracken, a big part of the problem was the SEC's approach. In her dissent, SEC Commissioner Hester Perce, wrote that it would have been better to have issued prior guidance on staking rather than communicating through an enforcement action. Perse went so far as to suggest that the SEC was acting in a manner of a, quote, paternalistic and lazy regulator. Given that the cryptocurrency industry is global in nature, projects have plenty of other options outside the United States. Countries that appear to be friendly or at least relatively clear on crypto are more likely

to attract talent. Dubai has just unveiled a new crypto-regulatory framework. Singapore's relative clarity and crypto-friendliness has long been a draw for Web3 projects. Now we also have Hong Kong seeking to establish itself as a Web3 hub of Asia, if not the world. Japan is also embracing crypto. These developments give me reason to believe that the next bull run might well come from Asia. At the same time, we are seeing crypto exchanges set up shop in Europe, which will soon have

an extensive regulatory framework for crypto assets. It's worth noting that it isn't particularly easy to do crypto business in places like Hong Kong or Japan. Both have strict standards for crypto exchanges and the tokens listed on them. What these two jurisdictions offer are relative clarity on rules and expectations, for projects that wish to operate there. The problem with the U.S. is that even projects that want to play by the rules find it difficult to do so, because the U.S. hasn't quite decided how to regulate crypto.

Soon after the Cracken decision, SEC Chairman Gary Gensler stoked the flames of crypto Twitter by saying the following on CNBC. Cracken knew how to register. Others knew how to register. It's just a form on our website. They can come in, talk to our talented people and disclosure review teams. The comment was swiftly mocked by Cracken co-founder and CEO Jesse Powell, who tweeted, quote, says just register. We say cool, but as what? Because the regulations just don't fit. In response,

we get blank stares, apologies, and mumbles that they're not going to give us legal advice. Rebecca Reddigg, chief policy officer of Polygon Labs, echoed that sentiment on Laura Shins-on-Chain podcast. If a company goes into the SEC to register, she said, the typical refrain is we're not sure what to register you as. Even worse, quote, you might get a well's notice or a subpoena letter from the enforcement arm of the SEC. This is a persistent problem. Lisa Briganka, a former SEC enforcement branch chief said, I represented a crypto trading platform back in 2018 that wanted to get registered and in compliance, but the SEC and FINRA were not the least bit interested in that process. That attitude has changed, it has only changed a small amount. Some of the

SEC's actions are more controversial than others. There probably won't be many tears shed over the lawsuit against Terraform Labs founder and CEO Doe Kwan, for example. But that one is too late. Doe's UST stable coin imploded last year, causing billions of dollars to evaporate. Doe has already escape to Serbia or wherever he is now. Meanwhile, as places like Hong Kong and Japan move forward with Staplecoin regulations, U.S. lawmakers are still debating various bills. The SEC went after a stablecoin issued by Paxos, which was registered with the New York Department of Financial Services, in an attempt to play by the rules. In the absence of any guidelines on Stablecoins, how are issuers to know what crosses the line? Paul Grewell, Chief Legal Counsel at Crypto Exchange Coinbase,

said recently, this breaks my heart to say this as an American. I think any Stablecoin issue or ought to first ask whether or not the United States in this current climate is necessarily the best place in which to develop their project in the first instance. And therein lies the problem, because stablecoins aren't just going to disappear. They will just go somewhere else. We've already seen how the actions against BUSD appear to benefit Tether, an offshore stable coin whose reserves and general opacity have sparked much concern. This is just one example of how a domestic U.S. crackdown is fueling an offshore player that U.S. regulators can't control, even though that player still has implications for U.S. investors in the U.S. dollar.

Custodia Bank founder and CEO, Caitlin Long, said that Tether said, quote, they've not done business in the U.S. but they're getting U.S. dollar clearing from somewhere, right? It's the so-called Eurodollar market, dollars that circulate offshore, outside of the United States, outside of, frankly, the reach of U.S. bank regulators. Let's be clear. Some in Washington would probably be thrilled if crypto just took off and left. That would be one less problem for them to worry about. Some enthusiasts will counter this with arguments along the lines of the U.S. can't afford to out on the crypto revolution and the next wave of financial innovation. But such claims aren't likely

to convince lawmakers who see crypto as little more than a traveling casino. It would be better to make a more practical argument about U.S. investor protection, and that is, if the U.S. fumbles the ball, the ball will get further out of its reach. Crypto businesses will just go offshore, where U.S. regulators will have less influence. And offshore businesses can still do great damage to Americans. There's probably no better example than the Bahamas-based Crypto Exchange FtX, whose implosion spark bankruptcies in U.S.-based companies and major losses in U.S.-based venture capitalist firms. The CFTC alleged that FTX's demise affected commodity prices in the U.S. The collapse of Singapore-based Terraform Labs also had disastrous effect on some U.S. investors,

such as a surgeon in Massachusetts who lost his nest egg on the failed project. Briganka said, people living in the U.S. want crypto. They can't buy it here. They will use technology to hide their residency to buy it on foreign exchanges. There is so much more to be done in terms of establishing clear rules and guidance. Japan, for example, has a rule that exchanges must segregate customer and corporate assets. The regulation played a big role in ensuring that FTX Japan customers get their money back. The SEC has taken a first step by proposing new rules for qualified custodians in crypto,

but the rule is still in a public comment phase, which means it's far from becoming a reality. A larger problem is that there is no federal regulator for U.S. crypto exchanges. One advantage of a jurisdiction like Japan is that there is only one regulator for the crypto industry, the financial services agency. In the U.S., crypto is regulated by the various parties, including the SEC and CFTC, and crypto exchanges are mostly regulated at the state level. Starting out this confusion would have to come from Congress, which could help define who regulates what.

In the more immediate term, it would be good for the U.S. to establish stablecoin rules rather than going after individual issuers on an ad hoc basis. The SEC could be doing much more to outline guidelines and expectations, especially for the companies that walk through their front doors looking for direction. Of course, the U.S. could have the clearest regulatory system in the world, and there would still be companies that intentionally set up overseas in order to evade scrutiny. but there will also be customers who prefer the investor protections that come with safe and regulated exchanges. U.S. regulators should at least be working towards the goal of giving customers that option.

Gottlieb said, There are also projects who are trying to follow the laws as well as they can, but because of the regulatory scrutiny, take pains to put themselves abroad or even stay anonymous or pseudonymous. This is arguably worse for retail because the projects are harder to reach if something goes wrong, and U.S. regulators have less affirmative authority over them. A U.S. crypto ban is extremely unlikely, which means that if the U.S. continues its current approach, it will end up with crypto projects either operating overseas or within gray areas inside the United States. Some of those projects will eventually be targeted

by SEC enforcement actions, but it may be after some Americans already lost their life savings. Other companies at the gray zone may be never punished at all. Wouldn't it be better to at least give people a chance to play by clearly defined rules? Gottlieb said, sunlight is the best disinfectant. If the regulators don't light in some sun, everything will grow in the shadows. All right, guys, back to NLW here and listen. Emily does a great job bringing all these pieces, all these threads of the narrative together. And it just needs to be said over and over and over again. There is only one choice. Find a reasonable path forward for crypto in the US and see companies and innovation and economic value flourish here. Or don't and lose both the

ability to tap into the upside and prevent the downside. Choice seems pretty obvious to me, but hey, I'm not a politician. Anyways, guys, hope you're having a great weekend. Until tomorrow, be safe and take care of each other. Peace. Thank you.