The Breakdown - Is Voluntary Regulation the Right Approach to DeFi?

Starting point is 00:00:00 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 sponsored by nexo.io, Circle, and FtX, and produced and distributed by CoinDes. What's going on, guys? It is Saturday, October 22nd, and that means it's time for the weekly recap. 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. Also a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. Happy Saturday, everyone. It's another fine fall weekend. I hope you are

Starting point is 00:00:52 enjoying it wherever you are. Today we are doing a full classic weekly recap looking at a ton of stories that we haven't had a chance to review yet, largely concentrated on the legal and regulatory, because God damn if that's not everything that we're talking about in crypto during this bear market. I guess other than the post-narrative institutionalization that we talked about yesterday. So let's start with a victory for the good guys. The cat has won his case. TLDR, Craig Wright, not so affectionately known as fakedoshi among crypto Twitter, was planning to bring a defamation lawsuit against Twitter user Haudelanaut

Starting point is 00:01:26 for a series of tweets from March 2019. In those tweets, Haudelanot called Wright a fraud and a scammer, a frankly common refrain on crypto-twit. Now, Wright has often gotten litigious around this stuff, even though there are a huge number of people who routinely say these same things. Remember, to this day, Wright has never produced evidence to prove he is Satoshi. Now, the UK's court system with regard to defamation is fairly wonky and heavily favors the plaintiff. What Bitcoin did's Peter McCormick, for example, recently technically lost a similar case in the UK court. However, in that quote-unquote loss, the judge found right to have submitted false

Starting point is 00:02:02 evidence, and ultimately ordered Peter to pay, dot, dot, dot, dot, dot, dot, dot, one pound in damages, which more or less, to me, sounds like a win for Peter. In any case, Haudelanat's play was to preempt a suit by asking the Norwegian courts to rule that his tweets were protected by freedom of speech. After a week-long trial, the judge found in his favor. The judge acquitted Haudelanaut of all claims for compensation and ensured that he was not liable to damages relating to the tweets. Craig Wright has also been ordered to pay Haudelanaut's fees to the tune of about

Starting point is 00:02:32 $383,000. The judge went further in their judgment, writing that the evidence presented by Wright's lawyers was, quote, not suitable to change the court's prevailing opinion that Craig Wright is not Satoshi Nakamoto. Continuing that, quote, the court believes that fraud slash fraudulently in this context means one who is something other than what he claims to be. Fake has a similar meaning, illegitimate, false, something other than what he pretends to be. Scammer must be understood in the same way, in the sense of swindler or cheater. Wright has come out with a controversial claim and must withstand criticism from dissenters. The judge also basically reprimanded Wright to have a thicker skin. They said that Twitter is a tough place and pointed to Wright's own tweets where he had used

Starting point is 00:03:11 words like cuck and soy boy. Quote, right himself uses coarse slang and derogatory references, and so in the court's view, must accept that others use similar jargon against him. Now, Wright's lawyers say they're going to appeal, warning that, quote, anonymous online bullying could have a, quote, chilling effect on public discourse, which is fairly absurd given the use of lawsuits as a bullying tactic, but I digress. Congrats Kat, glad to have you back on Twitter. Anyways, that was not the only crypto legal news. As you guys know, after the SEC's most recent rejection of Grayscale's proposal to convert their Bitcoin trust into a spot ETF, the company filed suit against the SEC. This week saw a number of parties pile in to support them.

Starting point is 00:03:51 Coinbase has filed an amicus brief supporting that lawsuit against the SEC, and this adds to the amicus briefs filed by other trade and policy groups including the Blockchain Association, the Chamber of Digital Commerce, the Chamber of Progress, and Coin Center. An amicus brief is a third-party court filing typically aimed at assisting the court in making a novel or controversial legal decision. The core legal question in the grayscale case is whether the SEC has demonstrated bias or favoritism in denying every application for a spot Bitcoin ETF while approving futures-based ETFs. One of the central arguments is that while the SEC says that spot ETFs are more susceptible to price manipulation, both Spot and Futures-based ETFs use the same price index, and so theoretically,

Starting point is 00:04:31 would be susceptible to the same price manipulation. The trade group brief read, quote, the Commission's thumb-on-the-scale approach does not withstand scrutiny. The brief calls Spot ETFs, quote, ideally suited for investors who desire exposure to Bitcoin, and also noted that the SEC had allowed, quote, similar riskier products to enter the market. In the end, spot Bitcoin ETFs, they say, quote, plainly satisfy regulatory requirements for listing on a national securities exchange. A couple comments in their own words. Marissa Tashman-Copal, the Policy Council at Blockchain Association, said, Blockchain Association's brief provides the court with helpful context in Grayscale's lawsuit against the SEC.

Starting point is 00:05:08 By denying access to spot Bitcoin ETPs, the SEC engages in an arbitrary and capricious practice of picking winners and losers among investment products. The SEC's mandate is to ensure investors are free to choose products best suited to their goals and have the information necessary to make well-informed decisions. The SEC has contravened this mandate by denying access to spot. spot Bitcoin ETPs. To date, the SEC has categorically denied every proposal to list an ETP that seeks to track the spot price of Bitcoin, despite recently approving several Bitcoin futures ETPs. The SEC must treat like cases alike. It has not established material differences

Starting point is 00:05:41 between Bitcoin futures ETPs and spot ETPs that warrant disparate treatment. Jake Trevinsky, the head of policy at the Blockchain Association, says, I'm proud to stand behind Grayscale in its pursuit of approval for a spot Bitcoin ETF, something the SEC has unjustly withheld for far too long. I hope our brief helps the court see the unfair and unlawful double standard that the SEC has applied to Bitcoin for all these years. Paul Grewell, the chief legal officer at Coinbase, writes, Coinbase supports Grayscale in its pursuit of approval for a spot Bitcoin ETP from the SEC. By its petition, Grayscale seeks no special favors, no special treatment, just the same standards as were applied to comparable Bitcoin ETFs that were approved. Here's why.

Starting point is 00:06:20 Exchanges like Coinbase imply a variety of policies and procedures that adequately safeguard market integrity. Bitcoin markets are deep, liquid, and inherently resistant to potential attempts at price manipulation. The SEC has previously approved comparable futures products based in large part on those same factors, and denying investors the benefits of a spot Bitcoin exchange traded product, which would have allowed investors to gain exposure to Bitcoin without purchasing it directly. This needlessly hampers innovation, causing the U.S. to fall behind well-regulated markets around the globe that have already adopted such products. Now, whether the court thinks any of this is valuable is yet to be seen, but I think is great.

Starting point is 00:06:53 good to see industry consensus coming in around this legal challenge. Let's continue kind of on this regulatory front, first in the U.S. and then around the world. In the least surprising move ever, the IRS has clarified taxation policy around NFTs this week, and in an updated draft of its 22 instructions for Form 1040 filers, the U.S. Tax Agency changed the category of virtual currency for digital assets with explicit recognition of NFTs. Quote, digital assets are any digital representation of value that are recorded on a cryptographically secured digital ledger or any similar technology. For example, digital assets include non-fungible tokens and virtual currencies, such as cryptocurrencies and stablecoins. The previous year's virtual currency category

Starting point is 00:07:34 was a narrower definition of a digital token, quote, that functions as a unit of account, a store of value, or a medium of exchange. According to the latest documentation, crypto investors will need to calculate reportable income on crypto, quote, if you disposed of any digital asset in 2022 that you held as a capital asset through a sale, exchange, gift, or transfer. Now, this is, again, like I said, not at all surprising, and I don't think that anyone thought that it would be any different. NIRAS from Coin Center says, not surprising. If you earn income from trading NFTs, you owe taxes on that income. Just to be clear, it's unfortunate the IRS singles out crypto in this question, but it isn't a change in policy. If you've dealt with NFTs, you probably should have checked yes to that question in years prior.

Starting point is 00:08:12 Mike Dutas, however, from Sixth Man Venture says, bad news for the IRS. No one earned income trading NFTs in 2022. Want to keep more profits when trading? Get the best possible prices and trade with 50% lower fees on NXO Pro. The new spot and futures trading platform uses aggregated liquidity of over 3,000 order books collected from multiple sources. Utilizing the complete NXO Suite allows you to earn interest and borrow funds as you wait for the next trade setup.

Starting point is 00:08:44 Visit pro.nexo.io. That's PRO.N-E-X-O.io and sign up today. This episode is brought to you by Circle, the sole issuer of USDC, and a leader in crypto that's held to a higher standard. USDC is a fast, safe, and efficient way to send money around the globe. USDC is always redeemable one-to-one for U.S. dollars and has over $45 billion in circulation as of October 13, 2022. Plus, Circle posts weekly reserve reports and monthly attestations of reserve capital, letting users know that USDA is safe, transparent, and compliant with regulations. Just go to circle.com backslash transparency to see why USDC is a trusted stable coin.

Starting point is 00:09:31 The breakdown is sponsored by FTXUS. FDXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets, with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana and FDFTA. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. Now, staying in the U.S. for a moment, let's talk about some comments

Starting point is 00:10:11 from acting head of the FDIC on stablecoins. Martin Gruenberg is the acting chairman of the Federal Deposit Insurance Corporation or FDIC and spoke at a Brookings Institution event on Thursday. Groomberg said, the development of a payment stable coin could fundamentally alter the landscape of banking, possibly leading to forms of credit disintermediation that could harm the viability of many U.S. banks and potentially create a foundation for a new type of shadow banking. Now, Grunberg is fairly openly skeptical of crypto, saying, thus far, we haven't seen much evidence of a benefit. It remains to be demonstrated whether there's some potential there. He said that to deal with stable coins, Congress needs to intervene because there are, quote, clear limits to our authority, especially

Starting point is 00:10:48 in certain areas of consumer protection, as well as the provision of wallets and other related services by non-bank entities. Now, were Grunberg in charge, he offered three ways to make stablecoins safe enough in his view. First, they would have to be offered through bank subsidiaries. Second, they would have to be fully backed by short-term treasury bonds. And third, they would have to be put on permissioned ledger systems that comply with regulations. Quote, the ability to know all the parties, including nodes and validators that are engaging in payment stablecoin activities is critical to ensuring compliance with anti-money laundering and countering the financing of terrorism regulations, as well as deterring sanctions evasion.

Starting point is 00:11:21 Now, this is obviously not a particularly popular take and fairly out of sync with where even the recent stablecoin bills have been, specifically in terms of having them only offered by banks. However, interestingly, this idea of them being backed by short-term treasury bonds is something the market is already converging on anyways. From there, let's hop across the pond. A couple of days ago, we talked all about the wild political environment in the UK, but what about the latest when it comes to crypto? In July, a bill was introduced in the UK called the Financial Services and Markets Bill. This week, there was a bunch of discussion around it. On Wednesday, FinTech lobbyist Adam Jackson spoke before a committee of UK lawmakers. In his testimony, he said that the Bank of England must take

Starting point is 00:11:59 into consideration the crypto industry's competitiveness when it decides to issue its CBDC. The policy director of Innovate Finance said, quote, there's a question of whether we could apply a competitive objection to the Bank of England when we think about things like central bank digital currency and how it's implemented. He said that the CBDC could quote crowd out innovation and stable coins unless it's designed in a way that promotes competition. Now, when it comes to this bill that's being debated, among other things, it would ensure that UK regulators consider the country's economic growth and international competitiveness when making crypto regulations. The bill sets rules around stable coins, but Jackson articulated concern that the bill doesn't provide enough

Starting point is 00:12:33 regulatory clarity around other parts of the crypto sector, which means that they're lagging behind the EU's marketing crypto assets bill. Quote, the government has said before that they will bring forward proposals for wider regulation of other crypto assets. If that isn't the case, are we going have to wait another 20 years before regulators are given the power to regulate crypto assets? He highlighted the key areas of custody and new coin offerings as lacking in the UK's proposed bill. Another witness at the committee meeting, Mike Halley of CFAS, a nonprofit dedicated to fighting financial crime, said that the bill had already failed to keep up with a fast-moving crypto industry. Already, he said, we're looking at money laundering through coin swap services which don't need

Starting point is 00:13:08 an account and may not be under this regulation. He also pointed to cross-chain bridges as unregulated under the bill, potentially opening up avenues for money laundering to go unchecked. Interestingly, however, on Friday, Minister Andrew Griffith, who introduced the bill in the first place, introduced new amendments. As we've heard, the bill had been focused on stable coins, but these amendments aimed to extend existing laws to, quote, clarify that the powers relating to financial promotion and regulated activities can be relied on to regulate crypto assets and activities relating to crypto assets. Nicholas Taylor, the head of public policy at Crypto exchange, Luno, told CoinDesk in an emailed statement, quote,

Starting point is 00:13:41 The amendments enable the Treasury and the Financial Conduct Authority to introduce a full regulatory regime for crypto, a hugely positive step. Now, currently the bill is due to be discussed in committee between now and November 3rd, however, this may be affected by the departure of Prime Minister Liz Truss, which was announced Thursday. The nomination of a successor, which is due next week, may herald a change in other ministerial positions. Moving over into mainland Europe, the director of EU strategy and policy at Circle

Starting point is 00:14:05 Patrick Hansen wrote yesterday, a new report on Defi Regulation Commissioned by the EU Commission was published. This report will contribute to the EU policy debate on the topic that is expected to lead a DeFi report or even legislation in 2023. The report makes four policy proposals. One, regulate legal entities, macro-prudential provisions, etc. Two, introduce a voluntary framework for defy supervision. Three, establish a public observatory that issues opinions based on public on-chain data, aka embedded supervision. Four, build an approach for Oracle's supervision and regulation.

Starting point is 00:14:35 Patrick calls this, quote, an interesting report that will definitely contribute to the current discussion across the pond on how defy should be approached from a policy and regulatory perspective. Digging in a little bit deeper, in a hearing this week, finance professor Tarek Rookney told the European Commission that DFI could require new kinds of voluntary regulation to manage the severe threats it poses. Rukini said, quote, defy holds tools for a credible promise for new forms of financial services adapted to a globalized competitive, fair, and digital economy. At the same time, severe threats to consumers, producers, and the economy at large accompany this opportunity. Now, the MECA regulation that the EU is consolidating around doesn't really address Defi yet.

Starting point is 00:15:15 It's mostly just about centralized crypto. A lot of the ideas that are being proposed now as regards to DeFi have to do with voluntary registration. Rootney suggested that voluntary registration could act as a, quote, public stamp of approval and might mitigate users' fears about being led into a rugpole or other scam. Rukkney said you'll need to find incentives to make it attractive for protocol designers and protocol developers to enter a policy framework or to enter the sandbox you have in mind. And that is crucially different from other services. He also suggested that public authorities

Starting point is 00:15:43 could issue warnings about faulty defy protocols, citing the example of the MIT Digital Currency Initiative, which in 2017 ended up putting pressure on the IOTA protocol to improve its security by pointing out flaws. I think this idea of taking on defy through voluntary registrations which actually serve as a market validator is a pretty interesting and thoughtful way to approach it. Staying in Europe for a moment, crypto companies operating in France have been warned to prepare for tough EU standards by a senior official from the country's Financial Markets Authority on Wednesday. The Financial Markets Authority Secretary General confirmed that the country would be winding down its lighter national registration regime for crypto service providers.

Starting point is 00:16:20 In seeking to establish itself as a European crypto hub, France had been operating a registration system for crypto companies which saw companies including crypto.com and finance register with the nation's regulators. However, in 2024, the country will transition to adopting the EU markets and crypto assets framework. This includes much more stringent regulations around AML compliance, investor protections, market integrity, and financial stability. The Secretary General welcomed new EU rules intended to allow traditional financial market traders to test out securities market systems built on DLT starting next year, confirming that France would take part in the trial. Now, we are almost done just a couple more from around the world before we get out of here.

Starting point is 00:16:56 South Africa has declared crypto assets to be a financial product, according to a notice from the country's financial sector conduct authority. That change brings crypto assets within the purview of the South African financial regulator. The notice provides a definition of a crypto asset as a, quote, digital representation of value that is not issued by a central bank, but can be traded, transferred, or stored electronically for the purposes of payment, investment, and other forms of utility. The change comes into effect immediately and aligns with the South African Central Bank's view that cryptocurrency should be treated in the same way as other financial assets. Finally, in Japan, the Japan Crypto Assets Association, JVCEA, a legally recognized self-regulatory body

Starting point is 00:17:31 made up of crypto exchanges, is looking to get rid of a lengthy screening process which currently precedes listing of tokens on domestic exchanges. The measures could come into effect as soon as December, but would only make it easier to list crypto assets that are already known to the Japanese market. By 2023, the JVCEA could also scrap pre-screening for tokens which are new to the market. While Japan's financial watchdog is sometimes at odds with the JVCEA, a source familiar with the process told CoinDesk that regulators could delegate matters like this to the industry body. This loosening of rules comes in the context of a changing attitude towards crypto within Japan's government. The government recently announced a policy

Starting point is 00:18:05 intention to encourage crypto startups to stay within Japan, after high taxes led to an exodus of firms last year. Japan is considering corporate tax breaks to ease the regulatory cost burden for companies operating within the nation. While Japan's stance on domestic crypto industry is softening in some ways, the government is still planning to strengthen anti-money laundering controls for the industry. And so in that way, we have yet again a perfect microcosm of the regulatory conversations that are happening everywhere. Now, I know it must seem at some points, like the breakdown is at this point a circular rotation of about three shows. We've got the regulatory shows, the post-narrative institutionalization shows, then of course the

Starting point is 00:18:42 macro shows, which are more or less about what the Fed is saying versus what the market thinks, versus what data is telling both actors, whether they choose to ignore it or not. But I think that's kind of just where we are right now, and I think it's where we're going to be for some time. Hopefully you feel up to date with everything going on and ready to go pick a pumpkin or carve it or do something seasonal or just get off Twitter for one goddamn minute. Anyways, I want to say thanks again to my sponsors, nexus.com.com, and FTCS for supporting the show. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Is Voluntary Regulation the Right Approach to DeFi?

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