The Breakdown - Most Important Crypto Regulation Yet? Banks Can Treat Public Blockchains Like SWIFT and ACH

Episode Date: January 6, 2021

Yesterday, the Office of the Comptroller of the Currency released Interpretive Letter 1174. The letter allows banks to participate as nodes in “independent node verification networks” (which you might better know as blockchain networks) as well as use stablecoins for payments settlement.  In this episode of The Breakdown, NLW looks at:  Crypto Twitter’s response to the news  A review of key passages from the letter The response of critics The implications for CBDCs and the geopolitical battle between the U.S. dollar and China’s emerging digital currency  Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   The Breakdown is produced and distributed by CoinDesk.com

For me, though, the final and most interesting point has to do with the larger question of CBDCs and geopolitics. Celia Wan, who was previously at the block and is now investing with Huobi wrote, given that the U.S. is already late in the CBDC race, legitimizing dollar-back stable coins as a cross-border payment vehicle is an ingenious shortcut to strengthen dollar dominance against China's DeSep threat. 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 and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, January 5th, and today we are talking about yesterday's late-breaking news. A new missive from the Office of the Comptroller of the Currency says that banks have to treat open, permissionless blockchains like they treat the current SWIFT system. This has massive implications, so let's dive in. One quick note, you'll notice again that there's no brief today. I promise that feature is coming back. It's just that both yesterday and today have had such important topics that are so big, I wanted to dive right in. But the brief for those of you who rely on that for some more

traditional markets news will be coming back. Anyways, yesterday, we discussed interpretations of Bitcoin's massive move up over 30,000, followed by its dip back down under 30,000, followed by its move back up to between 31,000 and 32,000, where it's been for the past, I don't know, 18 to 24 hours. One of the interpretations we mentioned had to do with the price being contrasted to uncertain regulatory futures. That contrast, which came from the New York Times, was of course discussing the proposed new rules on self-hosted wallets and the FinCEN implications. So let's start on this regulatory-focused episode with a quick review of that. Yesterday was originally the end of the comment period on this midnight legislation from Stephen Mnuchin, but they agreed to extend it to

January 7th, which frankly was the promised 15 days. Anyways, there you go. Whatever the case, a flurry of commentary has come out in the last 24 hours, and I wanted to share a sample of it. The first comes from Cracken, and the TLDR is that sometimes regulation can hurt the regulator. So this is from Marco Santori, the chief legal officer at Cracken. He writes, Cracken has published its response to the Treasury's Midnight Rule on self-custodied wallets. The response is not short, it is not polite, and it concludes with an important message. Regulating crypto companies punishes the regulator.

How? Regulating a traditional bank is easy. If a proposed regulation forces the banks to provide the information the regulation, They implement the regulation and collect the information. Easy-peasy. Doesn't matter if compliance is costly. Regulator still gets the info it wants. Doesn't matter if those costs are passed on to the customer. Regulator gets its info. Makes the U.X cumbersome. Doesn't matter. Regulator gets the info. Risky for users. Too bad. Regulator gets info. After all, customers don't really have a choice. You need a bank to send a wire. You need a check casher to turn your paycheck into dollar bills. You need a savings account to store

large sums safely. You need financial institutions to use traditional currency effectively. Sure, financial institutions always argue that overregulation will drive business offshore where information can't be collected. The objection is rarely persuasive. Regulation of traditional financial institutions almost always translates net net into more information for law enforcement. What would happen, though, if the customer didn't actually need to use the financial institution? What would happen to the flow of information to the regulator if the customer didn't need any financial institution at all? What if the customer could just opt out and do it all themselves? Well, as a regulator, you wouldn't actually get access to the information you wanted, for one thing.

Worse, you would create a bunch of information you would never get access to. Wait, what? How? The more requirements you place on a monopoly, the more info you can get about its users. The more requirements you place on an opt-in service, the more costly, cumbersome and insecure the service becomes, the less people will use it and simply do it themselves instead. Create a regime burdensome enough and an entire shadow ecosystem springs up consisting of those who have opted out. The economy is cleaved into two, one economy that follows the rules and one with no desire or obligation to follow the rules. In this way, regulating crypto companies is completely unlike regulating traditional banks. The creation of the regulation works against the regulator, both limiting the amount of available information and growing the amount of forever unavailable information.

So can we stop regulating crypto companies now? Of course not. But we'd better be careful. The phenomenon is outside the control of crypto companies and even governments. There's little that even compliant companies like Cracken can do to slow the phenomenon. We have to be very, very careful about regulating in this self-custody-hosted area of overlap. Doing good crypto policy is really, really hard. Square totally reinforced this view. In their statement, they said, quote, To put it plainly, where the proposal to be implemented as written, Square would be required to collect unreliable data about people who have not opted into our service or signed up as our customers. This creates unnecessary friction and perverse incentives for cryptocurrency customers to avoid

regulated entities for cryptocurrency transactions, driving them to use non-custodial wallets or services outside the U.S. to transfer their assets more easily. By adding hurdles that push more transactions away from regulated entities like Square into non-custodial wallets and foreign jurisdictions, FinCEN will eventually have less visibility into the universe of cryptocurrency transactions than it has the day. So I think this is important to note because obviously this is one of the most important regulatory conversations right now. Jake Chervinsky has called this the central regulatory battle for the coming decade is around privacy, self-hosting, self-custody, etc. So it's really important that we keep track of the arguments that are being

advanced forth. Now, whether Treasury Secretary's Manuchin and all the people who are working on this end up caring is another story, but those are the sort of arguments that we're seeing going through to them. However, that's not actually the big regulatory news. Last night, news came out of another interpretive letter from the Office of the Comptroller of the currency. A few things to remember about the OCC. First of all, they are the biggest bank regulator in the United States. Second, acting director Brian Brooks is the former Coinbase legal officer. He is only the acting director right now. He has been nominated twice by President Trump to a full five-year term. It seems unlikely that that goes to a vote before the Biden administration

is formally inaugurated. The OCC got on everyone's radar last summer when they issued a note saying that federally regulated banks could custody crypto. That was a huge difference. And as I've said on the show numerous times, I've heard over and over from people in the institutional space that this was a huge game-changing decision. In the fall, they extended that sort of effort and they said that banks could work with stable coin issuers, again, freeing up how the traditional financial infrastructure gets to work with the new world of crypto. Now, all of this activity created some consternation among members of Congress, a group of whom sent Brooks a letter saying that he needed to stop focusing on crypto and stop acting so unilaterally. This group went on to even introduce these

Stable Act, which as we've discussed on this show, was a pretty stringent anti-crypto bit of legislation, but it appears that regardless of that, Brooks has entirely not listened to this group. So let me start by reading just a few of the headliner tweets about the OCC's new letter from last night. The founder of TechCrunch turned crypto investor Mike Arrington said, I thought this was years away at best. This is a BFD. Anderson Kill lawyer, Haley Lenin, wrote, wow, huge news, breaking guidance from OCC allows U.S. banks to use public blockchains and dollar-stable coins as a settlement infrastructure in the U.S. financial system. Pomp tweeted the OCC just told U.S. banks that they must treat permissionless, open-source blockchings like Bitcoin and Ethereum

the same way they treat Swift, ACH, and Fedwire. Game on. And Nick Carter wrote absolutely wild note from the OCC. Banks give an authorization to treat public blockchains as a another form of settlement infrastructure. I think this will be seen as a watershed moment. This is completely blowing my mind right now. May well be the most clear-eyed regulatory commentary on public blockchains I've ever seen. We'll come back to the section, the passage that Nick references around that idea of clear-eyed commentary, but first let's look to Jeremy Aller, the co-founder and CEO of Circle, who obviously launched USDC, who did his own interpretation of the news. Breaking major news from U.S. Treasury OCC, the largest U.S. banking regulator,

with new guidance allowing U.S. banks to use public blockchains and dollar stable coins as a settlement infrastructure in the U.S. financial system. This is a huge win for crypto and stablecoins. The new interpretive letter establishes that banks can treat public chains as infrastructure similar to SWIFT, ACH, and Fedwire, and stablecoins like USDC as electronic stored value. The significance of this can't be overstated. decentralized, permissionless, open-source, and internet-mediated software is literally becoming the foundation for not just the U.S. financial system, but for the global economy. We are on a path towards all major economic activity being executed on chain.

It is tremendous to see such forward-thinking support from the largest regulator of national banks in the United States. This paves the way for the use of leading dollar digital currencies such as USDC as a mainstream payment medium for all forms of payments in settlement and helps put the U.S. in a leadership position in embracing the power of public blockchains. Beyond payments and settlement, and unlike legacy settlement mediums, public chains combine transactions and compute, enabling a radically new mode of financial and commercial apps to be built. It also sets the stage for even more regulated financial institutions to run blockchain nodes or even become validators. This is a huge

way to start 2021, the year that crypto and stable coins go mass market. Many investors want to be a part of the next bull run. seek to build their dream home, finally launch that startup or fund their education. Try NXO's instant crypto credit lines and borrow against any major cryptocurrency with no minimum or maximum withdrawal amounts, no fees whatsoever, no credit checks, and flexible repayment. Not to mention the APR starts at just 5.9%. Stay on top of your investment gain with nexo.io. And remember, it's your crypto, your credit, your choice. Get started at nexo.io. Let's actually go back again to Nick, who pointed out some passages as particularly clear-eyed. And I just want to make one quick

note, these guys did invent a lot of new language. They talk about VASPs, virtual assets, service providers, and more crazily, they talk about INVN's independent node verification network, which really seems like just another way to say blockchain. So I wonder to what extent they're trying to maybe get around existing stigma. But either way, when you hear INVN, it means blockchain for all intents and purposes. So this is the passage that Nick called out. Stablecoins thus provide a means by which participants in the payment system may avail themselves of the potential advantages associated with INVNs. Billions of dollars worth of stable coins trade globally and demand for stable coins continues to grow. As discussed below, INVNs and related stable coins represent new technological means of carrying out

bank permissible payment activities. We therefore conclude that a bank may validate, store, and record payment transactions by serving as a node on an INVN. Likewise, a bank may use INVNs and related stable coins to carry out other permissible payment activities. A bank must conduct these activities consistent with applicable law and safe and sound banking practices. While the OCC neither encourages nor discourages banks from participating in and supporting INVNs and stablecoins, the recent adoption of INVNs and stablecoins by a major payment system operator, coupled with the rapid market adoption of INVNs and stablecoins, indicates that banks should evaluate the appropriateness of INVN's and StableCoin participation in order to ensure banks' continuing

ability to provide payment services to their customers in a manner that reflects changing demand. INVNs and stablecoins present both benefits and risks. Among the potential benefits is the fact that INVNs may enhance the efficiency, effectiveness, and stability of the provision of payments. For example, they may be more resilient than other payment networks because of the decentralized nature of INVNs. Rather than relying on a single entity or a small number of parties to verify payments,

INVNs allow a comparatively large number of nodes to verify transactions in a trusted manner. Simply put, these networks may be more resilient because they have no single point of failure and can continue to operate even if a number of nodes cease to function for some reason, and may be more trusted because of their consensus mechanisms requiring more nodes to validate the underlying transactions. In addition, an INVN also acts to prevent tampering or adding inaccurate information to the database. Information is only added to the network after consensus has reached among the nodes, confirming that the information is valid. The use of stablecoins to facilitate payments

allows banks to capture the advantages that INVNs may present in a manner that retains the stability of fiat currency. INVNs can transfer multiple different cryptocurrencies, including but not limited to stablecoins. Stablecoins serve as a means of representing fiat currency on an INVN. In this way, the stable coin provides a means for fiat currency to have access to the payment rails of an INVN. To sum up a bit of that,

this letter is basically saying that this change is happening. Banks are going to face increased demand to operate at the speed of crypto, and that frankly, by integrating with stable coins, they allow Fiat to function in this new modality. This sort of interpretation was reinforced by Haley Lennon in her write-up for Forbes. She wrote, So what does this really mean for the payment system as we know it today? While the United States financial system functions relatively smoothly, traditional payment rails are still slow, expensive, and subject to banking hours and holidays. The OCC's guidance opens the possibilities that banks will use INVNs and stablecoins to transfer funds between financial institutions faster and without the need for a government intermediary. Kristen Smith, Executive Director of the

Blockchain Association, noted, the OCC's interpretive letter shows that there are those in government who actually understand that cryptocurrency networks are the foundation of a next-generation payment system. Stable coins can power faster, 24-hour real-time payments in a way that existing U.S. payments infrastructure can't handle. Nick Carter, partner of Castle Island Ventures, added, this will allow banks to, quote, take advantage of always-on features of public blockchains. Banks adopting the use of INVNs and stablecoins could also vastly increase the efficiency of cross-border transactions, but that will require banks in the U.S. and abroad to implement a lot of technology. Carter cautioned, I don't see stable coins imminently replacing traditional financial rail,

but this is a vital first step in normalizing the notion of public blockchains as an alternative settlement infrastructure that banks can freely adopt. One more quick note, while a lot of the focus is on stablecoins, it's also saying explicitly that banks can run nodes on public blockchains and it doesn't preclude things like Bitcoin, so there is an implication there even beyond stable coins like USDC. But then what are the critics saying? Rohan Gray, who's the architect of the Stable Act, which I mentioned before tweeted, this is a bad development.

On the one hand, the OCC reaff forms the core premise behind the Stable Act, which is that stablecoin-related activities are best left to regulated banks. That's good. But it outsources the actual Stablecoin infrastructure to non-bank entities, which is bad. We're going to come back to that point in a minute when we're discussing the implications for CBDCs. Angela Walsh, a professor at St. Mary's Law, wrote basically that this was one regulatory capture, and that, too, it socialized the risk of crypto networks to everyone. She said,

fundamentally, this new guidance buys into the myths about public blockchains fails to address the governance and operational risks and erases any walls left protecting the mainstream financial system from crypto systems. Crypto risk has been made systemic because it is now fully able to be infrastructure for the mainstream financial system. I hope for all our sakes that the devs and mining pools making decisions now, on behalf of the entire global financial system, are worthy of the weight that we were placing on their shoulders. For me, though, the final and most interesting point has to do with the larger question of CBDCs and geopolitics.

Celia Wan, who was previously at the block and is now investing with Huobi wrote, given that the U.S. is already late in the CBDC race, legitimizing dollar-back stable coins as a cross-border payment vehicle is an ingenious shortcut to strengthen dollar dominance against China's DeSep threat. So putting it briefly, because this is worthy of an entire episode on its own, part of China's seeming intent with their digital currency is to get around the SWIFT system that the U.S. controls and that so much of global commerce runs on top of. Rightly or wrongly, from both an ethical and from an efficacy perspective, the U.S. has, over the past several years,

the past several decades, weaponize the SWIFT system. It is the main mechanism by which they impose sanctions and they take addresses out of the network. When you see certain actors are blacklisted, part of what they're blacklisted for is from that payment system. If China can get enough people to go around that with its digital currency that offers other sort of feature benefits, it could present a threat to the US. Now, many have noted that the US hasn't really been willing to move quickly on its own self-created digital dollar. However, another set of people have wondered if we would get to this exact point where instead the U.S. took advantage of the existing private infrastructure that has been built over the last several years and is actually farther in

many ways than China's own native CBDC. In other words, sure, China is massively ahead when it comes to a government-issued CBDC doing trials for millions of dollars in Shenzhen and other places, but USDA-backed private stable coins dwarf these trials, growing from less than $5 billion at the beginning of last year to nearly 5xat $23 billion plus by the end of the year. Now, not everyone on Twitter even who agreed that there were big implications for CBDCs necessarily saw this as a good thing for the existing private players. Malthus John tweeted, alternative take, you have about 12 to 18 months to collect data, sign people up, and otherwise beta test the U.S. entry to

CBDCs. After that, you will turn over files and cease and desist. This is only a temporary band-aid on losing that race to China, as are the recent rushed bills. Like I said, I think this geopolitical dimension of CBDCs is going to be one of the most important stories of 2021, and this certainly indicates that that feeling is right on. Maybe let's quickly summarize what is so exciting to people about this, And for that, I turn to a thread from Noel Acheson, the director of research at Coin desk. She tweets, the OCC says that banks can use public blockchains as a settlement structure. Biggest step I've seen so far towards a merging of traditional in crypto markets and much sooner than I expected. Here's a thread on why this step could be both good and bad news.

One, good news for crypto markets. This is a nudge to traditional banks to offer support for blockchain infrastructure and even facilitate crypto transactions. 2. Good for traditional markets, as it is likely to encourage the emergence of a new type of lower costs and more transparent settlement system. Three, good for the banking sector, potentially opening the door to new types of financial products, as well as payment and collateral services, and this is where we are likely to see mainstream financial adoption. Four, good for financial innovation. Banks can use stable coins, but they can also issue them, potentially with bells and whistles and functionalities attached. Five, good for liquidity, more crypto dollars sloshing around a system that allows for, interchangeable programmable settlement tokens is likely to allow for better optimization of use of capital. Six, good for the global economy. More efficient cross-border settlements will be good for trade,

lowering the cost of documentation and compliance and maybe finally giving blockchain supply chain plus trade finance apps the piece that they've been missing. Seven, good for the dollar. With the U.S. leading the charge on this, it is likely that dollar-backed stable coins will become the de facto global settlement token, further consolidating the dollar's hegemony. Eight, this last point could be bad news for the global financial pyramid. If more economies depend on the dollar that increases U.S. power and makes the global economy more vulnerable. Nine, but if public blockchains end up replacing Swift, for instance, then the U.S. loses some of its ability to weaponize the dollar by cutting off or even threatening to countries it doesn't like, so potentially also good

for humanitarian reasons. It is to sum up a pretty remarkable moment, and one that I think deserves all of the attention it's getting. In fact, I think that my favorite tweet about it came from 40K imminent hoddle on Twitter who said, Bitcoiners, we want to use internet money. Let's switch to that. U.S. government. Okay. I don't think at all that this battle is done. Like I mentioned right at the top of this show, OCC acting director Brooks might be out of a job in short order. We haven't got any indication that he'll be reconfirmed or that it'll even come to a vote. There's obviously existing battles and alternatives in the form of the Stable Act, but still it is a really, really significant moment. And hey, if enough companies and enough federally regulated banks

start to adopt this, it creates a whole additional lobby, and it makes it even harder to turn it back after the fact. So anyways, guys, I hope you enjoyed this breakdown of the new letter of interpretation by the OCC. Let me know what you think. Hit me up on Twitter at NLW. If you're liking the show, let me know in a review. And until tomorrow, guys, be safe and take care of each other. Peace.