A constant theme throughout 2019 – from the New York Attorney General’s (NYAG) investigation into Tether to the U.S. Senate Banking Committee’s worries over Libra’s likely handling of its customer’s financial information – has been regulation. Like no other theme, regulation has the power to drastically alter the dynamics of the market; for example, by making previously popular avenues for funding – initial coin offerings – undesirable or allowing certain kinds of business to thrive over others – exchanges which employ regulatory arbitrage (such as Binance) over US-based exchanges which can’t (such as Coinbase, Kraken, Gemini, and Poloniex). This research note will analyze the key regulatory issues of 2019 thus far, giving an overview of the issue in question along with its impact and long-term implications.
The Bitfinex-Tether NYAG Investigation
On April 25 2019, news broke that the New York Attorney General office had sued Bitfinex and Tether on allegation of fraud carried out by the companies against users in the state of New York. The key allegation was that Bitfinex and Tether had engaged in “undisclosed, conflicted transactions to cover Bitfinex’s losses by transferring money out of tether (USDT) reserve funds”. In total, around $700 million had been drained from Tether’s reserves and a line of credit had been issued to Bitfinex for loans totaling up to $900 million. The reason why Bitfinex had required the line of credit was because of the loss or theft of around $850 million of their funds by Crypto Capital – a Panama-based payment processor who had been helping the exchange handle customer withdrawals. Bitfinex has since responded to NYAG’s allegations and the investigation is ongoing.
One of our past research notes went into great detail about the immediate impact of the news of the NYAG investigation. The charts below compare pricing on Bitfinex for the BTC/USD trading pair with that of Coinbase and Kraken. One can see that, once the news broke, Bitfinex’s trading pair had been consistently trading at a premium to that of its competitors as investors try to get their funds out of the exchange.
On the day of the news, the premium was as much as 3% when compared to the averages of Kraken and Coinbase Pro. This point becomes even more obvious when we begin to look at Bitfinex’s on-chain inflows and outflows and how they have changed since the news broke. Below we plot the net outflows for both ETH and BTC on Bitfinex (Data: Token Analyst).
Moreover, another helpful metric to ascertain the effect the news had on users’ behavior is the number of new stable coins which have been issued since the April 25th announcement.
The spike in issuances amongst three of the most popular stable coins (PAX, TUSD, USDC) is noticeable and the highest it has been in the two months period around the news. The previous data showed the short-term impact of the news but two months on, the impact of the news can still be felt.
Bitfinex and Tether had always been met with some caution from some within the industry due to their sour history of hacks and fund withdrawal issues. However, the market has failed to react as strongly as some would expect following the data immediately following the news. For example, Bitfinex has remained one of the world’s most prominent crypto asset exchanges. Below we plot the most exchange’s trading volume for the BTC/USD pair from the start of the year. Bitfinex has maintained a steady share of overall volume throughout the year despite the news.
Whilst the outcome of the NYAG investigation is uncertain, Bitfinex’s launch of their LEO token can be said to have been the greatest resultant event of the drama. In order to raise funds to make up for Bitfinex’s and Tether’s aforementioned shortfall, the firm reportedly raised $1 billion in a token sale for an exchange token – LEO. The token was listed on Bitfinex on Monday 21 May and will be bought back and ‘burned‘ on a pre-defined schedule using Bitfinex’s accrued exchange fees, any funds recovered from Crypto Capital, and 80% of funds recovered from their 2016 hack.
LEO has performed exceptionally well since its listing – having returned around 76.6% to date. The chart below plots LEO’s price and trading volume on Bitfinex since May 21.
Moreover, we show the total amount of LEO which has been burned thus far.
Despite the ostensible implications of the NYAG investigation which could greatly impact Bitfinex’s ability to operate in the United States in the long term, the exchange seems to have survived relatively unscathed thus far. We expect this to change as the investigation progresses and there is the chance that the crypto asset market has not sufficiently priced in the possible negative long term consequences of the investigation.
The KIK SEC Lawsuit
On June 4 news broke that the SEC would be suing Kik for organizing what they judged to be an unregistered securities offering when it conducted its $100 million ICO in 2017 for their KIN token. This was not the first time the SEC had come after a token sale project for failing to register their token sale as a securities offering – other examples include Paragon and Airfox. However, this case was undoubtedly the most prominent and the first time of note where the accused party has refused to settle with the SEC, meaning that the lawsuit would be likely to go to courts.
There was an immediate impact on KIN’s price following the news.
The price of KIN fell from $0.000035 to $0.000027 following the news, with the token down more than 98% from its all-time high of $0.001493 in early 2018. The market certainly hasn’t judged the news of the lawsuit favorably in any way given the difficulties KIK has already faced throughout the legal challenge.
The other impact from the news was KIK’s launch of the Defend Crypto fund – supported by the likes of Messari, ShapeShift, and Arrington XRP Capital. The fund was set up to aid in KIK’s legal battle against the SEC on their token’s characterization as an unregistered security.
In the fund’s own words: “For the future of crypto, we all need Kik to win. This case will set a precedent and could serve as the new Howey Test for how cryptocurrencies are regulated in the United States. That’s why we set up the Defend Crypto fund to ensure that the funds are there to do this the right way. Kin has already spent over $5MM and is committing another $5MM of BTC, ETH, and KIN in our Coinbase account to fight this out on behalf of the industry.” The Defend Crypto fund has raised around $5,603,646 (including the amount committed by Kin) thus far.
As Defend Crypto has already argued, the KIK-SEC lawsuit’s outcomes will have longstanding implications for the crypto asset industry. KIK’s argument as for why their KIN token should not be considered a security rests on the argument of the token being “sufficiently decentralized“. It remains to be seen if such an argument holds up in court and, if so, under what ground.
Over the last month, we have heard news of Poloniex and Bittrex both delisting certain crypto assets due to the regulatory pressure in the United States. Moreover, Binance recently announced that they would be blocking U.S customers from July 1 whilst simultaneously launching a “regulatory compliant” portal for the same customer base. These news stories demonstrate the fear crypto asset exchanges have over the potential risk of offering crypto assets likely to be deemed unregistered securities to U.S. customers. Poloniex wrote in a blog post accompanying the delisting that “It is not possible to be certain whether US regulators will consider these assets to be securities.”
Impact and Implications
We expect further delistings over the year as exchanges try to air on the side of caution with U.S. securities law. Moreover, further delistings from US-based exchanges will only serve to further empower international exchanges like Binance and Bitfinex as they become the only place where investors can purchase new crypto assets which may have some amount of regulatory uncertainty surrounding them.
Below we plot the number of trading pairs available on Binance, Kraken, Poloniex, and Bittrex and compare trading pairs overlap (in percentage terms) with Binance.
More recently the Financial Action Task Force (FATF) released a set of standards that require that “virtual asset service providers” (VASPs), including crypto exchanges, pass information about their customers to one another when transferring funds between firms. Only adding to the regulatory overhead faced by crypto asset exchanges.
The Bitcoin ETF
Over the last few years, a number of entities have been vying to launch a US-based Bitcoin ETF including VanEck, Bitwise, and the Winklevoss Brothers. Since the Winklevoss brothers filed with the SEC in July 2013 for the Winklevoss Bitcoin Trust, a number of companies have tried and failed to launch a Bitcoin ETF in the U.S. The SEC has had many reasons for its past rejections, including concerns over market manipulation, liquidity, and financial crime.
Impact and Implications
The below chart shows a timeline of significant events relevant to the various Bitcoin ETF applications over the years.
It remains uncertain as to how likely the SEC is to approve any future Bitcoin ETF proposal, though it is without a doubt that the approval of a Bitcoin ETF could act as a large impetus behind future capital inflows into Bitcoin and other crypto assets.
The crypto asset industry was shaken last week by the news that Facebook would be launching their own crypto asset called Libra. In the wake of the announcement several politicians, governmental and bodies, and regulators across the world have aired their concerns about Facebook’s project. Below are a few of the comments made:
France’s finance minister, Bruno Le Maire, said Libra “can’t and…must not happen” and that “it is out of question’’ for the crypto asset to “become a sovereign currency.” Moreover, he called on Group of Seven (G-7) central bank governors and guardians of the global monetary system to review the social media giant’s upcoming crypto asset and submit a report next month.
U.S. Representative Patrick McHenry asked for a hearing on Libra
U.S. Representative Maxine Waters called for a halt on the development of Libra
Bank of England governor Mark Carney has emained open-minded about Libra but also said regulators would not give the crypto asset an “open door”.
France will create a G7 taskforce on “stablecoin” projects following the Libra announcement
U.S. Federal Reserve chairman Jerome Powell said that the central bank had already spoken to Facebook about Libra
Impact and Implications
Given how the recency of the announcement it is difficult to fully grasp the scale of impact of the regulatory uncertainty around Libra. However, we do believe that regulators around the world are likely to present several hurdles to a successful Libra launch especially given anti-trust concerns surrounding Facebook. We expect the implementation of Libra to be very much affected by feedback from regulators, presenting the possibility the final product in 2020 could be quite different from what was presented in the white paper.
2019 has been a unique year for the crypto asset industry partly due to the increased regulatory scrutiny it has faced. We believe the themes we have touched on in this research note will continue to develop over the next year and greatly shape the industry and market dynamics. In the long term, the development of friendly and transparent regulation for the crypto asset industry is a necessity if it is to fulfill its potential. As the aforementioned investigations, lawsuits, and events progress and eventually reach their conclusions we are likely to see a much more mature industry, primed for institutional and mainstream adoption.
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