Regulations
Merging traditional finance and DeFi is critical for mass adoption
Cointelegraph By Rachid Ajaja
When capital markets opened for the first time this year on Jan. 4, 2021, the focus of the front page of the Financial Times was squarely aimed at Bitcoin (BTC) with the headline: “Bitcoin tops $34,000 as record-breaking rally resumes.”
That Bitcoin is seeing institutional buy-in on a level unsurpassed in its history is certain, but what does this mean for the wider crypto space? How do we move from institutional adoption of Bitcoin or other crypto assets to connecting traditional finance markets with the decentralized finance and digital asset markets? If we can achieve this lofty goal, the inflows of capital, resources and attention would far surpass even the significant current DeFi space, thus leading to greater potential.
Few institutions are now in a position where they can invest in Bitcoin. The difficulty to reach such a stage should not be underestimated, and those funds investing in Bitcoin remain outliers. The largest institutional investors, such as pension and insurance funds, require highly sophisticated and liquid markets, lengthy historical track records, as well as needing to overcome significant internal risk and compliance concerns. These hurdles are multiplied when it comes to using crypto protocols. For example, a company looking to use digital tokens representing a firm’s shares on the Ethereum blockchain must adhere to existing financial and capital market regulations globally. This includes aspects, such as cross-border Know Your Customer and Anti-Money Laundering regulations.
To enable institutions to adopt DeFi, we must first let them access it in a compliant manner. This does not mean that all DeFi must be unduly regulated; this would defeat the purpose of a decentralized system. However, it is possible to introduce a protocol to facilitate the compliant use of DeFi. There are several aspects that make up such a system.
Digitization
While it is easy to create a digitized asset, the difficulty arises when compliance is introduced. One of the most pertinent issues centers around global securities regulation where there is a range of required actions to undertake before issuing a security, including consulting legal advice, documentation, due diligence, marketing and secondary trading, and corporate actions. These all incur further costs.
The unyielding inefficiencies throughout this process also create an opportunity for DeFi. A protocol able to solve these issues would significantly reduce a firm’s capital and resource expenditure while also improving the process for investors who would be able to access and trade in a similar manner to crypto assets today.
Due diligence checks
Due diligence checks including KYC and AML are a costly and mandatory process for institutions. An investor investing with multiple firms must complete the same checks with each of them — a time-consuming process for all parties. It also means that the investor is trusting multiple institutions with sensitive data.
DeFi offers the opportunity to redefine how KYC is completed. Instead of each firm doing its own KYC, an investor could conduct KYC protocols with an approved partner. This would enable the investor to retain control of their data, while institutions could share the burden of the KYC cost across each other. Institutions would, of course, be able to complete their own KYC if they did not approve of the KYC operator.
Data
Access to — and control of — data has become ever more contentious. The two prominent issues facing institutions regarding data are the security and privacy of users’ data, particularly post General Data Protection Regulation, as well as the ability to connect to DeFi through easy-to-use application programming interfaces.
User data can be protected using encryption methods such as zero-knowledge proofs, which enable users to share validated data with a third party without the data being revealed to said party. This would allow investors to prove they are eligible to complete a transaction without having to prove who they are or why they are eligible. This data can be encrypted and stored securely while always remaining in the hands of the user.
Institutions also require an easy way to share data. This can be achieved through APIs that will make it easy for institutions to connect to DeFi protocols while remaining compliant with regulations such as the European Union Payment Services Directive 2. This API needs to facilitate both on-chain and off-chain data.
Cross-border regulation
Requirements and processes vary from country to country, while fines for non-compliance have risen significantly since the financial crisis. The resource burden to meet this expanding compliance oversight has likewise increased. At the same time, investors expect to be able to invest globally rather than being constrained to their own jurisdiction. Blockchain technology, with its ability to digitize assets and transact instantly with peers globally, can provide a means to achieve this, but it requires firms to be able to maintain the same regulatory standards.
That is why a protocol is needed that can embed regulation at the layer level. Once a rule has been created or amended and subsequently accepted as smart contract logic, firms have no choice but to adhere to it. Furthermore, this can be tied in with the previously mentioned KYC checks to ensure an investor is able to invest in the product they want. This automizes cross-border transactions, significantly reducing costs for institutions.
DeFi investment terminal
Just like institutions leverage tools, such as Bloomberg Terminals, similarly, they require DeFi investment terminals to allow for access to real-time, actionable data. This would consolidate information across decentralized exchanges and blockchains, providing powerful and granular information.
Bridging TradFi and DeFi
There is often reluctance in the DeFi sector to countenance building a solution acceptable to TradFi. The fear is that it will corrupt the DeFi space. This is an unrealistic concern. DeFi, and blockchain more generally, offer myriad advantages to the financial system, which can be leveraged to make TradFi firms more efficient and compliant with ever more complex and increasing regulations.
By bringing TradFi to DeFi, we are in a more effective position to shape the future of finance. It would bring resources and attention on a different scale to what we currently have. We have seen the power that just a few teams can have in creating “Lego” blocks, on which the rest of DeFi has built. The task now is for us to build out the infrastructure through which TradFi can also develop.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Rachid Ajaja is the founder and CEO of AllianceBlock, the globally compliant decentralized capital market. With a deep-rooted understanding of traditional financial institutions, Rachid spent six years as a quantitative risk analyst at Barclays Investment Bank, BNP Paribas and Moody’s Analytics. A serial entrepreneur with a passion for modeling, analytics development, quantitative analysis and data science, for the last decade, Rachid has been developing and implementing models and methodologies to help organizations with forecasting and risk management. He currently also serves as a venture partner at Alpha Omega Capital.
Cointelegraph By Selva Ozelli
The United Arab Emirates is the world’s sixth-largest oil producer and one of the richest countries in the world, with a gross domestic product per capita of above $43,000 as of 2019, according to the World Bank. As per its “Vision 2021,” Iis petroleum- and natural-gas-reliant economy is committed to sustainable development in order to emerge as the Gulf Cooperation Council’s, or GCC’s, most diversified economy. This includes the digitization of the economy, which has become a priority during the COVID-19 pandemic.
Related: Not like before: Digital currencies debut amid COVID-19
A green economy for sustainable digitization
The first virtual Abu Dhabi Sustainability Week Summit 2021 was broadcast live around the world in English and Arabic on YouTube, receiving over 100,000 views during the event from participants hailing from over 175 countries, and it featured over 500 influential global leaders from government, business and technology who explored the social, economic and technological opportunities supporting a sustainable green recovery from the pandemic.
At the summit, GCC leaders reconfirmed their decarbonization pledges “to save the equivalent of 354 million barrels of oil through the deployment” of renewable energies. This represents a 23% reduction in oil consumption to reduce the power sector’s carbon dioxide emissions by 22%, according to the latest figures from the International Renewable Energy Association.
In his opening address, Sultan Ahmed Al Jaber — the UAE’s minister of industry and advanced technology, special envoy for climate change, and chairman of clean energy company Masdar — pointed out that with the COVID-19 pandemic, society is now witnessing the implementation of artificial intelligence, machine learning and the digitization of different spheres of life all over the world. Accordingly, electrification, decarbonization and digitization initiatives have become increasingly important across all industries.
Masdar’s solar energy initiatives
New digital technologies require a high consumption of electricity, which in the UAE is currently produced predominantly using fossil fuels that adversely impact the environment. Given the UAE’s vast hydrocarbon resources, Masdar is aiming to become a major blue hydrogen producer and contribute to the nation’s efforts to cut polluting carbon emissions by nearly a quarter. Masdar recently reached an agreement with Abu Dhabi’s Department of Energy and five additional institutions to develop clean hydrogen fuel solutions.
But the UAE’s Paris Agreement commitment to zero emissions by 2050 is heavily reliant on solar energy to diversify Abu Dhabi’s energy sector into renewable sources. Solar energy is seen as an anchor to Masdar’s renewable strategies from many perspectives. In Abu Dhabi, it is building the world’s largest solar power plant, as deserts are some of the best places to harvest solar power. They are never short of sunlight and are rich in silicon — the raw material for the semiconductors from which solar cells are made. Another benefit to installing solar panels in the desert, according to a 2018 study, is that it may create a more humid environment that causes vegetation to spread to combat desertification.
Masdar City: The UAE’s aerospace and green technology zone
Developed by Masdar, Abu Dhabi’s Masdar City is one of the world’s most sustainable urban communities, offering a strategic base through which companies can build their networks locally and globally and can explore multiple investment opportunities and test innovative new technologies from inception through to implementation to help the UAE diversify its economy.
Housing a free zone area, the city has more than 900 organizations, from international conglomerates to startups, developing innovative technologies in the areas of energy, water efficiency, mobility, space, blockchain technology and artificial intelligence to address the world’s most critical sustainability challenges in more than 30 countries.
UAE Space Agency
Based in Masdar City, the UAE Space Agency contributes to supporting a sustainable national economy by developing satellites used in natural resource mapping, environmental monitoring, land-use planning and security, and it has also launched a probe to Mars.
Digital economy
The UAE government has made the digitization of its economy a priority in order to bring efficiency to government, creativity to industry, and build international leadership. To accomplish this goal, the UAE has established in Masdar City the world’s first graduate-level, research-based artificial intelligence university, Mohamed bin Zayed University of Artificial Intelligence, which welcomed its first students in January 2021.
The UAE also adopted the Emirates Blockchain Strategy 2021 and The Dubai Blockchain Strategy, which have undertaken several blockchain projects. SustVest is a crowd-investing blockchain-based platform that lets people invest in solar projects and earn returns from consumers who use their funding to install solar panels. The company is based in the Dubai Silicon Oasis Authority and has built its solution on the Nem blockchain. Its founder, Hardik Bhatia, explained:
“The global rooftop solar segment is booming with opportunities, and is valued at over $66 billion. Emerging economies are looking to transition to solar as it offers a green and cheap alternative to conventional energy sources. SustVest enables this transition in emerging economies by crowdfunding rooftop solar projects in emerging economies on its platform. We tokenize solar projects granular to the level of individual solar cells, and investors purchasing these tokens can earn dividends generated by the sale of electricity from these individual solar cells. We are opening the gates for retail investment into solar space, and we do so by tokenizing the projects to reduce the barrier of entry and creating a secondary marketplace for providing liquidity to investors.”
The Central Bank of the United Arab Emirates, along with the Saudi Central Bank, is developing a state-backed bilateral central bank digital currency, “Aber.” Aber is initially set to help the UAE and Saudi Arabia make more cost-effective bank-to-bank, cross-border payments and financial settlements using blockchain technology on a probationary basis, and according to official statements, it will be exclusively available to a limited number of banks. Eventually, Aber will be used globally on China’s blockchain-based service network, or BSN, which will support future CBDCs from various countries such as the UAE.
Related: The United Arab Emirates chase crypto and blockchain adoption
Crypto-asset regulations in the UAE
The UAE prioritizes blockchain and distributed ledger technology and has launched various related ventures, especially since the COVID-19 pandemic. Nevertheless, cryptocurrency regulation in the nation remains limited.
Toward the end of 2020, the UAE’s Securities and Commodities Authority, or SCA, published “The Authority’s Chairman of the Board of Directors Decision No. (21/R.M) of 2020 Concerning the Regulation of Crypto Assets.” The SCA’s decision lays out its licensing regime for anyone who wishes to offer crypto assets within the UAE, including exchanges, crowdfunding platforms, initial coin offerings, custodians, and other services that use crypto assets.
The Financial Services Regulatory Authority, or FSRA, of the Abu Dhabi Global Market considers crypto assets to have characteristics like those of shares, meaning they are to be treated as securities and are subject to information disclosure requirements related to risk and transactions. On the other hand, utility tokens and non-fiat cryptocurrencies are considered commodities and are not subject to market regulations. Law No. 20 of 2018 on Anti-Money Laundering defines laundered funds to be assets in whatever form, including digital currencies. Article 3 of Law No. 8 of 2017 on value-added tax imposes a 5% tax on imported and exported commodities. This tax may apply to utility tokens and non-fiat cryptocurrencies, as the FSRA considers them to be commodities.
The UAE does not have a signed tax treaty agreement with the United States. However, according to the Conduct of Business Rulebook, crypto-asset businesses are obligated to declare international income for tax purposes according to the requirements of the intergovernmental Foreign Account Tax Compliance Act agreement between the UAE and the United States.
Conclusion
A green recovery is an absolute imperative for a sustainable social and economic future in the post-pandemic world, as pointed out by Alok Sharma, president of the 26th United Nations Climate Change Conference of the Parties — better known as COP26 — who praised Masdar’s undertakings in developing green energy technologies.
Related: The need to report carbon emissions amid the coronavirus pandemic
Finding financing for this green transition will likely not be too challenging, according to Khaldoon Khalifa Al Mubarak, managing director and group CEO of Mubadala Investment Corporation. Because a tectonic paradigm shift has occurred since the COVID-19 pandemic, with the markets pricing climate risk into the value of securities, there is a fundamental reallocation of capital toward sustainable investing to ensure a green recovery in a post-COVID-19 world. As Laurence Fink, chairman and CEO of BlackRock — the world’s largest asset manager — pointed out:
“I believe that the pandemic has presented such an existential crisis — such a stark reminder of our fragility — that it has driven us to confront the global threat of climate change more forcefully and to consider how, like the pandemic, it will alter our lives. It has reminded us how the biggest crises, whether medical or environmental, demand a global and ambitious response.”
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Selva Ozelli, Esq., CPA, is an international tax attorney and certified public accountant who frequently writes about tax, legal and accounting issues for Tax Notes, Bloomberg BNA, other publications and the OECD.
Cointelegraph By Kollen Post
Editor’s note
Ladies and gentlemen, it is bittersweet to welcome you to the final installment of Law Decoded, at least with yours truly at the helm. Though someone may pick this newsletter back up at some point, there are no plans to do so now.
Taking advantage of the rose-tinted glasses or maybe the graduation goggles that are in effect for this final newsletter, I will be shaking up the format. As last week’s Law Decoded focused on a few long-standing stories in crypto, this week, I wanted to get thematic.
As I will no longer be guiding you through the weekly changes in crypto law, I wanted to give you some idea of how I see the overall situation shaping up. There are plenty of major laws in motion and courts in session, but I’m going to be zooming back from those to present you with what I find to be the three issues to watch in crypto law. These are also predictions and opinions, so bear in mind that they are mine, not those of Cointelegraph as a whole. And, as always with the future, I could very well be wrong.
Certainty and securities
Prediction: The role of securities regulators, especially the U.S. Securities and Exchange will continue to determine the fate of new token issuance. And, it may take a while, but the SEC and other securities regulators are going to start kicking back at some but not all DeFi projects, as soon as they can figure out how.
Situation: High-profile legal actions against firms like Telegram, block.one and Ripple has scared many would-be token issuers out of the market. Less dramatic than these clampdowns have been the quiet tentative successes. Developers like the Filecoin Foundation and Blockstack seem to have found ways of not only raising money to develop tokens according to SEC exemptions but also of decentralizing those tokens to the point where the SEC has, for now, not stepped in when those firms stopped filing registration statements for those tokens.
Formalizing the process of token decentralization will help new developers enormously, whether it is by classifying tokens in statute or adopting a safe harbor à la Hester Peirce. Likely incumbent chairman Gary Gensler will not indulge securities issuance masquerading as decentralized tokens. We will not see another 2017. Optimistically, however, Gensler is clearly interested in formalizing the market, which means clear rules of the road.
Meanwhile, publicly traded companies like Square, Tesla and Microstrategy are increasingly becoming oblique means for stock market investors to get exposure to Bitcoin’s price movements. BTC ETFs in Canada and vast market interest in the U.S. mean that it’s only a matter of time before the SEC greenlights one in the U.S. Slowly but surely, tokenization of securities continues.
As for DeFi? The commission is going to be hashing that out for years. I predict with low confidence and the hope of being wrong that there will be attempts to hold programmers legally accountable for DeFi code.
The wealth of CBDCs
Prediction: Central bank digital currencies are going to move forward. Some will launch more quickly, but the ones that have actual significance as peer-to-peer payment mechanisms will take significantly more time, if they ever happen at all. Distributed ledger technology will need to do some serious upgrading if it’s going to play any role in this transformation, which I am not confident it will.
Situation: CBDCs had been mostly on the back-burner for some time. To crypto advocates, they were a hypothetical use case. To monetary authorities: unnecessary techie mumbo jumbo. Interest waxed and waned at various points, with the involvement of tech giants in digital payments adding brief moments of pressure to central banks to update old systems. But those moments would fade.
The COVID-19 pandemic, however, exposed the flimsiness of existing payment rails in a way that everyone could see. The need to get money into the hands of citizens alongside the sudden fear of spreading disease via in-person contact and, especially, the contaminant of cash pushed the CBDC concept to the top of the agenda for many of the world’s largest central banks.
CBDC development is going to remain a critical subject of conversation and development for the foreseeable future. It is, however, riddled with misconceptions and unconfirmed assumptions. None of the five great monetary powers — the issuers of the dollar, the euro, the yen, the yuan and the pound — have committed to specific features of their prospective digitization, nor even whether they will launch at all. Will CBDCs be bearer instruments? How anonymous will they be? Where will transaction data go? Will they be accessible to banks, businesses, citizens, or the world? Will they run on distributed ledger technology?
People are touchy to any changes to their money. If true self-settling currency ever hits the market, it will do so slowly. Of those five major currencies, the Chinese yuan has seen the most “digitization,” which has attracted the crypto world’s attention. But to all appearances, that currency bears none of the hallmarks of what the crypto world professes to want to see. The digital yuan seems designed to be just another third-party payment app except that the Chinese government is that third party.
CBDCs will be an interesting trend to watch in coming years. But don’t hold your breath. The public’s memory of not getting their checks for months will fade as the pandemic subsides. Along with it, so will broad political pressure.
All about AML
Prediction: Smart anti-money laundering rules are good for the world. The next few years of AML may not be good for crypto. The biggest economies have either tried to ban crypto entirely or have made major strides in deputizing fiat gateways — namely exchanges. The crypto industry has largely accepted this. But coming rules are going to get more intrusive.
Situation: In its much-repeated origin story, Bitcoin emerged when the global financial system was unraveling. Satoshi’s timing in pushing a means of moving power away from monetary authorities and financiers alike was perfect.
On the flip side, the subsequent decade saw a surge of attention on all of the devilish ways the powerful and corrupt have squirrelled away illicit gains all over the world, using financial instruments. The 2010s saw successive waves of mass leaks of dirty finance and offshoring — and this was after the U.S.’s “War on Terror” had expanded authority to pursue financial flows in the name of countering terror financing.
In response to, say, the Panama Papers, the public rightly reacted with outrage. Policymakers rightly set out to cut down on interjurisdictional money laundering. And crypto got rolled into these massive policy shifts and legislative packages, despite never coming close to UBS or Mossack Fonseca or Vancouver’s real estate market as a vehicle for money laundering.
But while it is not fair to slur Bitcoin as a money laundering mechanism, it’s obvious that lack of KYC has been extremely lucrative for a number of not-good actors in the crypto world. This is especially true of exchanges. It was the Paradise Papers that exposed that BitFinex and Tether are run by the same people, a fact they would clearly prefer to have kept hidden. It was only as Malta was trying to get its corporate registry in line with EU expectations that it outed Binance for lying about its registration on the island. Which is not even to mention how reckless the executives at BitMEX were.
As the EU rolls out AMLD5, and the U.S. starts demanding owner names for firms registered anonymously, the crypto world has already shifted its party line. Fewer and fewer industry voices are arguing in favor of fully law-agnostic Bitcoin, likely because many of these big players and, especially, exchanges profit by replicating the sins of the traditional financial world. Speaking in generalities, the consensus has been to center legal responsibilities like know-your-customer on fiat gateways. Which is what the Financial Action Task Force is already asking for, so in some ways this is just accepting the inevitable.
As governments have gotten more comfortable with managing exchanges, there have been pushes to go further. Most famous is the U.S. Treasury’s attempt to get info on transactions between exchanges and self-hosted wallets. Those rules are still in process and, pessimistically, some are going to stick.
I don’t foresee governments having any power over fully peer-to-peer transactions on, say, the Bitcoin network unless there has been some major operator error on the part of the wallet owner. But, pessimistically, I can envision a world of whitelists and blacklists, where it gets harder and harder to move between fiat and crypto without giving up all kinds of personal identifying information along the way. It’s not what I would call likely, at least not for several years, but it’s not impossible.
Cointelegraph By Osato Avan-Nomayo
Despite being in the middle of a $1.3 billion lawsuit with the United States Securities and Exchange Commission, it appears that it is still business as usual for Ripple.
Speaking to Reuters on Friday, Garlinghouse revealed that the company has not suffered any negative blowback in the APAC business theatre amid the current SEC lawsuit:
“It (the lawsuit) has hindered activity in the United States, but it has not really impacted what’s going on for us in Asia Pacific.”
In December 2020, the SEC charged Ripple and its principal executives of violating securities laws in the sale of XRP tokens since 2013.
Garlinghouse attributed the absence of any fallout to the company’s good standing with regulators in the region, stating, “We have been able to continue to grow the business in Asia and Japan because we’ve had regulatory clarity in those markets.”
Indeed, Japan and other APAC countries have historically been favorable for Ripple and XRP. Ripple is even part of a joint venture with Japanese conglomerate SBI Holdings to form SBI Ripple. The JV firm is at the heart of numerous projects aimed at creating a Ripple-powered payment corridor in Asia.
In March 2020, the blockchain payments firm expanded further into Southeast Asia, inking a partnership with DeeMoney, a Thai fintech outfit.
Garlinghouse also played down the effects of U.S. exchanges delisting or halting the trading of XRP tokens. According to the Ripple CEO, over 200 platforms across the world list XRP trading pairs.
Apart from U.S. crypto exchanges, asset managers and cryptocurrency funds like Bitwise and Grayscale have also liquidated their XRP holdings.
Back in December, the Ripple chief revealed that only 5% of the company’s customers were domiciled stateside. Garlinghouse has even stated previously that the company was mulling a move outside of the U.S. if the regulatory environment fails to improve.
Meanwhile, both Garlinghouse and Ripple’s executive chairman, Chris Larsen have moved to file separate motions for the case to be dismissed. Attorneys for both company executives say the Treasury Department’s Financial Crimes Enforcement Network has previously classified XRP as a virtual currency.
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