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Crypto Industry Report #15


Balzers (LI), 14 January 2020

This week, our blockchain experts assessed the following headlines:
 

+++ 5th EU Anti-Money Laundering Directive: Deadline for implementation reached +++

 

+++ The Chicago Mercantile Exchange (CME) launches bitcoin options  +++

+++ Former Bakkt CEO joins US Senate: potential conflicts of interest ahead? +++

 

+++ Telegram: legal case with the SEC continues +++

 

+++ Increased privacy demand: tether worth $15 million moved to the Liquid sidechain +++


Our weekly Crypto Industry Report news ticker provides you with the latest information on the global crypto industry – picked and analysed by our blockchain experts.


5th EU Anti-Money Laundering Directive: Deadline for implementation reached

Last week, on January 10, it was the deadline for European Member States to implement the 5th EU Anti-Money Laundering Directive (AMLD5).

These new rules cover also crypto-assets and service providers, requiring compliance with anti-money laundering (AML) and know your customer (KYC) procedures, registration with regulators and the need to obtain certain licences.

However, some EU countries have implemented stricter requirements than the AMLD5 and other countries are still not ready to implement AMLD5. Therefore, there is a complexity and fragmentation at the EU level regarding blockchain regulations, which is leading the EU Commission to analyse a potential EU legal framework for crypto-assets and the blockchain industry.


Assessment

The traditional passporting rights within the EU due to a common legal framework do not apply in the blockchain industry since there is not a regulatory framework at the EU level.

In addition, the implementation of AMLD5 is not homogeneous and it may increase the complexity further and facilitate regulatory arbitrage. The EU Commission recently started a consultation about an EU regulatory framework for crypto-assets in order to provide clarity and avoid regulatory fragmentation in the different EU countries.

Moreover, the European Securities and Markets Authority (ESMA) mentioned in its 2020-2022 priorities list that it will focus more on regulations about crypto-assets and related products and that the topic is also of increasing importance for other EU entities like the European Central Bank (ECB). This implies that in 2020 the first EU legal framework for crypto-assets may be introduced.

Due to the slow processes regarding AMLD5, some EU countries have gone beyond AMLD5 and have included also the Financial Action Task Force (FATF) guidelines. The FATF is an international organisation and in addition to fiat-to-crypto transactions, as covered in AMLD5, crypto-to-crypto exchanges are also included.

Netherlands missed the January 10 deadline to implement AMLD5 due to important disagreements between the legislators and the crypto industry, which claims that Netherlands is implementing a considerably stricter version of AMLD5.

The earliest date for implementation would be the end of February since the law is currently in the Senate for discussion, although further delays are possible. Crypto firms involved in crypto-to-fiat conversion or crypto asset deposit services, whether based or not in the Netherlands, that are serving Dutch nationals will need to register with the Dutch central bank according to the proposed implementation of AMLD5.

Some Dutch crypto firms have already announced that they will relocate to other jurisdictions since the AMLD5 implementation in the Netherlands would create significant barriers, both in terms of costs and regulatory compliance, such as the requirement to demand a large amount of information to their current and future customers.

Smaller firms may need to either merge or relocate, however the new regulations may provide more credibility to the blockchain industry, which could lead to banks and institutional investors becoming more willing to collaborate with crypto firms and provide financing. In addition, the regulations may also lead to a better filtering of the more serious and long-term focused crypto firms.

Germany introduced a bill to transpose the AMLD5 by adding amendments to the German Banking Act (KWG). Crypto-assets are established as financial instruments and crypto asset custody as a new financial service requiring authorisation from the Federal Financial Supervisory Authority (BaFin).

Following the January 10 deadline to implement AMLD5, an important impact is expected in the crypto industry in Europe, in particular in countries like Germany with stricter regulations than the AMLD5.

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The Chicago Mercantile Exchange (CME) launches bitcoin options

The CME launched bitcoin options following the demand from customers to better manage and hedge their risks and exposure to bitcoin at around 16:00 UTC on January 13.

Each bitcoin options contract is quoted in USD, represents an amount of five bitcoins and in order to avoid counterparty risks the clearing is done centrally. CME is one of the leading global derivative marketplaces and it was a pioneer launching bitcoin futures contracts in 2017.

Following the launch of bitcoin futures, it has become a liquid market, which now allows to develop options based on these bitcoin futures that will offer traders more advanced strategies to manage their risk and thus this may increase the interest among institutionals and professional traders to get exposure to bitcoin.

The CME CF Bitcoin Reference Rate (BRR) is the aggregation of the bitcoin price in some major spot exchanges and it is used for the bitcoin futures and options contracts. Bitcoin options provide the right to buy or sell bitcoin futures contracts at a specified price and date. Some analysts have reported an increased interest in the CME bitcoin futures in anticipation of the bitcoin options launch.


Assessment

Bakkt previously launched bitcoin options in December with the pricing based on the physically-delivered bitcoin futures. CME bitcoin options in contrast will depend on the BRR index for the pricing, which is based on several spot exchanges.

While Bakkt’s pricing mechanism may be preferred since it does not depend on spot exchanges, the volume of Bakkt’s bitcoin options was small following the launch. In contrast, some JP Morgan analysts mentioned an important raise of activity with open interest in the CME bitcoin futures increasing almost 70% recently and, in addition, the number of large open-interest holders has also increased as well.

The analysts believe that this was related to the upcoming launch of the CME bitcoin options. Moreover, there has not been a drop in bitcoin’s price before the options launch, while previously with the Bakkt bitcoin futures there was a significant bitcoin price drop around the time of the launch.

The introduction of CME bitcoin options further improves the professionalisation of bitcoin as an alternative asset class, providing traders with the usual tools to hedge and manage risks. Since hedging risk is key for traders, it is likely that with the options contracts more investors may decide to start allocating funds and getting exposure to bitcoin.

The CME bitcoin options are European type, meaning that the execution is limited to the expiration date, unlike American options, which can be executed earlier.

There are call options, which give the right but not the obligation to buy a certain amount of the underlying bitcoin futures at a specified price (strike price) and time (expiration or maturity).

Put options are similar but they give the right not the obligation to sell instead. If a call option is in the money (ITM) it means that the holder can buy a security below its current market price, and similarly a put option ITM allows to sell a security above its current market price.

An ITM option does not imply a profit since trading costs and commissions need to also be taken into account. The CME bitcoin options that are ITM are automatically exercised into expiring cash-settled bitcoin futures based on the BRR reference rate at 4pm London time on the last Friday of the month.

Since the bitcoin options are based on the CME bitcoin futures, they are a second derivative since the futures contracts are also a derivative, therefore they involve additional complexity, which requires increased expertise and attention from traders.

An important variable for trading options is the implied volatility (IV), which is the market’s expectation regarding a price movement of a security. For example, the S&P 500 reached levels of 65% only during the peak of periods of instability, while bitcoin’s IV is constantly above those values. This is because bitcoin’s price is quite volatile, which implies a high IV and therefore it increases the price of the options.

According to the JP Morgan analysts, an important anticipation was observed before the launch of the CME bitcoin options, which indicates that this tool to better manage risks was in high demand by traders and additional institutional investors may now decide to begin getting exposure to bitcoin, thus further accelerating the consolidation of bitcoin as an alternative asset class.

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Former Bakkt CEO joins US Senate: potential conflicts of interest ahead?

As reported last week, Kelly Loeffler, who was leading Bakkt as CEO since the project was announced in 2018 and towards the launch in September 2019, officially joined the US Senate on January 6, becoming a new Georgia Senator. Loeffler was sworn into the US Senate by Mike Pence, who is the Senate’s chief officer, and she is replacing Senator Johnny Isakson.

Loeffler joined the Senate Committee on Agriculture, Nutrition, and Forestry replacing Georgia Senator David Perdue. The Agriculture Committee has jurisdiction over the Commodity Futures Trading Commission (CFTC) and among its responsibilities is the approval of nominations for chairmen and commissioners of the CFTC. In addition, Loeffler will also join other committees such as the Senate Health, Education, Labor and Pensions Committee.


Assessment

Loeffler was appointed by Georgia’s Governor Brian Kemp to replace Johnny Isakson, however there will be a special election on November 2020 to determine who will serve the remainder of Isakson’s term until 2022 and, while Loeffler claimed that she will participate in the special election, it is not confirmed whether she will succeed and remain a Senator.

However, Loeffler is currently part of the US Senate, which is the upper chamber of the US Congress, one of the three branches of the US Government.

Furthermore, she joined the Agriculture Committee of the Senate, which has jurisdiction over the US CFTC that regulates the large derivative markets valued at hundreds of trillion dollars including futures, swaps and some options.

Therefore, being part of the US Congress, in particular the US Senate, which along with the Executive and Judicial is one of the three components of the US Government, brings Loeffler to a very influential position. This influence is further increased by being part of the Agriculture committee, which oversees the CFTC.

There are some potential conflicts of interest because she was previously Bakkt’s CEO and she is married to the founder and chairman of Intercontinental Exchange (ICE).

The CFTC previously approved Bakkt to begin trading the physically-settled bitcoin futures and it also regulates ICE’s exchanges. Furthermore, ICE is Bakkt’s parent company so since Loeffler will be part of the Senate committee that has jurisdiction over the CFTC that may lead to a potential conflict of interest.

In addition, while she has claimed that she supports the US President, Trump previously tweeted negatively about bitcoin and cryptocurrencies and he was not supportive of electing Loeffler to the Senate. Moreover, Bakkt is not mentioned in her official biography in the Senate.

While she is no longer Bakkt’s CEO, the platform is expected to continue growing in 2020 with increased trading volume of the bitcoin futures and options products.

In addition, the amount of bitcoin held in the Bakkt Warehouse custody is also expected to raise and there is an upcoming launch of a consumer app to spend bitcoin in partnership with Starbucks.

Therefore, with the professionalisation of bitcoin as an alternative asset class and the halving event expected in May, certain large asset managers could decide to allocate a percentage of their portfolio to bitcoin and they may use the Bakkt platform.

With the previous Bakkt CEO now joining the US Senate, this may increase the awareness about bitcoin and crypto assets within the US Congress and Government, which might accelerate the blockchain regulatory developments.

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Telegram: legal case with the SEC continues

According to an official announcement released last week by Telegram, the crypto wallet related to the TON blockchain will not be integrated into the Telegram app until approval is received from US regulators.

In parallel with the announcement, Telegram’s co-founder and CEO Durov testified last week in court in Dubai ahead of the schedule hearing in February 18-19 about the ongoing legal case with the SEC regarding the sale of grams tokens to US investors.

In the hearing, Telegram will need to justify that grams are not securities among other concerns in order to be able to launch on April 30, which was the new launch date accepted by the majority of investors. Recently, the SEC also requested information about Telegram’s bank accounts and records related to the $1.7 billion token sale.


Assessment

Since the SEC emergency action last year and the delay of the TON launch to April 30, 2020, there has been an ongoing legal case between Telegram and the SEC.

After the TON launch, the SEC is concerned that grams, which it considers unregistered securities, will reach US capital markets and unaccredited investors. Several members of Telegram testified in December and last week also the co-founder and CEO Durov.

Ahead of the court hearing in February 18-19 to discuss the case, the SEC requested information about the bank accounts associated with the $1.7 billion sale of grams tokens. In particular, the SEC is interested in how Telegram spent the $1.7 billion raised, however a judge declined SEC’s request and instead ordered Telegram to disclose information a certain date after the Durov court hearing last week, showing that the bank records comply with relevant data privacy laws in foreign jurisdictions.

Lawyers representing Telegram claimed that the requested review of financial records will take from five to seven weeks to prepare. Therefore, it seems that the SEC pressure continues and finally Telegram may not be able to launch with the US investors or the launch date may be postponed again, which will have an impact for all the investors that participated in the initial token sale.

Recently, the SEC also provided evidence that Telegram sold tokens after the initial sale and therefore this undermines Telegram’s defence that the token offering was exempt under regulation D.

Regarding the public notice, since Telegram claimed that the crypto wallet will not be integrated into the app until regulatory approval, the impact of the TON launch would be significantly reduced since the over 300 million Telegram users would not have automatic access to the TON wallet and grams tokens.

In addition, Telegram claimed in the notice that there should not be an expectation of profit regarding grams, however the initial investors are likely to have invested with expectations of future gains.

Moreover, Telegram said that they have no obligation to establish a TON Foundation. This implies that the regulatory pressure is leading Telegram to decrease the magnitude and expected impact of the TON project while in contrast Facebook seems to be continuing the efforts to launch Libra despite the exit of some key members from the Libra association and the regulatory pressure.

The SEC's Office of Compliance Inspections and Examinations (OCIE) has highlighted digital assets and service providers in its list of 2020 examination priorities. This seems to indicate that the SEC is prioritising and allocating more resources to the crypto industry.

In addition, for the first time in 40 years, the SEC is planning to decrease the barriers for investing in private securities. Although this measure is not specific to crypto assets, it was welcomed by the crypto community hoping that individuals could participate in token offerings not based on wealth levels but on the understanding of the products.

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Increased privacy demand: tether worth $15 million moved to the Liquid sidechain

It was reported last week that $15 million worth of tether were moved to Blockstream’s Liquid sidechain from Ethereum.

Liquid provides additional privacy for USDT and it was claimed that the decision to convert the tether from Ethereum to Liquid was motivated by customer demand. In addition, although $15 million is not significant compared to the total amount of USDT, previously the USDT on Ethereum started with a small amount and recently it reached a higher value than in Omni.

Therefore, due to the privacy provided by Liquid, a gradual shift of tether from Ethereum and Omni to Liquid may start in 2020.


Assessment

Tether remains the leading stablecoin with a market capitalisation and trading volume significantly larger than the other stablecoins.

During 2019, there was a major migration of tether from Omni to Ethereum, and recently the amount of tether on Ethereum surpassed the amount on Omni. This transition was motivated by certain advantages provided by Ethereum, such as the erc20 standard, which is widely supported.

However, privacy was still a concern since it was possible to track movements of the USDT in the Ethereum network.

While the initial amount of $15 million moved to Liquid is small, in 2019 there was a fast transition from Omni to Ethereum with currently around $2.3 billion USDT on Ethereum and $1.5 billion on Omni.

Therefore, in 2020 it may be possible that Liquid becomes one of the main networks to trade tether due to the privacy advantages. Liquid is a bitcoin sidechain and a payment and settlement network for exchanges, brokers and market makers.

While the amount of tokens on Liquid is public through the Blockstream block explorer, the privacy for trading is another important advantage for tether since traders would be able to move tether without risks of front-running.

For example, tether could be sent to exchanges to buy bitcoin without allowing others to notice this and increase the price expecting bitcoins to be bought. Without this privacy, movements of tether to and from exchanges can be tracked and used as valuable information for trading.

Therefore, given the privacy advantage for traders, it seems likely that a large amount of tether may be gradually moved to Liquid.

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Our weekly Crypto Industry Report news ticker provides you with the latest information on the global crypto industry – picked and analysed by our blockchain experts.




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