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Crypto Industry Report #4


Balzers (LI), 15 October 2019

This week, our blockchain experts assessed the following headlines:
 

+++ SEC Halts Alleged $1.7 Billion Unregistered Digital Token Offering +++

 

+++ Facebook's Libra Loses Mastercard, Visa, eBay and Stripe in Cascade of Exits +++

+++ The Swiss National Bank to Research Central Bank Digital Currencies (CBDCs) at New Bank for International Settlements (BIS) Innovation Hub Centre +++

 

+++ SEC Rejects Bitwise’s Latest Bitcoin ETF Proposal +++

 

+++ Bitfinex Doesn’t Have to Compile Documents During Appeal, Judge Says +++


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SEC Halts Alleged $1.7 Billion Unregistered Digital Token Offering

The US Securities and Exchange Commission (SEC) announced last week that it will halt Telegram from distributing the gram tokens to investors in the US. The emergency action is to prevent Telegram from flooding the US markets with the gram tokens, which the SEC considers that were unlawfully sold. The token distribution was expected to start on October 16 and the launch of the Telegram Open Network (TON) blockchain was planned to happen before the end of October. From the total 2.9 billion gram tokens sold by Telegram, 1 billion grams were distributed to US investors.
The SEC accuses Telegram and TON with not complying with the registration provisions of Sections 5(a) and 5(c) of the Securities Act. In addition, the SEC is seeking permanent injunctions, civil penalties and a court hearing has been set in New York for October 24. The SEC claims that Telegram and TON should had registered the sale of gram tokens, considered securities, according to the registration provisions of the Securities Act of 1933. Furthermore, the SEC mentioned that Telegram did not provide investors with the disclosure responsibilities regarding business operations, financial condition, risk factors or management.
Following the news from the SEC, the TON Board channel, which is a private channel for gram token investors, announced a temporary halt due to the increasing regulatory uncertainty. Also, it has been reported that Telegram sent a message to investors mentioning that they are analysing ways to resolve the temporary restraining order from the SEC and that the issuance and launch of the gram tokens and the TON network could be postponed from the previously planned deadline on October 31. 
Source


Assessment

Telegram submitted in February 2018 a Form D filing, which is used by companies to sell securities without registering them with the SEC by using one of two possible exemptions. The first exemption 506 (b) prevents the advertising of the securities and requires that only accredited investors and up to 35 non-accredited investors considered by the SEC as sophisticated, are allowed to buy the securities. The second exemption 506 (c) applies when the securities are only sold to accredited investors and in this case advertising is allowed. Telegram filed the Form D under the 506 (c) exemption.
While Telegram’s tokens were initially sold exclusively to accredited investors, since these investors would then be able to resell their tokens on the open markets to unaccredited investors, the SEC considers this a violation of the Rule 506 (c). If the SEC waited until the tokens were distributed and resold in the open markets, then it would be very challenging for the SEC to get back the securities and distribute them again only to accredited investors. This is the reason why the SEC decided to file for an emergency action to halt the distribution to the initial investors of the Telegram gram tokens.
Following the announcement from the SEC, Telegram claimed in a letter to investors that they had been trying to obtain feedback from the SEC for the previous 18 months regarding the TON blockchain. Telegram also mentioned in the letter that they do not agree with the recent SEC action and that the launch may be delayed while they assess how to resolve the situation.
Given that a large percentage of TON investors were based in the US, the action from the SEC is likely to have a major impact in the TON project and a delay of the token distribution and the launch of the network is quite probable. It is also not clear whether Telegram will manage to resolve the issues and be able to eventually distribute the gram tokens and launch the TON network.
A possible reason that may have accelerated the SEC actions was the announcement last week that Coinbase Custody, the largest and leading qualified crypto custodian in the world, was going to provide support for Telegram’s TON gram tokens at launch. Coinbase announced that they would provide gram token holders with cold storage and insurance, although the services were not going to be offered initially to New York based clients. Since Coinbase is the leading crypto exchange and custodian in the US, the fact that they were going to support Telegram’s gram token is likely to have contributed to the recent SEC actions.

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Facebook's Libra Loses Mastercard, Visa, eBay and Stripe in Cascade of Exits

Facebook's Libra Loses Mastercard, Visa, eBay and Stripe in Cascade of Exits
Following the recent announcement from Paypal confirming their withdrawal from Facebook’s Libra association, last week Mastercard, Visa, eBay, Stripe and Mercado Pago announced as well their withdrawal. The initial 28 announced members of the Libra Association only signed non-binding letters of intent. In addition, the House Financial Services Committee in the US announced last week that Facebook’s CEO, Mark Zuckerberg, will testify during a hearing on October 23 to defend the Libra project. Previously, both the House Financial Services Committee and the Senate Banking Committee discussed Libra in July with Facebook’s blockchain lead David Marcus. During that hearing, lawmakers had doubts and concerns about the project due to Facebook’s track record regarding data privacy and other issues.
In parallel with the withdrawal of key members from the Libra Association, an inaugural meeting of the 21 remaining members was held in Geneva to sign the Libra Association charter and to agree about interim articles of association detailing how the organization will be governed as required by Swiss law. In addition, the group elected a five-member board, which includes representatives from Facebook, Xapo, Andreessen Horowitz, PayU and Kiva. Decisions will require a majority of votes, including a two-third supermajority for changes related to membership or the management of the reserve. 
Source


Assessment

US Senators Brian Schatz and Sherrod Brown sent letters last week to Mastercard, Visa and Stripe warning them that if they continue as part of the Libra project they will be subject to a higher level of scrutiny from regulators. Furthermore, the senators warned them that this scrutiny will cover all their payment activities and not just Libra related payments and encouraged them to withdraw from the Libra Association. It is likely that these letters from the US Senators and Paypal’s announced withdrawal from the association contributed to the decision made last week by Visa, Mastercard, Stripe, eBay and Mercado Pago confirming also their withdrawal.
Given the signing of the group’s charter this week in Switzerland with the remaining members of the Libra Association and the court hearing the following week of Zuckerberg defending the Libra project, it may become clearer whether Libra could launch next year or whether the project would be delayed or even stopped due to regulatory concerns.

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The Swiss National Bank to Research Central Bank Digital Currencies (CBDCs) at New Bank for International Settlements (BIS) Innovation Hub Centre

The Bank for International Settlements (BIS) will cooperate with the Swiss National Bank (SNB) in the recently announced BIS Innovation Hub Centre based in Switzerland. The BIS board approved in June the establishment of the Innovation Hub in three initial locations: Switzerland, Hong Kong and Singapore.
The focus of the BIS Innovation Hub based in Switzerland will be in two specific research projects. The first will cover Central Bank Digital Currencies (CBDCs) and their integration into distributed ledger technology infrastructure. For this project, the SNB will collaborate with the SIX Group to develop a proof of concept (PoC). The aim will be to facilitate the settlement of tokenized assets between financial institutions. The second project is related to increasing requirements for central banks to monitor and track fast-paced electronic markets caused by the use of new technologies and the automation and fragmentation of the financial markets. 
Source


Assessment

The Head of BIS, Agustin Carstens, claimed in March 2019 that central banks saw no value in issuing digital currencies. Previously in 2018, the BIS attitude towards digital currencies was negative and it considered digital currencies such as bitcoin as a threat to central banks. However, the attitude has improved recently when Agustin Carstens said in July that central banks might issue digital currencies sooner than expected. This positive shift of attitude towards digital currencies may have been triggered by the Facebook’s Libra project announcement. Central banks met with Libra representatives in September and now BIS has announced that they will collaborate with the SNB and SIX Group to create a CBDC proof of concept. This could also be a move to counter the Libra project and to provide customers a sufficient alternative. 
CBDCs could decrease the costs of production, storage and transportation of physical cash. In addition, the amount of circulating banknotes and coins has decreased in several countries recently in favour of money in electronic form, so if cash becomes unavailable in some countries then a CBDC will allow businesses, households and financial institutions other than banks to store value and make payments. The CBDC would be legally recognised as a form of payment and represent a claim on the central bank. This could have important implications for monetary policy and financial stability.
CBDCs may increase the risk of bank runs since withdrawals could accelerate due to the efficiency and speed in which customers can complete transactions. It is also likely that central banks will gain more power from traditional banks, which will have less money supply in their accounts and hence they will not be able to lend as much as before through fractional reserve banking. This might cause instability within the banking sector.

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SEC Rejects Bitwise’s Latest Bitcoin ETF Proposal

After the Bitcoin ETF proposal withdrawal last month of VanEck/SolidX, the SEC announced last week that it had not approved the ETF proposal filed by Bitwise Asset Management and NYSE Arca. The SEC claimed that the proposal did not meet the legal requirements to prevent market manipulation and fraud as well as other illicit activities. 
BNY Mellon had been recently listed as the administrator and custodian of the Bitwise ETF. Both VanEck/SolidX and Bitwise/NYSE Arca will refile their application, in fact VanEck/SolidX claimed last month that they withdrew the proposal themselves before the SEC decision in order to improve it before further consideration by the SEC, not because they had decided to stop their plans of the ETF. Bitwise said that they will use the detailed feedback received from the SEC for their next proposal application. 
Source


Assessment

The main advantages of a Bitcoin ETF is that investors will not need to go through the complexity of buying the crypto asset and storing it securely. Furthermore, with a Bitcoin ETF investors would hold a regulated investment that would be tradable on exchanges. The custodian that supports an ETF would provide high security to investors compared to having to hold and protect the crypto assets themselves.
In addition, buying and securely storing many different crypto assets is a very complex process involving different exchanges and custody solutions to individually manage each of the assets. In contrast, an ETF would simplify this by allowing investors to track the same crypto assets efficiently. Other advantages of ETFs include ease of use and low trading fees. 
Bitwise had published a number of in-depth research reports showing the real bitcoin trading volume and claiming that the SEC’s market manipulation concerns could be addressed. However, the Bitwise ETF proposal has not been successful and now there is only one more bitcoin ETF proposal still pending the decision from SEC that was filed by Wilshire Phoenix and NYSE Arca.

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Bitfinex Doesn’t Have to Compile Documents During Appeal, Judge Says

A New York Attorney General’s (NYAG) office had requested Bitfinex and Tether to collect and provide all related documents to the $850 million Tether reserve funds provided to Bitfinex. Last week, a New York judge rejected this request. Initially, the judge had ruled in the NYAG’s office favour in the summer, but Bitfinex and Tether appealed and now they can improve this appeal until November with the hearing of arguments expected in early 2020. A second request concerning the extension of an injunction preventing Tether from lending any more funds to Bitfinex was however granted. Tether and Bitfinex did not oppose this request. Source


Assessment

This case started in April 2019, when the NYAG stated that Bitfinex had lost access to $850 million held by Crypto Capital Corp. and used Tether’s funds from its reserve to cover this shortfall. The NYAG then requested Bitfinex and Tether to provide all relevant documents surrounding this deal. Bitfinex tried to defend claiming that the NYAG had no jurisdiction and that they had not served New York based customers. This complex legal battle has been followed by a new lawsuit in which Roche Freedman, a prestigious law firm involved recently in a case against Craig Wright, is accusing Bitfinex, Tether and related companies of market manipulation and fraud. The estimated total damages are over $1 trillion, and Roche Freedman claims that Tether issued large amounts of USDT that was not backed by US dollars to manipulate crypto markets. The NYAG case is mentioned also as evidence supporting the lawsuit. Since USDT’s trading volume is quite significant in the crypto markets, these lawsuits against Bitfinex and Tether may have major consequences depending on the outcome.

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