Where Finance Finds Its Future


Why the case for regulating cryptocurrencies is becoming unanswerable

Season 1, Ep. 114

The peer-to-peer system of cash outlined by Satoshi Nakamoto in his famous paper of October 2008 did not mention regulators or regulations. But its ambition of dispensing with trusted third parties did mean jettisoning regulated financial institutions. Nearly 14 years on, only the irreconcilable libertarian wing of the Blockchain industry still considers regulation of cryptocurrencies to be unthinkable. Major cryptocurrency intermediaries are getting regulated already. Two of the major cryptocurrency exchanges (Coinbase and FTX) have multiple regulatory licences and even Binance has secured a licence in France and applied for licences in Bahrain and Dubai. Likewise, of a list of 100 digital wallet custodians, 42 have secured or applied for regulatory licences. Nor is it true to say any longer that cryptocurrencies are unregulated. The Financial Action Task Force (FATF) extended Know Your Client (KYC), Anti-Money Laundering (AML), Countering the Financing of Terrorism (CFT) and sanctions screening obligations to the cryptocurrency markets as long ago as October 2018. Grumbling by cryptocurrency brokers and exchanges about the application of the Travel Rule – which obliges them to share identifying information about buyers and sellers of cryptocurrencies – is merely the latest instalment of this long-running set of obligations. Suspicious Activity Reports (SARs) now have to be filed. Besides, regulators are losing patience with the seemingly unending series of scams, hacks and thefts of cryptocurrency. Since hackers made off with US$500 million of Bitcoins from Mt Gox back in 2014, thefts of cryptocurrency have remained a constant. According to Chainalysis, thieves stole $3.2 billion worth of cryptocurrency in 2021 and another US$1.3 billion in the first quarter of this year, most of it from Decentralised Finance (DeFi) protocols. Chainalysis reports an average of 66 crypto-currency thefts a year since Mt Gox. But thieves are not the only people taxing retail cryptocurrency investors. Almost all the rewards of cryptocurrency trading go to professionals, including via pump-and-dump schemes. So it is not surprising that regulators are clamping down on the sale and distribution of crypto-currencies. Singapore has been particularly vocal about discouraging sales of cryptocurrencies to retail investors but the United Kingdom is now pondering similar restrictions. In emerging market economies, cryptocurrencies are used routinely to bypass capital controls or evade tax.

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Data provides the prices that drive activity in tokenised asset markets

Season 1, Ep. 119
Liquidity in privately managed assets is hampered by a lack of reliable and timely data about asset values. If value is hard to discern, privately managed assets are more difficult to buy and sell, harder to use as collateral and suffer from a less favourable accounting treatment. It is also difficult to develop secondary markets in which the assets can be traded. A distributed technology such as blockchain is well-adjusted to capturing, validating and then distributing data scattered across multiple databases, within as well as between institutions. It enables Inveniam to deliver the data needed to value private managed assets regularly, frequently and reliably without the need to centralise it in a single data warehouse.The data garnered by Inveniam is used by orthodox valuation agents such as Cushman & Wakefield, CBRE, Houlihan Lokey, Mercer and others to mark privately managed assets to market on behalf of their buy-side clients. The data enables the valuation agents to provide a faster, more frequent and more reliable valuation service to their clients. Where privately managed assets such as real estate, infrastructure and private equity can be marked to market daily, weekly, monthly or quarterly, by an independent third party and at low cost through the use of technology to retrieve and process data from widely distributed and highly variegated systems, two-sided markets can develop to facilitate price discovery.Accessible, reliable data improves valuations and makes two-sided markets possible, but liquidity ultimately depends on the engagement of market-makers with tokenised asset classes. They have already engaged with the cryptocurrency markets and can be expected to engage with the security token markets once issuance volumes gain sufficient momentum.The emergence of two-sided markets on blockchain-based networks will attract issuers of privately managed assets and funds invested in privately managed assets in tokenised form, because better functioning markets will lower the cost of raising and servicing capital (for example, paying dividends). Estimates indicate savings of between 20 and 50 basis points.Real estate will pioneer the tokenisation of privately managed assets in the United States because the impact of more accurate, frequent and independent valuations in reducing the capital financial institutions must allocate to the asset class is so dramatic. Similar benefits will accrue to holders of infrastructure and private equity investments as well.Reliable valuation data also cuts the cost of fund accounting or calculating the Net Asset Value (NAV) of a fund. If the cost of the NAV is borne by the fund, it lifts returns. If it is borne by the management company, it widens margins for general partners (GPs). With independent valuations, it also becomes easier to post fund units as collateral for margin loans.In the United States, the Decentralised Autonomous Organisations (DAOs) that issue tokens to raise funds and use smart contracts to service the tokens are now obtaining formal legal recognition. Three states have granted DAOs legal status and the leading jurisdiction for publicly traded corporations (Delaware) is expected to follow suit.