Moving fast to change things

Will crypto come of age in a new era of regulation? Amanda Shoffel, Bitstamp’s Chief Compliance Officer, has high hopes

Of all the financial innovation to have taken place this century, crypto occupies a space of its own, far out in the left field. Its founding myth, its faceless architect, the anarchy latent in its decentralised vision, all conspire to achieve what punk did in the 1970s –horrifying the adults.

But everyone has to grow up eventually. The Stranglers went on BBC TV’s Top Of The Pops. Johnny Rotten appeared on Question Time. And the crypto market, for all its radical swagger, now looks ready to cross the aisle, too – embracing rather than frustrating the regulatory bodies it has for so long eschewed.

The warmth of that embrace might betray the chill felt during the ongoing crypto winter, with crypto markets losing more than $2trillion since their November 2021 peak. Faith is waning, too: victims of crypto hacks and scandals lost $3billion last year, up from $2billion in 2021, and three in four Bitcoin investors are now in the red, according to the Bank for International Settlements. A February report from JPMorgan, meanwhile, found that 72 per cent of institutional traders ‘have no plans to trade crypto’ in 2023.

Crypto service providers are notoriously bullish, but while hot air alone won’t thaw this deep freeze, regulation might. That’s the view of Bitstamp, the crypto exchange, which has placed security, transparency, and regulation at the heart of its approach since 2011.

“We see regulation as very much part of the business, something that drives the business,” says Amanda Shoffel, Bitstamp’s chief compliance officer. “The more the market is stabilised, and the more people put trust in crypto, the more we can spread adoption of crypto.”

Based and licensed in Luxembourg, Bitstamp is a compliance trailblazer in the crypto space, having been fully audited by a Big Four accounting firm since 2016. Today, 29 per cent of its workforce is devoted to risk management and regulation. Bitstamp keeps 95 per cent of its crypto offline, in bank-grade, Class III vaults – yes, just like the ones in the movies. Caution and care lends Bitstamp credibility, and better, tighter regulation will do the same for the entire crypto market, it believes.

In the US, many crypto-asset service providers have been crying out for regulation for this reason, with limited success. In February, crypto-focussed securities, the other as commodities. It’s a regulatory mess.

The neatest regulatory intervention for the crypto space has been the extension of anti-money laundering rules to cover digital assets. In the UK, the Financial Conduct Authority (FCA) currently has some remit to check that crypto-asset firms have the right procedures in place to spot and report wrongdoing. But in April, members of the European parliament voted in favour of the Markets in Crypto Assets (MiCA) regulation, which will be the world’s first comprehensive regulation for the crypto sector, giving most firms much-needed clarity –although it will require institutions to conduct due diligence checks on large transactions and ban anonymising tools and privacy wallets.

“Regulation and know-your-customer (KYC) will help scalability because it will combat harmful stereotypes that crypto is only used for illicit purposes, or used primarily for money laundering purposes,” explains Shoffel. “So the more regulation around KYC that we have, the more trust people will have in the product, and the more comfortable they’ll be including it as part of their financial portfolio.

Custodia Bank had its application to be supervised by the US Federal Reserve rejected for the second time. In March, two separate US agencies – the Securities and Exchange Commission and the Commodities and Futures Trading Commission – sent warnings to Coinbase and Binance, respectively. One sees crypto-assets as

“But KYC isn’t enough, on its own, to combat fraud and money laundering. Firms really need to have transaction monitoring. They need up-to-date information, they need to make sure that the information that they’re seeing, or that they have about the customer, is consistent with the transaction types, and if it’s not, all those things can trigger an investigation into suspicious activity.”

All that seems reasonable, but doesn’t it

Star performer?: Crypto firms hope regulation will bring credibility to the market meet in Hiroshima, Japan, to hammer out the details of a joint regulatory strategy.

Still, it’s likely that the EU’s new framework will set the course, just as Europe’s General Data Protection Regulation (GDPR) reached far beyond the bloc’s borders following its 2018 implementation. MiCA will have a phased introduction but appears to be as comprehensive that have gathered over Silicon Valley Bank, Credit Suisse, and others in recent months. The IMF has referenced the ‘crypto contagion’, while Belgium’s former Minister of Finance, Johan Van Overtveldt, recently termed crypto ‘speculative poison’ that ought to be banned outright to help shore up confidence in the banks. fly in the face of the crypto dream?

We’re seeing these fears, which are without causal evidence, play out in real time. When Flagstar Bank, a subsidiary of NYC Bank, stepped in to rescue the failing Signature Bank in March, it did so without purchasing Signature’s considerable digital assets business, which includes its crypto activity. The key concern here is the depositor selloff – the crypto market’s equivalent of a bank run, and the phenomenon that felled FTX. Transparency and trust are things Bitstamp takes extremely seriously.

“Yeah, the downside is that KYC can be a touchy subject, especially in an industry that’s built on the founding principles of privacy and permissionless transactions,” says Shoffel. On the other hand, many crypto-asset investors aren’t in it for the vision but for the bounty. They’re likely to welcome moves to tame the Wild West status quo, especially if they’re made a regulatory requirement.

In any case, regulating a global market throws up issues familiar to readers of this magazine. “One of the problems we face in crypto is that regulations are not as standardised [as we might like],” says Shoffel, “and it really depends on not just the location of the firm or exchange, but the products that it’s offering, as to what KYC we should, can, and do collect.”

The supranational institutions are moving through the gears on this, with the Financial Stability Board, the Bank for International Settlements, and the IMF collaborating to publish guidelines. In February, the G20 announced its collective bid to standardise digital asset regulations; in May, the G7 was due to as its digital privacy predecessor. The regulation is aimed at protecting consumers and investors, supporting financial stability, and promoting innovation in crypto-assets. And it comes with fangs: proposed fines for breaches of €5million, or between three and 12.5 per cent of annual turnover.

"One of the requirements is to issue a white paper on any token that’s being issued in the bloc, including things like who the issuer is, the team behind it, the technology underlying it, the protocol and consensus mechanisms used – even things like its impact on the environment,” says Shoffel.

“When people are more educated, and more aware of the questions they should be asking, they’re less likely to fall for scams. And unfortunately, because of the economic downturn and inflation, scams are way up.”

Some commentators have seen the spectre of cryptocurrency in the clouds

“Bitstamp has been audited since 2016,” says Shoffel. “We hold all assets on a one-to-one basis, and we have for quite some time. Exchanges are rushing to get proof of reserves to show that they are holding customer assets. But a proof of reserve is just a snapshot in time. You don’t know if they are being lent out to somebody else, or if they’re being moved into a different account. That’s why a full audit is the best way to be transparent about customer funds.”

And that would deliver an additional benefit to consumers, as Shoffel explains. “Transparency helps put an accurate value on crypto, and on assets in the marketplace. So you reduce the likelihood of pump-and-dump schemes, or of exchanges issuing their own tokens that are hard to value. On an open market, where buyers and sellers can determine value with information that they possess, it’s a more even playing field for everyone.” the technology began making headlines more than 10 years ago. Given the relentless hype, that’s hardly surprising. It remains an emerging technology, widely discussed and touted, but is yet to change the world in the same way the internet has.

Transparency might be anathema to strict crypto-evangelists, but letting the light in might be the market’s best chance of experiencing a new dawn.

And, if the cost of survival is assimilation into the mainstream, expect to see even the most crypto investors amending their principles – even if they retain the digital regalia of a rebel.

However, although we haven’t reached the tipping point, the technology has matured enough to support many business applications and has proved its potential across a variety of industries, from agriculture to health, travel and many more.

The core features of a blockchain –namely decentralisation, immutability, and traceability – make it a particularly attractive technology for banks and financial institutions, where accuracy and trust are essential. Potential use cases include payments, securitisation, smart contracts, loans and credit, and clearance and settlement systems.

But, despite the obvious applications, there has only been piecemeal progress to date. Some are more notable than others. A number of global banks are working with software company R3’s permissioned blockchain Corda, for instance, to provide a discrete number of services. And Ripple, the blockchain-based, cross-border digital payment network with its own cryptocurrency, has ruffled the feathers of incumbent providers with its three-second settlement rate and underlined what a blockchain future might mean for finance.

There are fewer sceptics than there were. In the not-so-distant-past JPMorgan’s CEO Jamie Dimon famously damned Bitcoin as ‘a fraud worse than tulips’ referring to the tulip bulb asset bubble of the 17th century – before the bank itself entered the space with its own JPM Coin and an underlying permissioned distributed ledger for the instant clearing of multi-bank, multi-currency assets. The sound of backtracking footsteps was deafening.

So, could banking follow other sectors in embracing what many clearly see to be a progressive technology?

A Question Of Trust

Finboot is a software-as-a-service enterprise blockchain low-code technology company, launched in London and 2017, which began operations in Wales after securing £2.4million in funding in 2021 –including from the country's development bank, which is helping to grow a local blockchain technology hub.

Finboot works with a wide variety of industries with complex ecosystems. Its contribution to chemical giant Sabic’s attempt to increase the circularity of its supply chain, reduce emissions, increase efficiency and save money earned it significant praise in the company’s 2022 third-quarter report.

The report said of the project, which included packaging specialist Intraplás: “This is the first of its kind in the industry to trace the product from feedstock production to converter, going further than previous industry applications of blockchain in end-to-end tracing.” It found the platform delivered reduced costs, time and improved data integration for all the value chain partners.

Finboot’s chairman and co-founder Nish Kotecha has a background in financial services and he sees blockchain as essential to building the Web3 ecosystem, because it provides one critical element.

“Trust is the most important thing,” says Kotecha, “and it’s usually administered through intermediaries. So, for example, if you look at oil, gas, energy and similar industrial supply chains, there are a complex set of processes for each one; and at every junction point, someone will be verifying who the sellers and buyers are.

“Blockchain can provide that assurance because it can administer end-to-end traceability, which is exactly what Finboot’s MARCO platform does.”

Kotecha says that the platform is building trust for customers in Finboot’s principal industries – energy, chemicals, retail, and aviation – but that the same approach could reduce friction in any business where trust and visibility are vital, including finance.

It’s unfortunate, he says, that the crypto use case has distracted from blockchain’s many positive applications and slowed its adoption in the very industry where increased control and transparency are top of the agenda.

“Blockchain and regulation are not mutually exclusive,” he insists. “In fact, blockchain can aid regulation.”

As for the banking industry harbouring conservative attitudes, he says: “I’ve spent many years in financial services and know that once the industry sees that innovative solutions are available out of house, it will start looking externally for help to innovate.

“Indeed, many financial institutions have completed pilots, such as green bonds that are being administered on blockchain. One of my shareholders, who is in financial services, even recently asked: ‘When will we see full payments being made across blockchain?’ My answer to that is: ‘Very soon.’”

Given their systemically important role, financial institutions are perhaps understandably uncertain as to what role they can and should play in the blockchain universe, as well as how best to gain value from the technology. Kotecha’s view, though, is that if they don’t hurry up and get on the blockchain bus, they’ll be left out of the Web3 loop.

“A traceable, end-to-end, secure, immutable database is a core requirement in banking and finance,” he says. “In the same way that it can track oil, gas, liquids and other commodities in the industries we currently support at Finboot, it can also be used to control each part of a financial supply chain.”

Education will be fundamental to its adoption, he adds: “As with any new tech, there is a learning curve, and you have to show the return on investment to be confident of investing further and growing the technology. For that, you need platforms like MARCO, which allow organisations to move rapidly from scoping a use case to integrating applications in a matter of weeks. Faster deployment means significantly lower costs, and you can quickly prove the value of any new application."

Web 3 is predicated on organisations being able to talk directly with their audiences, the blockchain itself taking the place of trusted intermediaries – a role banks have long played in finance.

“But banks are realising that it’s better to be part of the blockchain ecosystem," says Kotecha. And, in his view, they are also coming around to working with third parties that can support developments, rather than to try to own them.

As to the issues of privacy and regulation, which vex many in the industry, he says blockchain could be a very useful ally.

By way of illustration, Kotecha explains: “If you need to trust a supply chain, say in relation to new European environmental regulations, you need to prove provenance.

You can’t do that unless you confirm identity, and to do that you need permission. So, the person giving identity says, ‘I’m happy for you to use my identity’, and then it is encrypted and moved to the next part of the process.

“That’s what blockchain does. It collects permission and data, simultaneously locking them into the same data block, and then you can move forward.”

Kotecha says this is what regulators are looking for and what consumers will demand, and if you’re not preparing to do it today, you’ll have a big problem in five years’ time, because it will probably be too late.

“You need to start using blockchain now,” says Kotecha, “to collect data that will create value tomorrow.” they could even have made the recently shuttered Silicon Valley Bank a more viable proposition.

“SVB unravelled quickly through a lack of trust. Blockchain can enhance trust because it gives you provenance, and, with the right permissions, transparency and traceability of what’s happening where – unlike any other database today.”

Some time prior to SVB’s collapse, America’s Harvard Forum on Corporate Governance urged the banking industry to come off the fence on blockchain. “There is a historic opportunity for the banking industry to modernise dramatically by incorporating both public and private blockchains,” the authors wrote. “Through a combination of governmental regulation and partnerships between the public and private sectors, the legal uncertainties prevalent in the space can be clarified and the banking industry... can expand its use of blockchain technology to provide more

One of Finboot’s solutions is called MARCO Track and Trace. It gathers and shares data, creating digital product passports and accurate reporting, enabling trusted connections between stakeholders in a supply chain. As well as sharing data with customers and suppliers, businesses can also share data with regulators. And Kotecha says that while you need regulation to administer blockchain in a bank, blockchain also enables banks to comply with regulation. Together efficient and secure products and services.” Wherever supply chains are siloed and fractured, wherever data sharing is a challenge, Kotecha believes it has a role. “Every business needs to understand blockchain’s capability. To see it as a core technology that is not going away and is the key to success in the future.”

Building blocks?

Despite its potential, blockchain growth within the financial sector has been patchy

SEBA Bank’s Mathias

Schütz

Summer visitors to Lake Zug, the picturesque, mountain-ringed hiking hotspot half an hour south of Zurich, are greeted with images of a bygone Europe. The old towns here are a palette of pastel-coloured façades, shuttered windows, and gothic spires that pierce the morning through the lake’s rolling mist.

But all is not as it seems in this chocolate-box landscape. Up in the high Alps whirr modernity’s miners, hacking into cyberspace. Follow the cables down to the valleys, and you’ll find ordinary citizens accustomed to paying their taxes in cryptocurrency. And, in June, the world’s blockchain elite will descend on the quiet lakeside village of Rotkreuz for the fifth iteration of the Crypto Valley Conference.

Across the water lies Zug, the town at the heart of this liberally regulated Swiss canton, which is fast establishing itself as the global crypto capital. In 2021, its top 50 companies, which include Ethereum and 14 unicorns, were valued at $611.8billion. And with Zug town hosting half of the region’s blockchain companies, it’s as close to the pulsing arteries of decentralised finance as one can get.

It’s why SEBA Bank chose to be based there. The ‘bank for the new economy’ became one of the first two digital asset banks in the world – both Swiss and licensed within days of each other in 2019 by the Swiss Financial Market Supervisory Authority (FINMA). While the other, Sygnum Bank, chose Zurich as its base, SEBA set up headquarters in the very building where Zug’s crypto revolution began.

“It used to be the town hall,” says Mathias Schütz, SEBA’s Chief Client Officer for the EMEA region, speaking below its beautiful timber roof. “It’s more than 500 years old, but it’s in line with our history because we’re trying to build a bridge between traditional finance and the new economy of digital assets.

“This town hall was where the first Bitcoin transaction for government services happened – meaning the citizens of Zug were able to pay their tax bills in Bitcoin. Now, we have our premises here.”

Dolfi Müller, the town’s mayor, spoke to Deutsche Welle in 2016 about his administration’s new crypto policy, proclaiming: “With Bitcoin, we’re sending a message: we in Zug want to get out in front of future technologies.”

Today, its inhabitants can pay taxes of up to 100,000 Swiss Francs (£89,000) with Bitcoin or Ether by following a QR code sent to them by the tax authority. Those transfers are then immediately converted into Swiss

Francs by the local service provider Bitcoin Suisse, protecting tax receipts. A handful of US states, including California, Colorado, and Arizona, have since introduced legislation similarly enabling inhabitants to pay for government services in Bitcoin, but little Zug’s Crypto Valley got there six years before Silicon Valley.

As for Müller’s rallying call, it had a halo effect – Zug ranked eighth in The Expat City Ranking list in 2019, with the highest quality of life score globally. Initial coin offerings and incorporations have boomed. The medieval fishing village is having a blockchain-driven renaissance.

Back in SEBA’s headquarters, Schütz points to the floor. “Downstairs, we have designed our own vault for the cold storage of digital assets, in a very highly secure manner, using NATO-grade infrastructure.” Gold bullion and priceless fine art are what you find in most Swiss repositories: this one contains military-grade TEMPEST computers encased in radio-blocking Faraday Cages that can only be accessed after passing multiple layers of biometric access controls. With computers loaded with cold wallets and stashed with NFTs, it’s a Fort Knox for the digital age.

The trend of vault-building has been taking off across the crypto space, partly due to the spooking effects of recent arrests.

“In the aftermath of what happened with FTX,” explains Schütz, “one thing which is clear is that all digital assets should be stored and kept safe. They are off balance sheet. Here, they are totally segregated, so that, in the unlikely case of bankruptcy, those assets will never be touched.