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Cellulant Bullish On Zambia’s Payments Ecosystem, According To GM

by with No Comment FinTech

Source: techcabal

Author: Ephraim Modise

Having entered the Zambian market in 2011, Cellulant is bullish on the country’s payments ecosystem, a sector the company pivoted to after dabbling in banking.

TechCabal talked to Gilbert Lungu, general manager of Cellulant Zambia, to find out more about the fintech startup’s motivation for pivoting, the overall state of payments in the country, challenges they have come across in their operation, and more.

Please give us a brief overview of Cellulant’s operations since it entered the Zambia market.

Gilbert Lungu: Cellulant has been in Zambia since 2011. Primarily, at the time, the business was in a phase where the focus was on banking and providing mobile banking platforms, and then also doing what we call merchant aggregation, which is essentially just layering the mobile banking platforms with the actual merchants to enable payments to happen. In terms of that phase of the business, I think it went fairly well. We acquired 15 out of 18 banks, providing services in one form or the other for them.

Around 2017 and 2018, there was a view that there were other opportunities in the market that spoke to payment collections and there were hypotheses around it. The main one was that there was no dominant mobile network operator in the market. The second one was that the primary product that the mobile network operators were pushing was peer-to-peer payments. Number three was that there was a clear cut case in terms of being able to do merchant acquisition, and provide digital payments for them based on the ecosystem that existed, either with the mobile network operators, as well as the banks. The fourth one was the view that there was general fragmentation in the market as a result of hypothesis number two. So the market was fragmented, because there was no one operator that was ahead of the other,  and we realised that the fragmentation provided an opportunity to get into payment collections.

After considering all those hypotheses, we then decided to pivot to payments. The banking business kind of took a back seat and we pushed the payments business more. Since that pivot, Zambia continues to be quite exciting as a market and we continue to experience growth month on month. 

Where do you think the payments landscape in the country is headed in the next 2-3 years?

GL: The way I see it, Zambia is definitely poised to be a significant tech hub. There’s a lot of innovations that are going on with respect to young startups in ecommerce which I think will be big in the coming years. I think with the additional interest in terms of potential prospective investors looking for all sorts of opportunities, including in tech, when some of that money starts landing in terms of fundraising, we are going to see significant growth of the ecosystem. For a lot of these startups, I think what will then happen is that scale will begin to show.

From a macro environment point of view, stability will see the economy start to take shape in terms of the growth plans that the government has put in place. I see that also being an accelerant to many sectors, including tech. There is significant consultation between the government and the ecosystem which is well needed. We are having quarterly engagements with the minister and presenting ideas and papers to him about how we can accelerate digitization in our country. In short, we are putting across ideas and he’s driving it from a policy point of view, to ensure that some of those ideas become a reality. 

For instance, there is an idea from a payments point of view that if the government takes a decision to start compelling some of the government departments to do payments via digital platforms and then puts the relevant policy framework to guide that, it will guide customer behaviour towards using digital means for transactions. 

I think over the next two to three years, opportunity size is also going to grow in terms of what else the tech startups can actually do. From a product point of view, I think payments is the thing right now. I see payouts, disbursements being the next big thing, as well as remittances, inward remittances, and then the relevant rails to be able to receive those remittances, and make sure that they’re flowing in the economy. So I see a positive picture overall.

Which challenges would you say have been prominent in the Zambian tech ecosystem?

GL: I think for Zambian startups, capital is still pretty much a challenge. I mean I’ve seen that there is activity now with angel investors trying to invest in these young tech startups but there is still some way to go because raising money is very difficult because of the nature of the places from which you can obtain that money. If you go into the banking sector, the cost of money is extremely high especially for startups.

Challenge number two is in terms of incubation. People have a lot of ideas. I meet all sorts of youngsters that walk in here or find me on LinkedIn, and they’re telling me about very, very nice ideas, that if they got the right level of attention and training, they would become really grand ideas. The incubation to move from ideation to a point where they implement the ideas into scalable businesses is still relatively lacking in my opinion. We don’t have a lot of incubation hubs where these youngsters can take the ideas to be stress-tested.

The third challenge, in my opinion, is the fact that tech businesses typically thrive and scale in the context of an ecosystem. They don’t work in isolation. Unfortunately, the ecosystem in Zambia has not developed to a point where there is sufficient trust between each of the ecosystem players in terms of who should play in what space. The bigger guys are always suspecting the smaller guys of trying to sabotage what they are doing and vice versa. For me, those are some of the most significant challenges in the ecosystem.

What are some solutions you reckon could address these challenges?

GL: For the capital challenge, I’m aware that in some developed markets, startups get access to things like government funds for working capital purposes, but at much cheaper rates compared to, say, banks. There is some effort there and I must really commend the government in availing monies that are now going into what we call the constituencies, and people who have fantastic ideas can then form cooperatives, and drive those ideas to fruition. I would like to see tech start taking up some of those funds. The other element around capital is that I know that on the international market capital is much cheaper so we need to position ourselves as an investment destination. Ultimately when that capital comes in, because it is much cheaper in relative terms, when these guys access it, then we’ll be able to create scale. 

In terms of ecosystem development, banks are talking with mobile network operators, who are also talking to fintech startups, which is a welcome development. Ultimately, we should create some level of trust, create some level of collaboration, and create some kind of structure in terms of how all the ecosystem players fit into this equation. With the passage of time and more of those engagements via the structured arrangements that are there, either with the Bankers Association, or with the fintech Association and so on, I guess in the end, we’ll get the result that we are looking for. In terms of the conversations around hubs, collaboration between private sector players and government would help because the government by nature has got access to the resources, the infrastructure, and the means to be able to make some of these ideas sort of come to fruition. So let’s start with ideas around creating hubs that are driven by the private sector, but to some extent, funded by the government, because ultimately, it’s a development issue. If we’re going to develop ideas, and the government’s primary interest is development, we then need to have stronger private sector and government collaboration to ultimately deliver some of these results. 

What traction would you say Cellulant has had in Zambia since launch?

GL: I think we’ve had fairly good traction in terms of growth. Over the past three or four years, if I take our blended growth rate, we’re sitting at anything between 30 and 40% year-on-year which for any business, is fairly significant. And then we look at what is it that drives that growth, and it’s essentially the new products that we create as well as some of the legacy products that we have. Some of the strategic partnerships have also greatly accelerated our growth.

 We had our own challenges in the beginning especially with ecosystem incumbents who perhaps weren’t so trusting of us as a fintech but by not giving up and collaborating, we have done relatively well so it’s been a very interesting journey. But I guess the challenges are part of the excitement. Every morning, you wake up, and wonder what will happen on that particular day to overcome a hurdle. There has also been a lot of discussion and talking points with our regulator, the Bank of Zambia, and I think they’ve been extremely supportive in terms of driving innovation. For example, crypto has been a big discussion in our market, as it has been in many other markets. But through engagement, there’s been some developments in the recent past where there is a crypto operator that is currently in the regulatory sandbox of the Bank of Zambia, testing out the product and drawing out all that data. 

How would you say the competitive landscape has changed between when you entered the Zambia market and now?

GL: If we look at 12 years ago when we entered the market, the landscape was very different in terms of our competitors, who then were mostly the mobile network operators. Strategically, what we did, and that sort of remains our strength, was to be extremely clear minded about where we wanted to play. The danger of being in a market like this is that there are so many opportunities that you might be tempted to chase the next shiny thing. But I think being very clear minded about where you are going as a business can be very vital.

As the years have passed, naturally, there’s been so many other players that have come in, both local and international. If you say that I’m going to do two or three things in which I’ll be very strong, and you invest your time, your energy or effort in growing and making sure that you become significant in those things in the end, it pays off and you stave off competition.

Over the past two to three years, with the pivoting that we’ve done, the investment we’ve made in terms of driving collections, if anybody is talking collections, everybody’s benchmarking against Tingg, our seamless payment gateway.. This has taken a lot of discipline and resilience. 

In terms of the future, what’s next for Cellulant in Zambia?

GL: The big goal is to be number one amongst our peers as a payments provider. Number one in revenue, number one in terms of number of merchants, number one in terms of gross payment values we process, number one in terms of brand affinity and so on. So that is very clear. The second is that we want to be Zambia’s most loved payments brand. Anybody talking about payments should talk about us.

In summary, we are pinning our growth on both organic growth and also looking at opportunities to build on our current partnerships and explore new partnerships within the market. So that’s essentially how the next two to three years will look like. Continue driving innovation and solving for very real problems in the country.

Fintech, financial technology, components displays

Fintech Driving Financial Inclusion in Zambia

by with One Comment FinTech

Author: Mark Chirwa – Assistant Research & Publications Officer – PAYZ

Fintech Driving Financial Inclusion in Zambia

Around the world especially in emerging economies, the term Fintech has become a buzzword in the financial sector. This article will try to shed more light on how the fintech industry has been spearheading the financial inclusion agenda over the past few years in Zambia.

Financial inclusion has been defined as a state in which all people have access to a full suite of quality financial services such as savings, borrowing, account ownership, insurance, and payments that are provided at affordable prices, in a convenient manner and with dignity for the clients (Joshi, 2012)

Financial inclusion though, is about a lot more than just having a bank account, it’s about being able to send and receive money easily, quickly, and cheaply. This is important for micro-merchants around the country that are trying to earn a livelihood to support their families, staff, and communities. When people have more choices and opportunities to access financial services, it enables them to improve their lives. Financial inclusion is a key part of the government’s ambition to build a sustainable, inclusive, and robust economy that works for everyone.

In driving this agenda, Fintechs have become an integral part of the financial inclusion movement in Zambia, paving the way for new opportunities to provide people with accessible, affordable, and innovative products or services such as mobile money, digital payment platforms which allows people to receive remittances, pay for electricity/school fees/bills over long distances and other digital services. But it is not accurate to say that having a mobile wallet amounts to financial inclusion.  One of the United Nations Sustainable Development Goals, goal 8 hinges on promoting sustained, inclusive, and sustainable economic growth. One of the targets of this goal is to expand access to banking, insurance, and financial services for all, exactly what Fintechs are doing. Although relatively small, the Fintech industry in Zambia has the potential to help people who have been traditionally underserved by the banking system, such as women, low-income earners, refugees, people with disabilities or learning difficulties, and young or older adults. It has the power to help people build a better life and improve their future. Hence Fintech’s potential remains much greater than what has currently been achieved.

In 2019 for example, Money transfers and digital payments boasted an adoption rate of 75% globally among fintech products compared to Borrowing which stood at 27% and was the least adopted product as insurance had a 29% adoption rate. (EY 2020)

In Zambia, mobile money has proven to be a huge contributor to financial inclusion which in turn is beneficial to socio-economic development. Between 2015 and 2020 mobile money use by the adult population rose from 14% to 58.5% in 2020 (Finscope Study 2020). An indication that mobile money has been increasing employment opportunities for the people of Zambia. For example, in a study conducted by (Lewis-Landy Gakpa 2023) on the relationship between financial inclusion and entrepreneurship, results show that there is a positive correlation between the two variables in the case of Zambia.

 Mobile money can also drive poverty alleviation. When more people get access to mobile money services, they will save more, invest more and generally improve their financial behavior which in turn will drive consumption and lift people out of poverty.

According to a report released by the McKinsey Global Institute, it was estimated that digital finance such as mobile money would add $3.7trn to the GDP of emerging economies in the years leading up to 2025, presenting an opportunity for expansion in serving the underserved population and the development of innovative financial products for the Fintech players. 

In its latest report on Inclusive Digital Economy 2022 in Zambia the Ministry of Technology and Science has noted that Financial and Digital literacy is trailing behind basic skills which stood at 30% and only 20% for Financial and Digital Literacy. One primary goal of the Ministry of Finance is increasing financial literacy in the country, as embodied in the National Strategy on Financial Education with an overall objective of seeing that the Zambian population “has improved knowledge, understanding, skills, motivation and confidence to help them secure positive financial outcomes.” This indicates that more must be done going forward to increase financial literacy levels such as investing some money in financial literacy activities, Consumer awareness programs on the use of Digital Financial platforms, and protection. Fintechs can also empower organizations who work with low-income families and households to offer a viable alternative to high-interest, pay-day loans and bank charges to continue driving the Financial Inclusion agenda.

Financial Inclusion has a multiplier effect in that not only does it add to financial stability but contributes to a country’s development also. Hence going forward there is a need to continue boosting Government’s efforts and capacity to harness Fintech in the country and foster collaborations among different stakeholders in the ecosystem to take the industry to another level. 

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Global Trends In Crypto Regulation: Implications For Zambia Part 4

by with No Comment Crypto Currency

Author: Jeffrey Stewart

Regulatory Regimes

These three dimensions – the purpose of the token, public policy risks, and crypto activities – are evinced in emerging regulation. At the international level, global efforts at regulation have come from the industry itself 92 and supranational bodies such as the EU, 93 IMF, 94 Financial Stability Board, 95 International Organization Of Securities Commissions, 96 and Basel Committee on Bank Supervision (BCBS). 97

An overriding consideration is that legal authority must necessarily precede regulation and enforcement. For instance, a 2022 survey of standards setters and regulators, conducted by the FSB, reveals that the will to regulate key crypto activities such as issuance, wallet provision, and exchange is often hampered by the lack of a clear mandate and enforcement tools. 98 Another key impediment for rule-makers is the lack of a coordinated global approach and the resultant risk of regulatory arbitrage, “in which some actors may be incentivized to structure their businesses to circumvent the application of certain jurisdictions’ more stringent regulatory requirements.” 99

Almost all major economic jurisdictions are working on a suite of regulatory measures along the lines of these global efforts, in an effort to balance risk against innovation. Beyond the previously-discussed US case, some important initiatives include:

● the UK’s recently-unveiled phased approach to align regulation with traditional finance. 100 Targeting crypto trading, financial intermediaries, and custody arrangements, starting first with stablecoins, it is purported that this, “robust approach to regulation mitigates the most significant risks, while harnessing the advantages of crypto technologies.“ 101

● the EU parliament’s Markets in Crypto Assets (MiCR) initiative which imposes obligations for Issuers (e.g. environmental impacts, whitepapers), exchanges (activity-based oversight, service providers (capital requirements), custodians, and other businesses tied to the crypto market. 102

Further, a recent PWC review of the state of crypto regulations worldwide shows that at least thirty-five countries are “researching, defining, consulting, negotiating and legislating in order to bring digital assets…under the existing financial services frameworks”. 103

Implications For Zambia

In keeping with regional trends, 104 the Bank of Zambia (BoZ, “the Bank”) and the government of
Zambia has until quite recently, given limited signals about plans to regulate crypto assets and
currencies. 105 A 2021 press release by the Bank clearly asserts that cryptocurrencies are not regarded as legal tender, that the Bank does not oversee or regulate any crypto activities, and that end users should be wary. However, the release also signals that, in keeping with global attitudes, the Bank is open to innovation in the fintech space and leaves room for further clarification and regulation. 106

An earlier 2018 public notice by the Zambian Securities and Exchange Commission evaluates crypto tokens as securities on a “case by case basis”. 107 Again the focus is on investor protection and reasserts that those operating as crypto intermediaries must adhere to Zambia securities statutes. The notice also concedes that “the emergent technology on which cryptocurrencies and other related digital assets are based may prove to be positively disruptive, transformative and efficiency enhancing.”

Very recently, there has been an uptick in buzz around crypto regulation in Zambia. Vitlik Buterin, co-founder of Ethereum – and backer of Zambia’s aspiration to become a regional tech hub 108 – visited the country in February 2023 and met with the Minister of Finance and senior finance officials. 109 The Minister of Science and Technology has also recently remarked that the Zambian Securities and Exchange Commission and BoZ are “testing technology to enable regulation of cryptocurrency” 110 as well as stressing the need for a crypto regulatory framework, perhaps emulating the Nigerian approach, 111 in order to position Zambia as a “hub of technology” in the region.

It is helpful to view these developments and signals in their wider context. The Bank of Zambia periodically releases vision documents 112 and multi-year strategic plans 113 for activities under its mandate – and in alignment with the government’s National Development Plans 114 and overarching Vision 2030 to move Zambia towards a “prosperous middle-income nation”. 115 The current strategic plan, launched in July 2020, 116 covers the 2020-2023 period and, while it does not address crypto directly, the posture adopted by the BoZ and Zambia government does provide some context for directions in electronic payments infrastructure, even if pertaining primarily to fiat-based payments:

First, there is a strong impetus towards digitization of the economy. The government is targeting, “an overall increase in financial inclusion (formal and informal) from 59 to 80 percent and an increase in formal financial inclusion from 38 to 70 percent by 2022.” 117 under its National Financial Inclusion Strategy (NFIS) 118 which prioritizes increased access to digital financial services (DFS). This corresponds to the BoZ focus on a less cash-reliant economy and “promotion of electronic /digital financial services and products” underlying its strategic objective of “significant adoption of electronic payments”. 119 At the same time, Zambian regulators will doubtlessly be somewhat circumspect about the role crypto can play in augmenting financial inclusion. 120

The Bank is also putting into place infrastructures and environments that can support a broad range of digital financial offerings, including a sandbox regulatory environment to support fintech offerings, 121 a centralized KYC infrastructure, 122 and proportional financial supervisory regimes. 123 Additionally, the Bank has regulated private money issuers and service providers, such as telcos, 124 and exceeded international standards for operational cyber resilience. 125

It is also important to bear in mind that Zambian regulatory environments are typically structured to align with international guidelines to control financial risk at the institutional and infrastructure level. Accordingly, the BoZ has implemented Principles for Financial Market Infrastructures (PFMIs), 126 EMV card standards, 127 payments automated clearing houses 128 and switching systems, 129 and an updated high-value real-time gross settlement (RTGS) 130 system with subsequent integration of securities depositories 131 and financial information systems. 132 Further, the Bank promulgates BIS/World Bank general principles for remittances, 133 is migrating financial messaging to the ISO 20022 standard, 134 and is implementing Basel III standards to improve commercial bank risk management. 135 The list goes on.

In other words, Zambia regulators are highly cognizant of international efforts to regulate and standardize the financial and regulatory space. In order to both facilitate the potential of new technologies and to tame risks of regulatory arbitrage, they are more likely than not to craft crypto regulations to align with global frameworks and in accordance with efforts such as those to extend PFMIs to the crypto and stablecoin space. 136

A Like Path Forward For Zambia Crypto Regulation

As a result, the likely path forward for Zambian crypto regulation is a cautious approach that avoids stifling innovation while tackling attendant risks. Oversight will likely be allocated according to the purpose of the crypto instrument, financial threats, and specific crypto activities being performed. This regulatory path will also likely be trod with an eye toward other potential initiatives to meet social and economic policy objectives, such as those in the traditional banking space, 137 fintech services, 138 and potentially a central bank-issued digital currency 139 to act as a complement or substitute for cash.

That being said, some key regulatory movements in the Zambian crypto space – perhaps to be signaled in the forthcoming BoZ Strategic Plan for 2024-2027 – may include:

● the necessary statutory authorities to regulate the various aspects of the crypto space as described above;

● specific controls and rules pertaining to different token types, with particular differentiation between payment and security tokens. Among backed payment tokens, stablecoins will likely receive particular attention 140 under the expansion of PFMI principles into this space; 141

● unbundling of crypto services into key functions, including issuance, exchange, key custody/wallet provision, mining/validating, and retail use and investment. Furthermore, regulatory firewalls will likely be erected between these services in line with TradFi, emerging global consensus, and in order to avoid the repetition of recent catastrophes in the crypto space; 142

● activities will also likely be subject to emerging global guidelines pertaining to market conduct, public safety (e.g. KYC/AML), prudential treatment of crypto assets by banks, accountable and transparent governance, and operational and cyber resilience.

Clearly, regulators will be busy. But service providers and fintech operating in the crypto space in Zambia 143 have a lot to consider as well. They must clearly understand the nature of the crypto objects they handle, their role in the chain, and how it may be constrained or split up over time. Their toughest task will be compliance with existing and emerging rules designed to tackle threats to financial stability, payment system efficiency, public safety, and consumer protection. This “regulatory risk” – that what is tolerated today may not be tomorrow – is further exacerbated by the regulatory house of cards that is built on the shaky precept that crypto objects are financial assets in the first place.

References

92 E.g. Global Blockchain Business Council (GBBC): GSMI – Global Blockchain Business Council

93 European Parliament: Markets in crypto-assets (MiCA) | Think Tank | European Parliament Nov 2022

94 IMF: Crypto Contagion Underscores Why Global Regulators Must Act Fast to Stem Risk. Jan 2023

95 FSB: Assessment of Risks to Financial Stability from Crypto-assets. Feb 2022

96 IOSCO: Issues, Risks and Regulatory Considerations Relating to Crypto-Asset Trading Platforms. Feb 2020

97 BCBS: Second consultation on the prudential treatment of crypto asset exposures June 2022

98 FSB: Regulation, Supervision, and Oversight of Crypto-Asset Activities and Markets: Consultative document. Oct 2022. Annex 3.

100 HM Treasury (UK): UK sets out plans to regulate crypto and protect consumers – GOV.UK. Feb 2023

102 European Parliament: Markets in crypto-assets (MiCA) | Think Tank | European Parliament Nov 2022

103 PwC Global Crypto Regulation Report 2023 – Amended to include the BCBS rules. Dec 2022. p.5

104 IMF Blog: Africa’s Growing Crypto Market Needs Better Regulations. Nov 2022

105 See e.g. Bloomberg News: Zambia Explores Digital Currency, But Warns Against Crypto – Bloomberg. Feb 2022

106 Bank of Zambia (BoZ): Press Release On Cryptocurrencies. Dec 2021

107 Securities and Exchange Commission of Zambia: Notice on cryptocurrencies and related digital products/assets. Feb 2018.

108 Bloomberg: Ethereum (ETH) Founder Buterin Is Backing Zambia’s Bid to be Africa’s Tech Hub – Bloomberg. Mar 2022

109 Beincrypto.com: Zambia Takes First Steps in Establishing African Crypto Tech Hub. Feb 2023

110 Zambia Ministry of Science and Technology: Zambia Testing Technology To Regulate Cryptocurrency – Mutati. Feb 2023

111 Central Bank of Nigeria: PSMD vision 2025.

112 BoZ:Bank Of Zambia – National Payment Systems – Vision & Strategy 2018-2022.

113 BoZ: Bank of Zambia Strategic Plan 2020-2023.

114 Republic of Zambia: Eighth National Development Plan: 2022-2026. Aug 2022

115 Republic of Zambia: Vision 2030 For Zambia. Dec 2006

116 BoZ: strategic plan of the bank of Zambia 2020. Accessed Jan 2023.

118 Republic of Zambia: National Financial Inclusion Strategy 2017–2022.

119 BoZ: Bank Of Zambia – National Payment Systems – Vision & Strategy 2018-2022. Strategic Objective 6.1.1

120 Brookings Institute: Debunking the narratives about cryptocurrency and financial inclusion. Oct 2022

121 BoZ: Bank of Zambia Strategic Plan 2020-2023. Strategic Initiative 3.2

124 BoZ: National Payment Systems Directives on Electronic Money Issuance, 2018. May 2018

125 Bowmans Law: Zambia: Regulatory Developments On Cyber Security. June 2022

126 BoZ: Principles for Financial Market Infrastructures. Circular 4/2015. Feb 2015

127 BoZ: Europay, Mastercard and Visa (EMV) Implementation. Circular 13/2014. May 2014

128 Zambia Electronic Clearing House Ltd (ZECHL): ZECHL

129 ZECHL: National Financial Switch – ZECHL

130 BoZ: ZIPSS

132 Timothy Muwema, Jackson Phiri: The Impact of Integrated Financial Management Information Systems on Procurement Process in Public Sector in Developing Countries—A Case of Zambia. Open Journal of Business and Management Vol.08 No.02(2020). Mar 2020

133 BIS-Committee on Payment and Settlement Systems (CPSS); World Bank: Committee on Payment and Settlement Systems The World Bank General principles for international remittance services. Jan 2007

134 BoZ: Bank of Zambia Strategic Plan 2020-2023. Strategic Initiative 3.5

135 See BoZ: Bank of Zambia Strategic Plan 2020-2023. Focus area #1: Financial stability

136 BIS-CPMI: Application of the Principles for Financial Market Infrastructures to stablecoin arrangements. July 2022

137 See e.g. AfricaNenda: The State of Instant and Inclusive Payments Systems in Africa 2022 – AfricaNenda. Oct 2022

138 E.g. UNCDF: The Regulatory Playbook for Zambian FinTechs – UN Capital Development Fund (UNCDF). June 2021

139 E.g. Freight News: Bank of Zambia explores CBDC route | Freight News. Aug 2022

140 IMF: Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements. Oct 2022

141 BIS-CPMI: Application of the Principles for Financial Market Infrastructures to stablecoin arrangements. July 2022

142 E.g. Organization for Economic Cooperation and Development (OECD): Lessons from the crypto winter: DeFi versus CeFi | en | OECD. Dec 2022

143 E.g. Techcabal.com: South African crypto exchange VALR launches in Zambia | TechCabal. Nov 2022

Crypto 3

Global Trends In Crypto Regulation: Implications For Zambia Part 3

by with No Comment Crypto Currency

Author: Jeffrey Stewart

Regulation By Crypto Activity

Regulation in the crypto space, as in traditional finance, is migrating towards an “activity-based”
approach and away from entity-based oversight under the rubric of “same activity, same risk, same regulation.” 66 The FSB and others identify key risks in the crypto space by the activity being undertaken. As with all things crypto, categorization can be elusive – and not exclusive – but key activities include:

● Token issuance: As per the IMF, there are, “several ways to create and issue crypto assets, the three most popular being pre-mining, continuous mining, and a hybrid approach. Crypto assets are usually distributed in five main ways: pre-token sale, initial coin offering or token sale, mining, airdrops, and forks.” 67 Each of these approaches entails different types of risk.

The two most common of these approaches to issuance are continuous mining on
algorithmically controlled ledgers, as with Bitcoin; and pre-mining on ledgers controlled by private entities, as in the case of Ripple (XPR). The continuous mining case is difficult to regulate as no issuing entity exists to be overseen in a traditional sense. New token issuance becomes concentrated in mining pools and big stakes players (aka “whales”) 68 with the power to manipulate market volume and time transactions. On the other hand, pre-mined tokens do have identifiable issuers who exchange the tokens for fiat money and have accordingly been subject to regulatory scrutiny – and to charges that the issued tokens are unregulated securities. 69

To the degree that pre-mined tokens are analogous to securities offerings, regulators are
pushing for similar customer protections measures, including the publication of “white papers” clearly laying out issuance, backing and redemption protocols, notification, licensing, and registration requirements, adherence to fair marketing practices, environmental impact assessments, and more. 70

● Wallet providers: Perhaps unintuitively, cryptocurrencies and assets are not actually held as virtual tokens in a wallet or account. Instead, private keys are housed in the wallet as “codes that are stored and accessed electronically.” 71 The private key is used to unlock and reassign a public key associated with blockchain data. These data usually include value and sometimes other information (e.g. smart contracts). So control of the private key is of critical importance, and its loss is often catastrophic. 72 Private keys may be self-custodied, which places a burden on the user to safely store and use the information. Alternatively, keys may be “custodied” by a service provider as a hosted wallet. This arrangement has many benefits but also entails reliance on a centralized structure that may suffer operational failure, hacks and misuse of funds. 73

Hosted wallet providers, often housed at crypto exchanges, are also a primary conduit for establishing identity and authenticating transactions before they morph into pseudonymous tokens. As such, they have been a priority for extending KYC requirements from the trad-fi space into crypto. 74

● Exchanges: Online marketplaces for buying crypto either with other crypto or fiat money
represent a key risk activity in the crypto space, reflecting the operational importance of the exchange function as well as the due diligence to make sure trades are executed as instructed. Accordingly, this role has faced particular scrutiny in calls for activity-based crypto regulation. 75 Exchanges may be either centralized in an entity (CEX) or decentralized (DEX) across multiple nodes. “Many of the largest and most popular crypto asset exchanges are centralized intermediaries that in practice negate the aim of decentralization and disintermediation”, and face “similar issues to those of securities exchanges.” 76

Beyond the problem of centralization, much of the risk in crypto trading results from the concentration of functions within the exchange. These functions may include: wallet provision and key custody, which may be subject to commingling, 77 hacking, 78 or loss of
access to tokens; 79 staking facilities, where users make some of their crypto tokens or balances available as liquidity for automated market making (AMM) functions; as well as
KYC and reporting functions.

Additionally, centralized exchange operators may engage in a broad array of functions that tend to be segregated in TradFi, including: brokering, order management, and traditional market making functions; provision of liquidity; lending, investing or speculative leveraging, and conflict- of-interest proprietary trading.

● Traditional financial institutions: Banks and other TradFi players have been watching
the crypto space closely and veering between disdain and enthusiasm for its potential and that of its underlying technology. 80 As a speculative asset, they may hold crypto on their balance sheets or provide access for retail and institutional clients. 81 They also may engage in investment banking ventures to support emerging players in the crypto space. 82 Because banks are tightly regulated in most jurisdictions through prudential oversight of their balance sheets, and these regulations generally conform to international principles and best practices, treatment of crypto assets has been at the forefront of efforts to control solvency and systemic risk. 83

Banks have also been active in the wholesale space where they have developed stablecoins or used crypto vehicles to effect faster settlement, particularly in the cross-border space. 84 Similarly, they have also been at the forefront of exploring the possibilities of DLT and its various permutations (e.g. public/private, permissioned/less etc.) to implement smart contracts, tokenized assets and liabilities, and atomic settlement. 85

● Miners and validators: Proof-of-work (PoW) and proof-of-stake (PoS) consensus protocols incentivize entities to do the work of validating blocks through fees and newly issued tokens. The decentralized nature of submitting and propagating transactions across the network creates many potential valid blocks vying for consensus at a given time. Miners and validators are thus in a position to see potentially market-swaying transactions and engage in insider trading and market manipulation accordingly. 86 This insider trading advantage results in “miner extractable value” (MEV). 87

The nature of the consensus mechanism itself is also increasingly in the sights of rule makers, particularly as regards its ecological impact. 88 Specifically, the massive carbon footprint of proof-of-work (PoW) protocols 89 is worsened by the enormous amount of electronic waste generated by continuously obsolete mining processors and equipment. 90 Less energy-intensive proof-of-stake (PoS) protocols drastically reduce the energy footprint but trade off against “excessive concentration of decision-making powers on crypto exchanges and wallet services providers, which may increase market integrity risks.” 91

References

66 E.g. FSB: Financial Stability Implications from FinTech: Supervisory and Regulatory Issues that Merit Authorities’ Attention. June 2017

67 IMF: Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets. Sept 2022. p.16

68 BIS: Crypto shocks and retail losses. BIS Bulletin no. 59. Feb 2023

69 E.g. US Securities and Exchange Commission (SEC): SEC Charges Ripple and Two Executives with Conducting $1.3 Billion Unregistered Securities Offering (Dec. 2020)

70 E.g. IMF: Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets. Sept 2022

71 IMF: Regulating Crypto. Sept 2022

72 BBC News: Bitcoin: Missing hard drive could fund Newport crypto hub – BBC News. Aug 2022

73 FSB: Regulation, Supervision and Oversight of Crypto-Asset Activities and Markets: Consultative document. Oct 2022

74 E.g. IOSCO: Issues, Risks and Regulatory Considerations Relating to Crypto-Asset Trading Platforms. Feb 2020

75 IMF: Regulating Crypto. Sept 2022

76 IMF:Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets. Sept 2022. p.18

78 Investopedia: The Largest Cryptocurrency Hacks So Far. Nov 2022

79 E.g. Vanity Fair: Ponzi Schemes, Private Yachts, and a Missing $250 Million in Crypto: The Strange Tale of Quadriga. Nov 2019

80 E.g. Fortune.com: JPMorgan CEO Jamie Dimon says that Bitcoin is a ‘hyped-up fraud’ and cryptocurrencies are a ‘waste of time’—but the blockchain is a ‘deployable’ technology | Fortune. Jan 2023

81 BNY Mellon: BNY Mellon Launches New Digital Asset Custody Platform. Oct 2022

82 Investmentmonitor.ai: ‘Crypto winter’ won’t stop institutional banking sector from investing in digital asset business. Jan 2023

83 Basel Committee for Bank Supervision (BCBS): Second consultation on the prudential treatment of crypto asset exposures June 2022

84 E.g. JP Morgan: Coin Systems | Onyx by J.P.Morgan. Accessed Jan 2023

85 E.g. Thomson Reuters: Banks explore tokenizing liabilities with eye toward gains in instant settlement & risk management – Thomson Reuters Institute. May 2022

86 BIS: Crypto shocks and retail losses. BIS Bulletin no. 59. Feb 2023

87 BIS: Miners as intermediaries: extractable value and market manipulation in crypto and DeFi. June 2022

88 European Parliament: Markets in crypto-assets (MiCA) | Think Tank | European Parliament Nov 2022

89 E.g. US Whitehouse: FACT SHEET: Climate and Energy Implications of Crypto-Assets in the United
States – OSTP – The White House. Sept 2022

90 E.g. Business Insider India: Bitcoin mining generates 30.7 kilotons e-waste annually – enough to cover Luxembourg’s e-waste five times. May 2022

91 IMF:Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets. Sept 2022. p.25

Crypto 2

Global Trends In Crypto Regulation: Implications For Zambia Part 2

by with No Comment Crypto Currency

Author: Jeffrey Stewart

Three Dimensions Of Regulation

So how do we predict the direction of crypto regulation, given that it is being built on a shaky conceptual foundation of financial assets? 31 Crypto regulation continues to evolve but appears to be developing along three related dimensions that we can explore in turn:

● The nature of the crypto object itself;
● The financial and social risks being addressed by the regulatory effort;
● The activity being undertaken by the player in the crypto space.

The Nature Of The Crypto Object

The discussion above hints that crypto objects are more accurately and helpfully understood by their purpose rather than being uncomfortably pigeonholed as a class of financial asset. The uses and functions of various crypto tokens introduce varying risks to individuals, corporates, and financial infrastructures and are accordingly serving as a basis for distinction in regulatory regimes. 32 Categories of crypto objects vary across sources and tend to bleed into one another, but typically include:

● Unbacked digital currencies: Native tokens, like Bitcoin, that are issued and exist on a distributed ledger, usually a blockchain. 33 These are sometimes categorized as “payment tokens”. Indeed originally, these tokens were intended for payment purposes 34 but, because unbacked cryptocurrencies don’t behave as money or currency (see above) except in their own ecosystems, they essentially become speculative assets driven by supply and demand. 35 This has led some to recommend regulating the crypto space in a manner similar to gambling. 36

● Asset-backed tokens represent the opposite case and include two main subclasses:

○ Stablecoins, sometimes called asset-referencing tokens (ARTs) when applied to multiple assets are pegged to fiat currencies (usually USD) by either holding assets – combinations of fiat money, securities, and other cryptocurrencies – or through algorithmic stabilization measures that balance supply and demand by buying and selling other cryptocurrencies. Backing with fiat-based currencies and securities requires careful auditing and evaluation to confirm adequate collateral. 37 Algorithmic stabilization works…except when it doesn’t. 38 The stablecoin’s purported raison d’etre is to
maintain stable value while harnessing the benefits of distributed ledgers, but critics contend that stablecoins are increasingly becoming an unstable source of liquidity for decentralized trading and lending. 39

○ Security tokens are “tokenized”, or “dematerialized” versions of real-world assets such as stocks. They may either be issued natively and exist only on a blockchain or alternatively, their real-world doppelganger must be held in custody while the proxy token exists. New ideas such as the Regulated Liability Network (RLN) 40 and the BIS’ nascent “unified programmable ledger” 41 build on this
concept to represent balance-sheet liabilities – like bank deposits and trade invoices – on a blockchain. Non-fungible tokens (NFTs) point to non-financial digital assets such as artwork, and unlike other “fungible” tokens such as Bitcoin, are not interchangeable. 42

● Utility tokens: allow access to a service and often double as a means of settlement within an ecosystem. The Ripple XRP token is an example of a utility coin used for interbank settlement across borders. Ether facilitates the completion of smart contracts and pays “gas” charges for processing on Ethereum blockchains while also remaining an unbacked digital currency that can be bought and sold on exchanges. Governance tokens, initial coin offerings (ICOs) etc also authorize the bearer or give rights over activities such as blockchain governance.

There are many theoretical advantages to keeping track of things on a distributed ledger technology (DLT), like a blockchain. They include 24/7 always-on functionality, instant “atomic” (all or nothing) settlement, “composable” programmability, 43 arbitrary granularity (can be almost endlessly subdivided), and operational resilience across many distributed nodes. These benefits can even be extended across disparate ledgers through technologies like hashed timelock contracts (HTLCs). 44 The regulatory task is to harness the benefits associated with DLT for each type of token while curtailing the attendant financial and social risk.

Financial And Public Risk

The second broad dimension of crypt regulation pertains to the financial risk imposed by crypto assets. The traditional financial industry is typically regulated in an effort to control risk in four key areas:

● Financial stability – the ability to allow money and credit markets to continue operating via resilient institutions and infrastructures;

● Financial efficiency – the standards, rules, and procedures that allow money and credit to flow smoothly and reduce credit and liquidity risks that hinder system performance;

● Public safety – monitoring and minimizing the use of the financial system for crime, money laundering, terrorist financing, tax evasion, and other antisocial purposes;

● Consumer protection – ensuring that consumers have accurate information to judge risks in financial activities and are not financially exploited.

Regulators’ and global standards-setters (GSS) efforts to extend financial system protections to
crypto assets can be analyzed through the lens of this categorization:

Financial Stability

Financial stability is becoming an increasing area of concern as banks and other regulated financial institutions increase their exposure to both unbacked crypto assets, stablecoins, and tokenized assets and liabilities. This risk of financial contagion has been brought to the fore by recent high-profile failures of stablecoin arrangements, 45 crypto lenders 46, and exchanges, most saliently the FTX trading platform and its speculative arm – Alameda Research 47 and its contribution to the “crypto winter”. 48

Accordingly, regulators around the world are crafting prudential oversight and corporate governance rules and orderly unwinding requirements for crypto players in their purview. Globally, the Financial Stability Board (FSB), 49 the BIS Committee on Payments Market Infrastructures – International Organizations of Securities Commissions (CPMI-IOSCO) 50 and the BaselCommittee for Bank Supervision (BCBS) 51 are leading the international charge to standardize regulatory approaches in this space.

Financial Market Efficiency

Likewise, crypto market efficiency is coming under increasing regulatory scrutiny. A variety of
intermediaries and algorithmic protocols have emerged that trading efficiency against risk in order to meet users’ needs. For example, the native throughput (transactions per second or “TPS”) of blockchain systems like Bitcoin and Ethereum is a bottleneck, so “layer 2” protocols like the
Lightning Network 52 has emerged to aggregate, clear, and settle transactions in batches. Exchanges, traders, and algorithmic Automated Market Makers (AMMs) also serve the purpose of clearing and settling transactions between cryptocurrency pairs. 53

These processes clearly improve the efficiency of crypto transactions; but where there is efficiency, there tends to be a combination of centralization, aggregation, and delayed settlement, which introduces risk. AMMs, which underlie algorithmic stablecoins, are decentralized but can run off the rails in a spectacular automated fashion in stressed market conditions 54 and are also subject to manipulation by liquidity providers and miners. 55 Accordingly, global standards setters 56 contend that crypto-clearing infrastructure should face risk-based oversight and, where possible, abide by the Principles for Financial Market Infrastructures applied to traditional financial structures. 57

Public Safety

Public Safety has of course been a concern for regulators since the early days of Bitcoin. Cryptocurrencies allow transactions to be submitted by whoever holds the cryptographic “keys” just as whoever holds cash can spend it. Hence, cryptocurrencies have filled a “pseudo-anonymous” 58 remote-payment gap that neither cash nor electronic payments properly inhabit, making cryptocurrencies a magnet for criminal activity. 59

Accordingly, many jurisdictions have imposed Know-Your-Client (KYC) and anti-money laundering (AMLs) regulations on chokepoints in and out of the world of crypto; namely exchanges, brokers, and wallet providers. This muscular law enforcement has forced true anonymity to more arcane protocols like Monero and Zcash. 60

In the global space, work by the G7-launched Financial Action Task Force (FATF) provides risk-based assessment guidance for traditional banks and financial institutions in combating crime, money laundering, and terrorist financing. It has further extended these guidelines to activities involving virtual assets and their service providers. 61 Among other recommendations is the “travel rule” requiring intermediaries to share personally-identifying information (PII) for transactions above 1000 USD or EUR. At a jurisdictional level, entities such as the US Financial Crimes Enforcement Network (FinCEN) 62 and the UK’s Financial Conduct Authority (FCA) 63 drive regulation and enforcement in the realm of public safety.

Consumer Protection

Consumer protection is at the heart of much regulatory activity. Consumer risk is driven by many factors including cyber-security protocols and the operational and business resilience of issuers, exchanges, and other intermediaries. These risks are exacerbated by the opacity of the crypto offering itself and the market’s ability to ascertain its true scarcity and value. A particular risk is
introduced through the intermingling of duties – and customer funds – by exchanges and other
intermediaries, often resulting in unauthorized leveraged speculation. 64

Regulatory efforts in this area focus on Investor and consumer protection and market conduct regulations that seek to align information about crypto offerings with that required of other financial securities and products. For example, many jurisdictions are pursuing requirements that crypto issuers produce white papers describing their business models, technology, and issuance plans. Furthermore, issuers and service providers, such as hosted wallets should clearly lay out rights obligations, and recourse in legally enforceable service contracts and provide regular statements and notifications. 65

References

31 E.g. Patrick McConnell (LinkedIn): Are regulators completely confused about cryptoassets? Feb 2023

32 See e.g. Financial Stability Board (FSB): Regulation, Supervision and Oversight of Crypto-Asset Activities and Markets: Consultative document. Annex 3. Oct 2022

33 Analytic Steps: 5 Types of Distributed Ledger Technologies (DLT) | Analytics Steps. Apr 2022

34 Satoshi Nakamoto: Bitcoin: A Peer-to-Peer Electronic Cash System. Oct 2008

35 Bank for International Settlements (BIS): BIS Working Papers – No 1049 Crypto trading and Bitcoin prices: evidence from a new database of retail adoption. Nov 2022

36 CLS Blue Sky Blog: Let’s Stop Treating Crypto Trading as If It Were Finance | CLS Blue Sky Blog. Nov 2022

37 Forbes: Stablecoin Failures Highlight The Need For Crypto Audit Standards. May 2022

38 Investopedia: TerraUSD Crash Shows Risks of Algorithmic Stablecoins. May 2022

39 ECB: Stablecoins’ role in crypto and beyond: functions, risks and policy. July 2022

40 The Regulated Liability Network (RLN):The-Regulated-Liability-Network-Whitepaper.pdf. Nov 2022.

41 BIS: Innovation and the future of the monetary system. Speech by Mr. Agustín Carstens, General Manager of the BIS, Singapore. Feb 2023

42 Worldcoin.org: A Beginner-Friendly Guide to Fungible vs. Non-Fungible Tokens | Worldcoin

43 See e.g. Ethereum.org: Smart contract composability | ethereum.org. Accessed Jan 2023

44 E.g. Corporate Finance Institute: Hashed Timelock Contract (HTLC). Jan 2023

45 Investopedia: TerraUSD Crash Shows Risks of Algorithmic Stablecoins. May 2022

46 Forbes: Celsius Crypto Meltdown: A Crypto Lender In Crisis. Oct 2022

47 Investopedia: The Collapse of FTX: What Went Wrong with the Crypto Exchange? Jan 2023

48 Investopedia: Which Companies Are Exposed to FTX?. Nov 2022

49 Financial Stability Board (FSB): Regulation, Supervision and Oversight of Crypto-Asset Activities and Markets: Consultative document. Oct 2022

50 BIS-Committee on Payments and Market Infrastructures (CPMI): Application of the Principles for Financial Market Infrastructures to stablecoin arrangements. July 2022

51 Basel Committee for Bank Supervision (BCBS): Second consultation on the prudential treatment of crypto asset exposures June 2022

52 See e.g. Investopedia: Lightning Network Explained: What It Is and How It Works. July 2022

53 BIS: Trading in the DeFi era: automated market-maker. Dec 2021

54 E.g. Forbes: From Hero To Zero: How Terra Was Toppled In Crypto’s Darkest Hour. May 2022

55 BIS: Trading in the DeFi era: automated market-maker. Dec 2021

56 E.g. IMF: Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets. Sept 2022

57 BIS-CPMI: Application of the Principles for Financial Market Infrastructures to stablecoin arrangements. July 2022

58 See e.g. Time: How Investigators Are Tracing Crypto Criminals | Time. Dec 2022

59 See e.g. Wall Street Journal: Cryptocurrency-Based Crime Hit a Record $14 Billion in 2021 – WSJ. Jan 2022

60 E.g. Coindesk: What Are Privacy Coins and Are They Legal?. Aug 2022

61 Financial Action Task Force (FATF): Updated Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers. Oct 2021

62 Financial Crimes Enforcement Network (FinCEN): FinCEN Guidance, FIN-2019-G001, May 9, 2019

63 Gov UK: Factsheet: cryptoassets technical – GOV.UK. Jan 2023

64 E.g. New York Dept of Financial Services: Industry Letter – January 23, 2023: Guidance on Custodial Structures for Customer Protection in the Event of Insolvency | Department of Financial Services. Jan 2023

65 E.g. International Organizations of Securities Commissions (IOSCO): IOSCO Crypto-Asset Roadmap for 2022-2023. July 2022

Crypto

Global Trends In Crypto Regulation: Implications For Zambia Part 1

by with No Comment Crypto Currency

Author: Jeffrey Stewart

Crypto objects versus financial assets

It has been observed that “crypto trading isn’t economically similar to any part of the traditional
financial services system and serves none of the productive purposes that define finance.” 1
Indeed, cryptocurrencies don’t act much like money 2: they are rarely used as a medium of exchange; 3 make a poor store of value owing to their volatility 4 and insecurity; 5 and are of not
much use as a unit of account except within their own ecosystems. 6 Further, they don’t carry the legal imprimatur and legal-tender status 7 of fiat currencies that are issued by central banks.

Equally, crypto-assets do not act much like securities: 8 the “investment contract” 9 is generally lacking and – except in the case where digital tokens point to real-world securities 10 – they do not represent claims on a stream of fixed income. Furthermore, they are rarely used as derivatives, except with respect to other cryptocurrencies. 11 Finally, “crypto-assets lack intrinsic economic value” 12 and the scarce tangibility found in commodities like gold, wheat, or oil.

Hence, cryptocurrencies and assets – instead of having their own intrinsic worth, being claims
on intrinsic worth (like money), being claims on future money (e.g. financial securities), or even
being derivatives used to bet on the future price of real-world securities or commodities, are a
different breed. It is more informative to view them as such.

Crypto assets are virtual digital objects that either point to something “out there” in the real world
– such as stocks, bonds, or even real estate or art – or alternatively, they are self-referencing
(“native”) and are largely constrained to their own ecosystem.

The regulatory conundrum

The misplaced desire to peg virtual objects as financial instruments is at the root of the would-be crypto regulator’s conundrum. The fact that crypto ledgers live offshore and are global
in nature further complicates regulatory efforts. 13 Accordingly, cryptocurrencies, assets, and tokens (also slippery definitions 14) are subject to a mish-mash of regulatory regimes around the
world.

In the United States for example – where President Biden issued an executive order for a”whole-of-government approach” to digital asset regulation in 2022 15 – crypto assets may be considered commodities under the CFTC, 16 securities under the SEC, 17 money under the
financial crimes regulator, 18 bank assets subject to prudential oversight under the Office of the
Comptroller of the Currency (OCC); 19 and property under the IRS for tax purposes, 20 all the while struggling, as a “virtual object”, to meet even the definition of property. 21 Law associations in the US go further, suggesting crypto assets should be regulated as “controllable electronic records”. 22 Many activities are not regulated at all. 23 Other jurisdictions may be further along in the coordination of their crypto-regulation but face the same hurdles. 24

The notion of cryptographically “controllable electronic records” is worthy of further
consideration: Other tokens and artifacts of blockchains and decentralized protocols, such as
governance and utility tokens, non-fungible tokens (NFTs), and smart contracts make an even
poorer fit with financial assets. Yet they impose risks on users that will likely be addressed with the regulation that views them as such. This mismatch exposes players in the ecosystem to a significant risk that the ground rules will shift under them as a result of a regulatory reckoning.

The emerging regulatory approach

Notwithstanding caveats about the nature of crypto objects, regulation around the world is steaming ahead in this space. The Bank for international settlements (BIS) has proposed three
broad models for controlling the risk associated with crypto activities: 25

First, specific crypto activities could be outright banned in a jurisdiction. China has done just that and has been largely successful and stamping out domestic crypto ownership and intermediation. 26 There are credible supporters of this approach even in less-regulated economies. 27 Critics of this approach point out that it “throws the baby out with the bath water” in terms of stifling potential innovation in the space and that it leads to “workarounds” that push risk into the unregulated dark corners.

The IMF nuances this approach and contends that “broad bans on crypto assets are likely to be disproportionate and ineffective in the long run, but targeted restrictions could help address immediate challenges while regulatory capacity is being built.” 28

Second, crypto activities could be “contained” in a manner that protects users and institutions in the traditional finance (Trad-Fi) sector from risks in crypto. This approach rests primarily on establishing “chokepoints” for individual and institutional flows of money into and out of the crypto ecosystem. However, investor risks would persist in the unregulated environment beyond the wall, and in practice, it would be difficult to stop the
two worlds from becoming intertwined.

The third approach involves regulating crypto in a manner analogous to the tradFi system. The imperfect fit of crypto into the realm of financial assets has not stopped rule-makers around the world from trying to do just that. Further complicating this approach is the fact that decentralized protocols often lack analogs to the TradFi world – and the associated functions and entities that are currently overseen by financial regulation. For instance, there is no issuer of Bitcoin per se, in the same way, a commercial bank issues liabilities (deposits).

Most regulators are keen on the third approach and are partial to IMF advice that “…authorities should take a balanced approach to harnessing the benefits of technology-driven innovation in financial services while ensuring that consumers and markets are protected.“29 Their hopeful
vision is that “regulation should not be seen as stifling innovation but rather as building trust.”30

References

1 CLS Blue Sky Blog: Let’s Stop Treating Crypto Trading as If It Were Finance | CLS Blue Sky Blog. Nov 2022

2 See e.g. PositiveMoney.org: What is Money. Accessed Jan 2023

3 See e.g. Coindesk: Why Haven’t Crypto Payments Taken Off? April 26, 2022

4 E.g. Naimy, Viviane & Chidiac, Johnny & El Khoury, Rim. (2020). Volatility and Value at Risk of Crypto Versus Fiat Currencies. 10.1007/978-3-030-61146-0_12. Nov 2020

5 E.g. Investopedia: Can Crypto Be Hacked?. Sept 2022

6 E.g. Ycharts: Ethereum Average Gas Price. Continuous update.

7 See e.g. CNBC: El Salvador’s bitcoin experiment: $60 million lost, $375 million spent, little to show so far (Oct. 13, 2022); Pymnts: Central African Republic Adopts Bitcoin as Legal Tender; Most Don’t Notice. Sept 2022

8 See e.g. European Central Bank (ECB) Blog: Bitcoin’s last stand. Nov 2022

9 E.g. Lee Reiners: Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets. Prepared statement for the U.S. Senate Committee on Banking, Housing, and Urban Affairs. Feb 2023

10 E.g. Forbes: What Are Tokenized Securities And Why They Matter. Mar 2019

11 See e.g. Carnegie Mellon University: Cryptocurrency Derivatives Markets Are Booming, New Study Shows – Tepper School of Business – Carnegie Mellon University (Apr 2021)

12 ECB Financial Stability Review: Decrypting financial stability risks in crypto-asset markets. May 2022

13 E.g. International Monetary Fund (IMF): Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets. Sept 2022

14 Aligning taxonomies has been a priority of international efforts. See e.g. GSMI – Global Blockchain Business Council

15 US Whitehouse: FACT SHEET: President Biden to Sign Executive Order on Ensuring Responsible Development of Digital Assets | The White House. Mar 2022

16 Commodity Futures Trading Commission (CFTC): Bitcoin Basics

17 Securities and Exchange Commission (SEC). See e.g. SEC and Crypto: Is Cryptocurrency A Security? – Forbes Advisor

18 Innreg: FinCen Cryptocurrency Regulation – Part 1: Foundations and Four Key MSB Considerations

19 Office of the Comptroller of the Currency (OCC): Interagency Statement on Crypto-Asset Risks to Banking Organizations

20 Internal Revenue Service (IRS). See e.g. Investopedia: Are There Taxes on Bitcoin? Nov 2022

21 E.g. Eldwick Law: Crypto Assets as Property | Eldwick Law. June 2022

22 Global Legal Insights: Blockchain & Cryptocurrency Laws and Regulations | USA | GLI. Accessed Feb 2023

23 E.g. American Action Forum: Who Regulates Crypto? – AAF. Aug 2022

24 See e.g. PwC: PwC Global Crypto Regulation Report 2023 – Amended to include the BCBS rules. Dec 2022

25 BIS: Addressing the risks in crypto: laying out the options. Jan 2023

26 World Economic Forum (WEF): What’s behind China’s cryptocurrency ban? | World Economic Forum. Jan 2022

27 E.g. Fortune: Warren Buffett’s right-hand man Charlie Munger, who once called crypto ‘rat poison,’ says we should follow China’s lead and ban cryptocurrencies altogether. Feb 2023

28 IMF: Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets. Sept 2022. p.5