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So THIS Is ‘And Then They Fight You’

Crypto finds itself in an inevitable set of regulatory battles.

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Crypto finds itself in an inevitable set of regulatory battles.

This episode is sponsored by NYDIG.

“First they ignore you, then they laugh at you, then they fight you and then you win.”

In this episode of “The Breakdown,” NLW examines crypto’s current “and then they fight you” phase, citing recent regulatory battles:

A New Jersey Bureau of Securities order calls for BlockFi to stop accepting new clients residing in the state. CEO Zac Prince remains optimistic, believing the company’s products are lawful and that further discourse with regulators would clear up concerns, the most important of which seems to be surrounding yield delivery. Is a new macro narrative emerging as competition ramps up with high yield enticing new crypto users?

In a meeting with the President’s Working Group on Financial Markets, attendees discussed the rapid growth of stablecoins and their risks and benefits for the future. Of the eight political and regulatory figures in attendance, who are likely to provide pro-stablecoin input?

This morning, an incendiary headline dropped – “EU Aims to Ban Anonymous Crypto Asset Wallets” – following a European Commission release. Is the severity of the commission’s reform as fierce as the headline suggests?

The Breakdown is written, produced by and features NLW, with editing by Rob Mitchell and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Razor Red” by Sam Barsh. Image credit: Greg Nash/Bloomberg/Getty Images, modified by CoinDesk.


What's going on guys, it is Tuesday, July 20 and the theme of today comes from that famous old phrase, "First they ignore you, then they laugh at you, then they fight you, and then you win." We were flying high at the beginning of this year, but man, it is hard to ignore how aggressively things have taken a turn. Someone actually shot me a DM on Twitter the other day and said that they were finding the show increasingly bleak or negative. Basically, their point was, we all know how much new FUD there is, and that the prices sucked and maybe we could focus on some of the good stuff. And, their feedback was totally shared in good faith so I appreciate it. The reality is, though, that this is a pretty pivotal moment for bitcoin and the entire crypto space, one does not shift power systems without arousing the ire of the existing power structure. And right now, that power structure is finally recognizing bitcoin and stablecoins and these new financial rails as, if not a threat, a priority, and at least something they need to have a much better handle on. Because of that, I predict a lot more turmoil, volatility and a generally more intense environment. Now, importantly, I don't view this as inherently negative. All of this was something we were going to have to go through at some point. In fact, as we find ourselves starting to go through it, we're on a much stronger footing than I might have thought.

This infrastructure is more used, there's more history, there are better counterpoints to the critique, there are actual factual allies in positions of power, there is more consumer exposure and interest, there's more integration with mainstream business and traditional finance. So, the point is that I don't find this part bleak or depressing. It's just a part of the journey and in fact, a really, really important part. Now, that also doesn't mean that anyone is obligated to follow the play-by-play. One of the great things about this being a daily show is that if you're just not in the mood to hear about some new, dumb congressmen saying some stupid crap that shows how little work they're putting in trying to understand, skip it, and hopefully the next day will be more in your wheelhouse. I appreciate you guys listening however often it is. 

That said, back to the main theme of this episode, "and then they fight you," let's start with an unexpected one from the state of New Jersey. Last night, they sent a cease and desist to BlockFi around the company's interest accounts. BlockFi CEO Zac Prince tweeted, "Late Monday evening BlockFi received an order from the New Jersey Bureau of Securities regarding BlockFi Interest Account (BIA) operations in the State of New Jersey. We remain fully operational for our existing clients in New Jersey.   All aspects of the BlockFi platform continue to be accessible to our clients in New Jersey.   The order calls for BlockFi to stop accepting new BIA clients residing in New Jersey beginning July 22, 2021. BlockFi is engaged in an ongoing dialogue with regulators to help them understand our products, which we believe are lawful and appropriate for crypto market participants. BIA is not a security, and we therefore disagree with the action by the New Jersey Bureau of Securities. We will continue to engage with all relevant authorities to protect our clients’ interests and ensure that our products remain available."

The issue at hand seems to be how BlockFi is delivering this yield to its customers. Michael del Castillo over at Forbes writes, quote, "The undated, unpublished draft contends that BlockFi has been funding and facilitating its cryptocurrency lending and trading operations, at least partly through the sale of unregistered securities, in alleged violation of relevant securities laws. The draft statement goes on to highlight how decentralized finance platforms, known in the industry as DeFi, do not offer FDIC or SIPC insurance like traditional banks and brokerages. However, while BlockFi offers similar savings and lending platforms to those that operate on top of decentralized ledgers, such as Uniswap or Compound, it is a centralized company," Michael and Forbes had to point that out because the statement from the New Jersey regulator called BlockFi a DeFi platform, I think that's relevant just to get a sense of perhaps how nascent their understanding of this space is. 

This one I find really interesting because I think that the discussion around yield is the next obvious major macro narrative that could potentially drive people into crypto. So briefly, the narrative driving the bitcoin bull market over the last year was "The Great Monetary Inflation Thesis," right? The idea of bitcoin as a counterbalance to that, in a world of never ending fiat money supply, invest in the thing with the fixed monetary supply. This is a macro argument for bitcoin that relates specifically to the larger global environment and monetary policy. Recently, some members of the Ethereum community have been pushing the "Ultra-Sound Money Thesis." It's basically the idea that based on planned upcoming changes in EIP 1559, Ethereum won't just be reducing its regular issuance, à la the way that the amount of bitcoin being produced is halved every four years, instead, the total supply of ethereum will actually be declining. Hence from quote, "sound money to ultra-sound money." Holding aside any specifics of that, or whether it's the right monetary policy for Ethereum, I think there is a much more obvious macro narrative sitting there and waiting for, especially, the DeFi world. And that is yield. 

It's not just inflation that is a consequence or outcome of zero bound or negative interest rates. It's also the difficulty in finding yield. It is in fact, this difficulty finding yield that has pushed so many firms to move farther and farther out on the risk curve, looking for assets that can actually generate a return. In crypto meanwhile, we already see competition to provide yield everywhere. The sort of yield that people are getting through crypto protocols is totally different than what's available to them in the traditional finance world where bank accounts are basically giving people nothing. Now, to be clear, there is no comparison of the risk profile of these two different things. But still, from the standpoint of attracting more people to the space, saying, "Hey, we offer real yield on your assets just for parking them here while banks don't" is a pretty strong argument. That's why this New Jersey thing is worth paying attention to. 

Let's go back now to the bigger boogeyman of the moment, at least when it comes to the U.S.: stablecoins. I mentioned yesterday that there was a meeting of the President's Working Group on Financial Markets to discuss stablecoins. To some extent, the most notable thing about the conversation was the fact of its existence. In other words, we didn't really get a sense yet of anything about how this group was thinking about stablecoins. The thing that's clear is that they view them as enough of a priority to take time away from all these folks' schedules for this meeting, and that itself is pretty meaningful. So here's who was there. Janet Yellen, the secretary of the Treasury; Jerome Powell, the chair of the Fed; Gary Gensler, the chair of the SEC; Rostin Behnam, the acting chair the CFTC; Jelena McWilliams, the chairman of the FDIC; Michael Hsu, the acting Comptroller of the Currency, Randal Quarles, the vice chair for supervision at the Fed and J. Nellie Liang, the under secretary for domestic finance at the U.S. Department of the Treasury. 

Most of the reporting after this group focused on the fact that the advisory group imparted urgency in the need to get a regulatory framework set up. The follow up readout is only about two paragraphs long, so let me just read it out. "Today Secretary of the Treasury Janet Yellen convened the President's Working Group on Financial Markets joined by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation to discuss stablecoins. In the meeting, participants discussed the rapid growth of stablecoins, potential uses of stablecoins as a means of payment and potential risks to end users, the financial system and national security. The Secretary underscored the need to act quickly to ensure there's an appropriate U.S. regulatory framework in place. The group also heard a presentation from Treasury staff on the preparation of a report on stablecoins, which would discuss their potential benefits and risks, the current U.S. regulatory framework and the development of recommendations for addressing any regulatory gaps. The President's Working Group expects to issue recommendations in the coming months."

Now one thing I'll note that I haven't seen too many commenting on is the presence of one Mr. Randal Quarles at this group, based on a speech from last month that I covered in a show about a week ago, Quarles is one of the most calm, level-headed voices in the administration when it comes to this topic. He's the person who said we don't need to fear stablecoins, and that gives us at least one person in that meeting that provides a force for mitigating the potential worst instincts. Also, while Gary Gensler is a pro-regulation type of person in general, he's taken the time to know the crypto space and anyone with intimate knowledge of this space tends to have a less inflammatory position. So perhaps that's at least two people present who can be voices of reason. 

That's good to see particularly in light of a recent paper from Fed attorney Jeffrey Zhang and Yale University economist Gary Gordon, which argued that stablecoins were akin to the wildcat banks of the 1800s and could pose a systemic risk to the financial system. Now, to be clear, Zhang was writing in his personal capacity not as a representative of the Fed, but still, not exactly the argument you want to see coming from inside. Anyway, I'm not going to go much deeper into that now as I have a sneaking suspicion that this week's "Long Read Sunday" may be a recent response to that paper from our very own Nic Carter. 

What about reactions in the community? Well, Circle's Jeremy Allaire, perhaps not surprisingly, argued in a thread that 1), stablecoins are here to stay; 2), of course, that means there should be regulatory leadership; but, 3), that doesn't mean stifling the space out of some unfounded fear. Quote, "There seems to be an emerging consensus view, outside of extreme academic positions, that private digital currencies and stablecoins are here to stay and likely to become global scale systemic parts of the economic and financial system. The speed of adoption of dollar and other fiat digital currencies appears headed for exponential versus incremental adoption and should achieve mainstream scale far ahead of any CBDC projects in most parts of the world. It's not only appropriate but critical for national governments and regulators to take a view on this just as they are in other areas of exponential tech. Taking a view in determining policy should be a journey of learning and it's crucial that the President's Working Group and related agencies not simply try to fit a square peg in a round hole. The pace of innovation in the space is astounding and has the potential to impact the world on a scale far greater than the impact of the information and communications revolution of Web 1.0 and Web 2.0. Patience is a virtue, Web 3.0 breaks a lot of molds. This moment of engagement offers an enormous opportunity for leadership by both the U.S. government and the global digital currency industry. For the U.S. government, the leadership opportunity is to embrace and enable an open and competitive field and financial infrastructure innovation on the internet, much like was done in communications with the 1996 Telecommunications Act. Don't try to out China, China. For the digital currency industry, this is an opportunity to step up and engage and foster constructive dialogue with important policy leaders. This is a process, not a meeting and it will very likely ultimately take years to get things right. We remain committed to engaging and helping the U.S. find a path forward for stablecoins at global scale."

Now, this wasn't the only Circle news however, MasterCard announced a pilot to test USDC as a settlement currency, it's specifically around crypto businesses, but still could make the crypto to fiat conversion all the easier. But the bigger thing is that Circle followed through on Allaire's promise from a couple of weeks ago to have more transparency around their reserves. John Paul Koning, a monetary researcher and writer tweeted, "Great news. USDC's latest attestation report has a full breakdown of its investments and plenty of explanatory notes to help address further questions.   In terms of transparency, the other stablecoins now have some catching up to do." So the reserves of the $22.2 billion of USDC out there include 61% of their $13.4 billion in cash and cash equivalents, 13% or $2.9 billion in Yankee CDs, 12% or $2.7 billion in U.S. Treasuries, 9% or $2 billion in commercial paper, 5% or $1.1 billion in corporate bonds, and 0.2% or $0.1 billion, or about $100 million in municipal bonds and U.S. agencies. Importantly, unlike the Tether report, for example, they also give a bit more information about what they mean when they say something like commercial paper, they define it as unsecured debt obligations of corporations and financial institutions with original maturities between 91 days and 13 months, minimum S&P rating of S/T A1, maximum maturity of 13 months.

So, if you're watching the game theory of all this Circle and USDC are working hard to be the good faith, regulated version of a stablecoin that can be pointed to by regulators as the reason that the whole enterprise should not only be not shut down, but as witnessed by all these big business partnerships emerging, seen as something that can be a force for innovation and for good. The question: Will regulators buy it? And we're just gonna have to wait and see. 

Last today though on the "And then they fight you" report, The Bloomberg Wire dropped the headline this morning, "EU Aims to Ban Anonymous Crypto Asset Wallets." That is pretty incendiary. So, what's actually going on here? Well, it came from a much larger release from the European Commission. The follow up press release of which was titled "Beating Financial Crime: Commission Overhauls Anti Money Laundering and Countering the Financing of Terrorism Rules." There are four legislative proposals of which crypto is just a small part. So here's specifically what they wrote about crypto. "At present, only certain categories of crypto asset service providers are included in the scope of the EU AML CFT rules. The proposed reform will extend these rules to the entire crypto sector, obliging all service providers to conduct due diligence on their customers. Today's amendments will ensure full traceability of crypto asset transfers, such as bitcoin, and will allow for prevention and detection of their possible use for money laundering and terrorism financing. In addition, anonymous crypto asset wallets will be prohibited, fully applying EU AML CFT rules to the crypto sector."

Neeraj Agrawal from Coin Center responded to the initial headline breaking "absurd, unenforceable," but then when he learned a little bit more, tweeted again and said "Yet another trash headline that makes regulatory news seem worse than it is by an order of magnitude." Tim Copeland from The Block explains, "Just read it. It's basically fat if guidelines being applied to money service providers for payments above 1000 euros. Nothing major." This is mostly where I saw crypto Twitter land, that 1), it wasn't particularly out of line with things that we would expect and 2), if they were really trying to ban individual consumer wallets, well then good luck. 

Now, one positive note came from investor Adam Cochran who wrote, "The markets shrugged off that EU FUD headline with ease. Usually when the markets have a rough set of reactions to news and then start shrugging off, it's a good indicator that the worst is over and you can start looking for relief movement." Not being a trading podcast, I don't know about that, but I'm happy to leave you with that. There you have it. That's the roundup for today. As I said at the top, I don't view these regulatory battles as negative. They're simply an inevitable part of these assets, maturing and competing and going about the process of creative destruction. But even if we shouldn't be scared of them, we certainly should be aware of them and understand what levers can be pulled to get the outcomes we desire. For now, guys, I appreciate you listening and I hope your week is off to a great start. Until tomorrow, be safe and take care of each other. Peace!