In the world of financial regulation, it may seem like progress is slow and arduous. But then there are weeks in which a lot happens, and pieces fall into place with loud clangs and reverberations.
This past week was one of those, and the pieces in question are being largely overlooked as they are settling into place in a relatively small corner of the crypto landscape. Yet, their impact is significant even at this early stage. And, as part of the bigger picture, these pieces are forming the base of a new crypto-based financial system whose influence is likely to extend further than many currently realize.
I’m talking about what’s happening in Wyoming. This week saw two significant announcements originating from the state which, together with other proactive legal initiatives, are creating long-awaited bridges between traditional markets and crypto markets.
So what happened?
This week the Wyoming Division of Banking issued a “no-action” letter to Two Ocean Trust, a Wyoming-chartered trust company that provides wealth management services to high-net-worth individuals, family offices and advisers. This authorizes it to custody crypto and traditional assets under Wyoming law.
That in itself is interesting, as it means that clients will be able to include crypto assets in a diversified portfolio without looking for a supplementary manager or custodian. This goes a long way toward overcoming the “hassle” barrier to crypto investing, at which investors’ enthusiasm for the idea is dampened by the additional steps needed.
But the no-action letter goes further: it classifies Two Ocean Trust as a “qualified custodian” under the Investment Advisers Act of 1940, making it the first firm to get official clearance to use this term specifically when it comes to crypto asset custody. This is a big deal because, under the SEC Custody Rule, investment advisers are required to store customer assets with a “qualified custodian.” The crypto markets have not, until now, had official clarity on how the definition of “qualified custodian” as set out in the Investment Advisers Act of 1940 could apply to blockchain-based assets.
Several notable firms offer crypto custody services through state-chartered trust companies. This makes them “qualified” and it makes them “custodians,” but it does not guarantee that they meet the definition as set out in the Advisers Act. This states that “qualified custodians” include banks, savings associations, registered broker-dealers and futures commission merchants. Trust companies can be considered banks if, according to Section 202 the Act, “a substantial portion of the business … consists of receiving deposits or exercising fiduciary powers similar to those permitted to national banks.”
Not all of the current cohort of crypto custodian trust companies do, so technically they're not “qualified custodians", according to the Advisers Act. The thing is, that doesn’t really matter when it comes to bitcoin, ether and other decentralized cryptocurrencies, because the qualified custodian requirement only applies to securities. Investment managers who want to handle bitcoin and ether for their clients don't have to use a "qualified custodian." But they would probably want to, given the opportunity, for the regulatory support. And official confirmation on where cryptocurrencies and other digital assets stand when it comes to custody requirements has been eagerly awaited, given the risk investment advisers could run if their clients' assets are mishandled.
What is significant here is not that a trust company is offering digital asset custody. That’s not new. The big deal is the legal clarity. A state regulator has officially recognized the custody of digital assets as a regulated activity, filling a gap that has been rife with unclear definitions and confusing boundaries. The scale is still very small – this is one no-action letter for one new and relatively small company in one sparsely populated state.
But in terms of potential reach, it is a big step. Regulation in the U.S. tends to build on regulation. A precedent has been set, and both clients and other service providers will no doubt take note.
The other main news of the week was the approval by the Wyoming State Banking Board of a Special Purpose Depositary Institution (SPDI) charter for Avanti Financial, making it the second company to become, effectively, a “crypto bank.” Avanti will be able to accept and custody fiat and digital asset deposits, while being designated a “bank” for regulatory purposes. Kraken was the first a few weeks ago, and Avanti not only broadens the field; it is also pushing the boundaries in terms of innovative service.
Like Kraken, Avanti is a crypto- and traditional-asset custodian that will have access to the federal window once a few more requirements are met. For institutions, this access to emergency funding is an added layer of assurance, and the official authorization to custody digital assets provides further validation of cryptocurrencies as an investable asset group.
What’s more, Avanti will not benefit from FDIC protection for its deposits, nor will it be able to make loans, so its deposits will be 100% backed by custodied assets.
Beyond granting the charter, the Wyoming State Banking Board also approved the future issue of the Avit, a blockchain-based token that represents “programmable electronic cash,” according to Avanti founder and CEO Caitlin Long. This innovative approach to asset-backed value in theory will remove some of the legal uncertainty regarding stablecoin settlement enforceability, in that it represents a token 100% backed by bank assets.
There are still a few legal hoops for Avanti and Avit to jump through, and reciprocity in key financial states such as New York is unclear. Also, as Wyoming Governor Mark Gordon told CoinDesk earlier this week, it is unclear how the federal government will respond to the state’s initiatives. But a legal precedent has been set that could form the basis of future lawmaking. What’s more, the clarity and support for financial innovation (Avanti’s charter request was approved by a unanimous commission) could attract both traditional and crypto businesses as well as clients to Wyoming, further encouraging regulatory progress even beyond the state’s borders.
Financial law is a complicated plate of entwined definitions and delegated authority that lacks the detail needed for innovations to take comfortable root. Wyoming seems to be tackling this confusion head on, paving the way for clarity to extend to other jurisdictions and applications.
Not that long ago, crypto markets were referred to as the “Wild West.” According to Wikipedia, Wyoming is sometimes known as the “Cowboy State.” The metaphor is both fitting and misleading – it’s not the land of the lawless, it’s the land that makes laws appropriate for the territory.
To further underline the symbolism, the state’s official nickname is the “Equality State.” Yesterday was the 12th anniversary of the Bitcoin whitepaper, which offered a glimpse of a decentralized system of financial transfers that had equality and censorship resistance at its core. Bitcoin was nurtured in its early years by a group of idealists that hoped to change finance from the remote edges of influence.
Wherever they are now, I like to think that they would be both encouraged and astonished to see it actually happening. Sure, the impact is beholden to laws, institutions and centralized authority. But it is originating in the least populous state in the world's largest economy, far from the traditional centers of power.
Can you think of anything more “crypto” than that?
(Note: We use Bitcoin with uppercase when talking about the network, and bitcoin with lowercase, or BTC, when referring to the asset.)
Anyone know what's going on yet?
This is starting to feel a bit like one of those old-school TV game shows where the contestants have to pick a door behind which might or might not lie a gleaming prize. Only the doors in question are “big worries of the month” and the prize is not exactly gleaming, but is a welcome understanding of what is driving market sentiment swings.
You could pick election uncertainty, possible civil unrest, pandemic surge, likely oil price crash, income cliff, looming bankruptcies, currency turmoil and I’m sure there are others I’m forgetting. I’ll throw in for good measure confusion as to why the market didn’t start crashing sooner or hasn’t crashed further. I know, I know – flows of funds and all that – but it doesn’t feel sustainable, or even that it should be.
Against that gloomy backdrop, bitcoin yet again outperformed other asset groups, in spite of a slump in sympathy with the wobbly global markets threw earlier this week.
Should markets get thrown into turmoil next week as the U.S. election grabs the world’s attention, bitcoin will probably join in the chaos. The progress this year in the evolution of cryptocurrency as an investable asset group is building tailwinds for lower correlations with stocks and even with gold.
Software company MicroStrategy is looking to add to its $521 million stash of bitcoin, the company’s president said Tuesday during the business intelligence firm’s earnings conference call. TAKEAWAY: The notion of using BTC purchases as a PR stunt is alarming. Sure, it might push the BTC price up, which is good for industry interest. But, as with most hype-fueled stunts, it introduces risk which does not feel properly quantified – and if (when?) a company’s balance sheet suffers because of BTC volatility, that won’t help the market’s reputation. Call me old-fashioned, but I also have an issue with a company saying it “will” buy more BTC, when it turns out the CEO has a sizable personal holding (which will presumably benefit from the intention signaling, while the company ends up having to buy at a worse price).
U.S. crypto exchange Coinbase suffered an outage earlier this week, apparently due to “feed issues,” as the bitcoin price was rising. TAKEAWAY: Although you’ll hear me talk a lot about how the crypto markets are maturing, the fact that a major exchange can go down during a sharp price rise (and this is not as infrequent an occurrence as we would like) highlights two things: 1) that the market infrastructure is not exactly mature yet, and 2) a layer of intermediaries to fulfill the role of broker (routing orders to whichever exchange has the best price at the time) would add to market resilience. Clients who had funded accounts at Coinbase would have found themselves restricted from trading during the outage, unless they also have funded accounts at other exchanges as well – not an optimal trading situation nor an efficient use of capital.
Crypto derivatives exchange Deribit has listed bitcoin options contracts that allow traders to bet on a potential price rally to $40,000 next year. TAKEAWAY: The options expire in March and June of next year. According to skew.com, the options-based probability that the BTC price exceeds that by those dates is too minimal to even appear on the chart.
The U.S. Securities and Exchange Commission (SEC) announced Tuesday that William Hinman, the director of the SEC’s division of corporation finance, is planning to conclude his tenure later this year. TAKEAWAY: Hinman was the first official at the agency to publicly share the view that Ethereum’s native currency ETH was not a security. His departure is relevant to crypto markets since the Commission will be losing a relatively well-informed and thoughtful member who helped form some of the agency’s early crypto-related initiatives. It is also relevant given the likelihood that his eventual replacement will end up having a meaningful voice in the approval of future crypto ETF approvals. Neither presidential candidate has offered much insight into their plans for financial regulation, so clarity on this issue may be some time in coming.
Bitwise Asset Management, a provider of cryptocurrency index funds to professional investors, has broken through the $100 million mark in AUM. TAKEAWAY: This is a strong indicator of the growth in institutional interest in crypto assets, and the figures contain an interesting twist: the bulk of the growth was not in bitcoin but in the firm’s multi-asset Bitwise 10 Crypto Index Fund.
Crypto investment manager Grayscale Investments (owned by CoinDesk parent DCG) has published its second annual survey of investorshttps://grayscale.co/wp-content/uploads/2020/10/Grayscale-2020-Bitcoin-Investor-Study.pdf. Some findings I found interesting:
- 55% of those surveyed expressing an interest, vs. 36% in 2019.
- 83% of investors surveyed have made a bitcoin investment in the past year.
- 38% of bitcoin investors have invested in the past four months, and two thirds cited COVID-19 concerns as the reason for doing so.
- Interest is highest in the 35- to 44-year-old cohort, with 68% expressing interest.
- 65% said that the small minimum investment was a motivating factor. 59% of investors were attracted by the prospect of growth.
INX Limited, a cryptocurrency exchange that went public through the issuance of tokens based on the Ethereum blockchain last month, has agreed to buy U.S. security token broker-dealer Openfinance Securities. TAKEAWAY: This boosts INX’s business model by bringing into its digital asset exchange mix an alternative trading system and a broker-dealer license. The company also this week announced that it intends to trade on the alternative market Canadian Securities Exchange once it wraps up its initial public offering, which could bring in greater liquidity.
Podcast episodes worth listening to:
- Hedge Funds Failures, Bankruptcies and Pandemic Fatigue – Nathaniel Whittemore, The Breakdown
- How Financial Advisers Should Think About Bitcoin with Morgen Rochard – Tyrone Ross, On Purpose
- The Global Macro Case for FA Allocations to Bitcoin With Kevin Kelly– Tyrone Ross, On Purpose
- Joel Revill (Two Ocean Trust) on building a Qualified Custodian in Wyoming – Matt Walsh, On the Brink
- Acting Comptroller of the Currency Brian Brooks on Crypto Banks – Laura Shin, Unchained
- The 2 Types of Investors Driving Interest in Crypto, with Matt Hougan of Bitwise – Laura Shin, Unconfirmed