The Impact of a Dramatic Two Weeks in DC

For the first time, crypto regulation took center stage in the political discourse in DC. The decisions underway have been a long time in the making but have dramatic consequences for the industry. What happened, how does this impact the industry, and what happens next?

SAB 121 Repeal

Two weeks ago, the Senate voted to repeal Staff Accounting Bulletin 121 (SAB 121). This came as a surprise to the industry as Senator Schumer and other Democrats broke ranks with Senator Warren and the Biden administration’s threat to veto the bill. Prior to the repeal, the SEC’s directive required banks to treat crypto custody as part of those firms’ own balance sheets. This required capital charges (think dollars) against those assets. State Street’s assets under custody or administration are nearly $44 trillion — but these customer assets don’t require State Street to hold capital against them. This directive effectively prohibited traditional custodians from pursuing the opportunity as it became costly from a capital perspective. What now?

• If the SAB121 repeal passes Biden’s desk, the largest custodians in the US will be able to offer digital asset custody. There are massive pockets of capital that have historically been hesitant to buy crypto because custodying those assets with a crypto-native player felt at odds with how they held other assets (equities, bonds, etc.). If Biden chooses not to veto, this friction will be removed.
  - Prediction: Asset managers, wealth managers, endowments, and other large allocators can now lean on existing relationships with the likes of BNY Mellon to hold spot crypto.
• The cost to custody crypto has been declining over the last decade. Bringing in new entrants with other business lines should drive the cost to custody down even further.
  - Prediction: Crypto-native custodians will benefit from selling software-like services to existing traditional custodians. A wave of new buyers with tremendous distribution will be unlocked should Biden choose not to veto the repeal of SAB 121.
• Custody will be step one for many financial institutions looking to serve this new asset class. Products to monetize this base will emerge on top — similar to how these FIs treat the other assets they custody. JPM spent $9.3 billion on technology, communication, and equipment last fiscal year. Six years ago, State Street acquired Charles River Development, a technology service provider, for $2.6 billion. These players have an appetite for financial market infrastructure.
  - Prediction: Crypto-native market data, prime brokerage, trade execution software, lending, and derivatives businesses now have a whole swath of new buyers with deep pockets.

Ethereum ETF

Following the Senate repeal of SAB 121 and Trump’s crypto endorsement , the White House appears to have done a 180 on the asset class with the SEC’s approval of 19b-4’s for eight Ethereum ETF sponsors. It’s worth noting that the approvals came with sponsors removing staking from the ETF. What now?

• There’s a new way for the masses to get exposure to Ethereum. People will now be able to buy exposure to Ethereum through traditional online brokerages. The Bitcoin ETF is considered the most successful ETF launch in thirty years with nearly $13.7 billion of net flows since launch. BlackRock, Fidelity, Ark, and Bitwise products have cleared $16.5 billion, $8.7 billion, $2.6 billion, and $1.9 billion of net inflows, respectively. BTC is up ~140% over the last year to ETH’s ~100%.
  - Prediction: We anticipate new buyers will have a material impact on ETH’s price performance.
  - Prediction: We believe the wealth channel will adopt separately managed accounts for clients to hold spot BTC and ETH to enable direct ownership, tax optimization, and access to other assets. Eaglebrook (CIV portfolio company) has built a crypto investment platform for wealth managers to optimize for tax-loss harvesting and direct ownership for end clients through a SMA structure.

Financial Innovation and Technology for the 21st Century Act Passes the House

The Financial Innovation and Technology for the 21st Century Act (FIT 21) provides clarity on the oversight of digital assets — with restricted digital assets overseen by the SEC and digital commodities overseen by the CFTC. Definitions are outlined such that restricted digital assets have a path to become digital commodities once they are deemed decentralized. With the passage of the bill, what does this unlock?

• The two big winners here are brokerages and the startup ecosystem. Brokerages finally get the clarity they have been looking for on tokens (security or commodity) and they can touch both and be dually regulated. Entrepreneurs in the US who have considered creating a protocol with a token now have a playbook to follow. We believe the unlock in entrepreneurial activity is under-discussed. Many entrepreneurs have been hesitant to build in the crypto industry because of unclear regulatory guidance and regulatory enforcement actions toward some of the industry’s best actors. You may not love the specifics of the bill, and it will certainly get reworked and fought in the Senate, but a market structure bill has extraordinary impacts on the startup ecosystem and legitimization of the asset class for all institutional participants.
  - Prediction: Expect to see a tidal wave of entrepreneurs entering the crypto industry in the next five years. Expect to see more experienced operators jump to growth stage crypto companies as the asset class will be de-risked from a regulatory lens.
  - Prediction: Better protocols get built as entrepreneurs can build what they want to build and focus less on regulatory theater.
  - Prediction: New categories are going to emerge across the board — new primitives, new needs to ensure compliance with the law, etc.
  - Prediction: Real-world assets on-chain will emerge faster than expected as traditional financial institutions partner with crypto-native players to tap into new pools of global liquidity through a composable structured product.
  - Prediction: As regulators become more entrenched in the industry, we anticipate chain monitoring companies, compliance software, and analytics businesses will benefit from must-have buyers.
  - Prediction: Cash-flowing protocols now have regulatory guidance, which will result in more value-based investors and activist investors within these decentralized organizations. Broadridge, a tech-enabled investor communication service for financial institutions, is a $23 billion public company, and we think voting and coordination software like Tally (CIV portfolio company) should benefit.
  - Prediction: We’ll see a surge of M&A as banks and broker-dealers will finally have regulatory clarity on the asset class and be looking for teams and products to service a new institutional asset.

CBDC Anti-Surveillance State Act Passes the House

Whip Emmer’s Anti-CBDC bill was approved in the house — mainly along Republican lines with a few Democrat defections. The bill prohibits the Federal Reserve from issuing a central bank digital currency without Congressional approval. With Congressional approval, a CBDC would need to be open, permissionless, and private. We remain incredibly impressed with Whip Emmer’s knowledge of the power of public blockchains and the benefits they bring to society. While we believe the bill will not pass the Senate, it’s a step in the right direction. How would this impact the industry?

• Existing issuers like Circle would benefit greatly if the bill passes, as they do not have to worry about competing with the federal government on a centrally issued stablecoin.
• Stablecoins are now the 16th largest buyer of US treasuries when compared to sovereigns. It makes sense for the government to allow the private sector to finance the never-ending amount of debt our bloated government allegedly requires.
  - Prediction: The green light would be on for privacy-preserving mechanisms around open and permissionless stablecoins. We think zero-knowledge startups will benefit, as issuers think through privacy-preserving, cash-like mechanisms to spend digitally.

New Leadership at the FDIC

Marty Gruenberg, the architect behind Chokepoint 1.0 and 2.0, agreed to resign following allegations within the FDIC of sexual harassment and bullying among ~10% of his workforce.

• It’s hard to overstate Gruenberg’s negative impact on the crypto industry. Startups have struggled mightily to get access to banking, and it’s all thanks to the illegal, Mafia-like directives that Gruenberg allegedly instituted to pressure banks not to provide accounts for crypto companies.
  - Prediction: As the anti-crypto army craters and crypto’s legitimacy as an asset class grows, growth stage capital will increase in the next two years in the industry. Startups are inherently risky, but the risk of losing a bank account created challenges for growth capital investors in the last 18 months. Expect to see that come roaring back in the next few years, as the entire industry just got de-risked.

The Kid Gloves Are Off

The seismic shift over the last two weeks didn’t really come out of the blue. Industry organizations like the Chamber of Digital Commerce, Coin Center, and the Blockchain Association have been hard at work educating and advocating in DC. Following the exposure of the White House administration’s effort to choke out the industry early last year, many industry participants increased their dedication through dollars and becoming more vocal online. The results have been astounding, and the industry is now recognized as a force. Today, Fairshake is the third largest political action committee in the country. As we have seen already, crypto PACs were able to swing close races in the primaries in favor of pro-crypto candidates. President Trump discussed freeing Ross Ulbricht and supported the individual right to self-custody Bitcoin at the Libertarian Convention this past weekend. The White House appears to be backpedaling on the Warren-driven anti-crypto army as politicians look at close House and Senate races and wonder if the effort to thwart new technology is worth losing power in DC. A recent Harris Poll found that 33% of US voters would consider a political candidate’s position on cryptocurrencies. For the first time ever, politicians are being asked about their perspective on crypto. As a political actor, if you have a problem with crypto, you run the risk of losing votes and dollars.

While many of the developments above are not perfect, they are the first time the industry has seen progress on a bipartisan basis in DC. If the momentum continues, the gating headwinds the industry has faced have suddenly been removed. There may have never been a better time to build and invest in crypto in the US.