2022: A year in review
TerraForm collapse, and the contagion that saw the demise of Three Arrows Capital, Celsius, and the implosion of the sprawling FTX and Alameda conglomerate run by the disgraced Sam Bankman-Fried. The fall of the price of Bitcoin from the heady price of $60,000 to $16,000, and the exodus of retail investors from the market, which to the casual eye may seem as a year to forget.
It is not all doom and gloom. The launch of Tgrade in June was the culmination of a lot of hard work and years of thinking behind what is a complex system with a simple value proposition. A blockchain built for business.
Since the launch with a hand selected validator set of 65, this has now grown to 82 with more in the process of joining.
There have been 154 applications for Engagement Points which has shown that Proof of Engagement is more than a theory and it has created the right incentives to coalesce the community around Tgrade.
There has been a Proof of Concept built based on solving the “last mile” problem in logistics using smart contracts and this gives a glimpse of what real world problems are being looked at. There are a number of businesses in various stages from fund raising to building on Tgrade and the theme is that they are solving real world issues, and have selected Tgrade as a business friendly blockchain.
While much of the first half of 2022 was focused on building and launching Tgrade it was hard to ignore the wider questions around regulations and how the industry responded.
Regulators have a mandate to ensure consumer protection and that markets are fair and orderly, and in a blog post I explored this topic in the context of Decentralised Finance with the good, bad and the ugly sides of the ecosystem and what steps could be taken.
The term “unhosted wallet” became a hot issue in context of the Transfer of Funds Rules (TFR) and there were influential voices favouring centralised custodians, with misinformed arguments that non-custodial wallets were the criminals choice. I made a spirited argument that with a public, immutable ledger, the term wallet is misleading as funds are not held in wallets, and what we have with a crypto wallet is to do with key management.
There was a consultation exercise by ESMA who wanted to know more about pre- and post-trade reporting and whether DLT should be treated differently. This got me thinking that while it might be easier to mandate reporting so that the authorities have a consolidated view, rather than moving vast quantities of data around and maintaining larger databases would it not be better for financial crime units to monitor the information at source on the public ledgers? I did an experiment with Paddy McHale from Ignite at creating a money mule operation on chain and having tools to detect them (spoiler, it worked a treat).
Much was made in 2022 about Institutional DeFi and I explored some of the risks in an article covering counterparty and custody risks. Clearly “maritime law” of DeFi is not going to wash with institutions or regulators and the article looked at the issues and proposed some solutions.
The meltdown of TerraForms and the de-pegging of UST raised issues around what happens with the collapse in token value and the impact it could have on a Proof of Stake chain. I explored a scenario where the digital assets on a chain are worth multiples of the value of the staked tokens, how this could be exploited and safeguards in Tgrade to mitigate such attacks.
2022 saw overuse of the term Web3 and a fair amount of hype, in this blog post I explored some of the issues around Web3 in the context of mass adoption and how Web3 in the context of Tgrade as a business focussed blockchain is a natural fit.
Another hot topic for 2022 is the Central Bank Digital Currency (CBDC) with a series of pilots being conducted. Tgrade has a compelling case for a CBDC platform using Trusted Circles to create a group of Central Banks and using it for wholesale transactions.
There was some discussion, in the US around validators and their operations in the context of delegators and whether this made the native (staking) tokens securities under the Howey’s tests. It is a finely balanced argument around what constitutes Common Enterprise and the legal uncertainty around it. In EU there is clarity through the MiCA regulation which does not raise this issue.
Returning to the institutional theme and the orthodoxy to evaluate chains for market capitalisation, I discussed whether this is the best metric to use, especially when you consider that the origin of funds are largely unknown and the approach Tgrade has taken to build a clean and transparent chain.
There are still some difficult and unresolved issues in DAOs, DeFi and the tussle between transparency and privacy which I discussed. DAOs have the dilemma that they want to be global and decentralised and yet want their members to have limited liabilities, DeFi struggles with KYC and AML and who would do these checks in a decentralised system. The debate around privacy vs disclosure is a hard one, everyone agrees that it is important to combat the proceeds of crime and there is an acceptance that people have the right to financial privacy and should not be disclosing their full transaction history everytime they make a purchase (where someone can link and address and identity).
The collapse of FTX bought many competing interests to the fore all jostling to have their voices heard and further their agendas. I explored who wanted what and how the status quo seems untenable and of course making a strong case for Tgrade. Since I wrote the article the US Senate have proposed a far reaching Digital Asset Anti-Money Laundering which is “cracking down on crypto” with a set of proposals to require a lot more reporting from Centralised Exchanges to wallet providers, miners and validators.
I reviewed the Green Finance articles I had written at the end of 2021 and looked at what had happened since and how regulatory uncertainty played a role, and rather than a big bang a step-by-step approach would see more traction.
What of 2023?
Despite Ulrich Bindseil and Jürgen Schaaf from ECB calling out the last stand of Bitcoin and the massive outflows from the crypto markets have blockchain, DeFi, DAOs, NFTs a future or will 2023 see the further closing of projects, as we have seen already with We.Trade, B3i, TradeLens, and ASX from the permissioned DLT sector?
Crypto hype and froth takes a back seat
The last two years has seen a wall of money come into the crypto markets and it has been the fuel of protocols offering oversize returns with no fundamental basis other than relying on the constant flow of new money.
Retail investors are notorious for jumping in towards the top of a cycle and getting out at the bottom, it seems that things are no different in crypto.
A theory that younger investors saddled with student debt, no chance of buying a property, getting low returns on their savings had gone all into crypto attracted by the high returns. With their fingers burned will they be back soon?
There is more competition now from traditional investments, especially since the cycle of near zero interest rates has been broken. Blockchain and the crypto markets need to offer more than staking, leverage and yield farming with assets linked to real returns.
The regulatory drum has been beating across the world and we have seen some progress towards regulatory certainty such as MiCA which has been approved and is now making its way through the technical and translation phases. There is the EU Transfer of Funds Rule (TFR), the tax initiative DAC8 which potentially widens the scope of MiCA. In the US there is pressure to “do something” in light of FTX and continuing initiatives to combat the proceeds of crime.
DeFi, DAOs and NFTs are being closely monitored and will at some stage be subject to regulations. The regulators and legislators are not jumping in now as they are not mature and are developing at a brake neck pace.
2023 will see more regulations and there may be conflict between the wider blockchain/crypto community and regulators. What is important is that dialogue and education finds a way for everyone to get a better understanding. It will neither be “ban it” nor will it be “we don’t do rules” and to work in the non binary (real world) it needs collaboration.
Real World Assets
Real World Assets are becoming much more discussed in the context of how businesses can use blockchain technology as a force for innovation and we will see a lot more of this in 2023. Seeing the levels of activity in the last quarter of 2022 with businesses discussing approaches to building, issuing digital assets and using smart contracts to connect parties and automate workflows points is encouraging.
Identity is key in taming the wilder aspects of crypto and the use of verifiable credentials strikes the balance between privacy and being able to verify the identity and attributes associated with an identity without revealing the information. 2023 will see further adoption of this and potentially extend the concept to verifiable wallets or assets and these technical measures will go a long way to demonstrate that there is a serious effort being applied to combat the proceeds of crime being used. The alternative is a regime with a lot of personal data being exchanged and all the implications this has.
Squaring the Circle?
Can the architects of a decentralised web of applications meet the needs of the nations, where their customers live and their legislation? What gives? Will this be part of the agenda in 2023?
Or does the industry push the design of decentralised networks and protocols further making regulation by nation states more and more difficult, and if so how does this work with reverse solicitation or the marketing and promotion in countries which effectively ban digital assets?
You cannot ban a decentralised network but you can effectively ban access through websites, marketing, make fiat on/off ramp illegal and ban the sale of hardware wallets. It then has to live on as a furtive activity through VPNs and cannot be connected in any meaningful way to real world activities, what do we have left? Casino chips?
Would it be possible to set global standards which would match decentralised businesses models better? We have precedence with organisation such as the Financial Stability Board. It would stem regulatory arbitrage and set the ground rules across the board. While it is possible it is unlikely as it needs buy in from all countries and changes to local legislation and there is not a sense of urgency to tackle this.
Shoehorning decentralised protocols into existing rules and regulations or inserting intermediaries seems counter-intuitive but seems to be the direction of travel. This needs the industry to pick the battles carefully and not to have blanket objections to any rules.
How this plays out in 2023 will have a lasting impact on crypto, blockchains and the movements around decentralisation. Tgrade will continue focusing on business and find practical applications within the regulatory frameworks.