Appleby's Technology and Innovation Team have recently attended several blockchain conferences globally, including MJAC in London, the Blockchain for Finance Conference in Singapore and Consensus 2018 in New York. Following these events, the team have set out below their key takeaways, including the key areas of focus for the London, Singapore and New York markets.
1. Virtual currencies and regulation
A key theme across all conferences was how regulators should treat cryptoassets or "tokens" and, in particular, whether they should be regarded as investment products, stored value facilities, foreign exchange currencies, securities offerings or whether they should be prohibited altogether.
With regards to virtual token offerings, often referred to as ICOs, while these may be great business opportunities there is still much legal uncertainty in this area. Not only do different jurisdictions take different approaches, but tokens generally need to be analysed on a case by case basis to determine which of the above regulatory categories they fall under. This applies both within the issuer's home jurisdiction and any other jurisdictions where the token may be offered or sold, or in which any other regulated activity may be deemed to be carried out. Each token and token offering is different; currently there are no internationally accepted codes of practice or a standardised model providing guidance for issuers. In addition, each token offering may have different commercial functions which require separate regulatory analysis on a case by case basis.
Whilst panel members in London were keen to discuss these issues, which are well known within the industry, when pressed it was much harder to come up with any real solutions. Many were in favour of a self-regulating model in which issuers adopt a voluntary "global code of conduct" but acknowledged how difficult this would be to achieve.
There remains a degree of nervousness around cryptoassets given their volatility and the recent investigations in the USA and elsewhere in relation to alleged market manipulation. In New York participants were acutely aware of the stance being taken by regulatory authorities, like the SEC, who are using existing regulatory regimes and their discretionary powers to regulate and police this sector. Many participants indicated their desire for legal and regulatory certainty, acceptance as legitimate business and credibility beyond what is currently afforded businesses in this sector.
Notwithstanding the generally libertarian atmosphere common at many of these events, many panellists had a history in traditional financial services and commented on the benefit that can be derived from engaging with the existing financial establishment to draw on their experience of raising capital and the risks involved. There is a real tension between the founding principles of cryptoassets, which include the democratisation of finance, and the need to make these assets "mainstream" to the extent that they attract ongoing investment and "legitimacy". There is a clear interest from many market players in some form of regulation, principally in order to draw a line between the genuine operators and the "scams" where people lose their money without (as it transpires) there being any intention of conferring any benefit in return. Sensible regulation can provide valuable legitimacy but the sense was that participants would also need to be able to carry out current and proposed business activities in a way that was not unduly constrained by such regulation.
Interestingly, when it came to the issue of taxation of profits made on investing in cryptoassets, the general feeling was that there would inevitably be "jurisdictional arbitrage", based on which were most favourable from an investor perspective.
2. Using blockchain for regulatory compliance – CDD and AML
For financial institutions, blockchain technology has huge potential for internal controls and for improving regulatory compliance. All data recorded on a distributed ledger could be readily available to risk teams and regulators. As such, transactions, financial activity, account openings, lending activity and more could all be monitored and reported in real time.
Blockchain technology allows for real time communication, and as such, risk officers could be notified of compliance violations by regulators in real time allowing action to be taken quickly. With the use of blockchain, organisations can benefit from a more efficient reporting process which mitigates the potential for violations to be unattended or missed.
Online identity management in the financial services requires increased level of security protocols to prevent fraud or identity theft. With cryptographic verification, sensitive data may be accessed by the financial institution to identify the individual customer. Through the use of a decentralised network, improved identity management using encryption based technology could be established.
"Regtech", as these systems are often referred to, is a rapidly growing sector and ideally suited to the offshore world where CDD checks are part of everyday life, meaning technical expertise is easy to find. Many developers also benefit from the smaller size of offshore jurisdictions which provides an excellent test bed for their products and easy and direct access to regulators.
Many jurisdictions are moving towards a more flexible regime where use of technology to identify individuals, their source of wealth and other relevant matters is encouraged.
3. Valuation of cryptoassets
While too technical for a short briefing, the London conference also featured an excellent session providing an overview of some of the valuation methods adopted by leading cryptoasset investors and exchanges. The session touched on a number of methodologies and ratios, but provided great insight into:
- The difference between relative and fundamental valuation approaches.
- The importance of daily transaction volume and velocity (the number of times an asset changes hands in a given time period).
- The flaws with valuations based on market cap, which see investors flock to the token offering based on little more than fear of missing out.
Ultimately, there is much uncertainty surrounding valuations, not least because there are insufficient datasets upon which to base any meaningful analysis over time.
It is important to remember that whilst there remains much uncertainty over cryptoassets, it is still a nascent industry, where many businesses will founder along the way, leaving the more "stable" enterprises to grow. At present, it is simply too early to determine what the industry will look like in a few years' time, or indeed if regulation will arrive. It is worth noting that for many jurisdictions, existing legislation, applied in a more creative way, ought to suffice. For others, specific legislation is in train and/or being discussed. Being alive to the issues and the benefits and challenges that cryptoassets bring is vital, regardless of whether the ultimate decision is to invest (or not).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.