Developments in Future of Money

Our survey of recent notable happenings in the world of digital assets

Photo Taken In Germany, Berlin

Compiled by the Oliver Wyman Forum

Efforts to tighten regulation of digital asset markets progressed, with key EU legislation nearing final approval and US and international authorities proposing measures to contain risks and tighten oversight. Meanwhile, a debate erupted among crypto-asset leaders over the industry’s best response to the regulatory pressure. Major financial institutions launched new initiatives in crypto-asset custody and blockchain-based payments while attacks on decentralized finance (DeFi) services increased. These are some of the highlights of our latest review of significant developments in the future of money.

Policy Front

FSB Calls for Tighter Regulation of Crypto-asset Markets

The Financial Stability Board is calling for tighter regulation of crypto-asset activities proportionate to the risks they pose, with a particular focus on stablecoins that have the potential to pose systemic risks.

In three reports released on October 11, the FSB provided broad recommendations on crypto-assets rather than detailed policy proposals. That’s in keeping with the role given to the Basel-based body after the 2008-09 financial crisis to coordinate stability efforts among national financial regulatory bodies and global standard-setting organizations.

One of the reports, outlining broad regulatory recommendations, said authorities should have the appropriate powers, tools, and resources to regulate and oversee crypto-asset activities and markets, and to do so on the principle of “same activity, same risk, same regulation.” It urged authorities to require crypto-asset issuers and service providers to have clear governance frameworks, effective risk management, and robust frameworks for collecting and reporting data. It also recommended that authorities monitor interconnections within the crypto-asset ecosystem as well as between crypto and the wider financial system.

A separate report said the collapse of the algorithmic stablecoin TerraUSD in May underscored the fragility of stablecoins that lack appropriate stabilization mechanisms. Authorities should treat stablecoins with the potential to become systemic in the same way as ones already deemed to be systemic. Further, they should adopt similar standards for non-systemic stablecoins, proportionate to their size and importance.

US Regulator Defends Stiff Limits on Banks’ Crypto Activities

A recent spate of bankruptcies in the cryptocurrency industry have underscored the need for continued tight controls on the banking sector’s exposure to digital assets, Comptroller of the Currency Michael Hsu said in two Oct. 11, speeches on the sidelines of the annual meetings of the International Monetary Fund and the World Bank.

Lending protocols Celsius Network and Voyager Digital and hedge fund Three Arrows Capital collapsed because they pursued fast growth despite having “poor brakes,” Hsu told a conference sponsored by the Harvard Law School and the Program on International Financial Systems. “The OCC is not going to allow that to happen in the national banking system,” he added.

In a separate speech at the DC Blockchain Summit, Hsu argued that the crypto industry’s dependence on hype to attract investors, its vulnerability to hacks, and the presence of contagion risks argue for a “careful and cautious approach to crypto” by the OCC.

US Regulators Call for Legislation to Contain Crypto Risks

The US Financial Stability Oversight Council on Oct. 3, identified a variety of regulatory gaps and systemic risks in markets for crypto-assets and called on Congress to pass legislation to contain those risks.

The report from the council, a Treasury-led body that includes the heads of the Federal Reserve and major regulatory agencies, contained no major surprises but provided a comprehensive view of regulators’ attitudes toward digital assets.

The council said crypto-assets posed risks to financial stability because of the market’s growth in recent years, greater connectivity to the traditional financial system through stablecoins, and the increasing participation of retail investors. It recommended that Congress pass legislation to give regulators rule-making authority over spot markets in crypto-assets that are not securities, such as Bitcoin, provide a comprehensive prudential framework for stablecoin issuers, and create authority for regulators to have visibility into all of the subsidiaries and affiliates of crypto firms and address regulatory arbitrage risks.

The report also recommended that agencies assess the impact of vertical integration in the industry that gives retail investors direct access to crypto markets, in contrast to the use of regulated intermediaries charged with providing best execution and managing custody of assets in conventional markets.

EU Crypto Bill Passes Key Hurdle

The European Union’s Markets in Crypto Assets bill, or MICA, was overwhelmingly approved by the European Parliament’s Economic and Monetary Affairs Committee on Oct. 10, virtually assuring its passage by the full parliament, the last step needed for it to become law.

The bill, which is likely goes into effect in 2024, will require crypto-asset service providers to obtain authorization from national authorities in the 27 member states, meet minimum standards for investor protection, and be liable if they lose any assets. National authorities will share relevant information on the largest service providers with the European Securities Markets Authority, The bill also orders the European Banking Authority to maintain a public register of non-compliant service providers and to supervise stablecoin issuers, which must have a presence in the EU and maintain a liquid reserve of deposits.

Separately, the European Commission, the EU’s executive body, has put out tenders for a pilot project to develop, test, and deploy technology to embed financial supervision into DeFi protocols.

Latest in CBDCs

Growth in Use of Digital Yuan Shows

Use of China’s central bank digital currency (CBDC), the e-CNY, has slowed this year, according to figures released by the People’s Bank of China, the South China Morning Post reported on Oct. 13.

Cumulative transactions using the e-CNY since its launch in December 2019 totaled 100 billion yuan ($13.8 billion) at the end of August, up 14% from the end of 2021. By contrast, cumulative volume grew 154% in the previous six months, the last time the central bank reported CBDC volume. The e-CNY’s total transaction volume to date amounts to about one third of the average daily volume of Ant Group’s Alipay service.

BIS and HKMA Complete Test of a Two-Tier CBDC

The Bank for International Settlements and the Hong Kong Monetary Authority announced on Oct. 21, the successful completion of a novel central bank digital currency (CBDC) experiment using both CBDCs representing direct claims on the central bank and CBDC-backed stablecoins.

Project Aurum used an intermediated approach in which commercial banks distribute CBDC to consumers while the central bank maintains only the wholesale ledger. The approach was chosen to minimize the operational challenge for the central bank and privacy concerns while preserving a private sector role in payments and a capacity for innovation. Decoupling the wholesale and retail CBDC ledgers also should enhance resilience against potential cyberattack, the project partners said.

The project included CBDC-backed stablecoins in an effort to replicate Hong Kong’s existing currency system, in which physical currency is issued by three note-issuing banks rather than the HKMA.

Business Moves

Regulatory Debate Breaks Out in Crypto Market

A proposal to create a set of industry standards on investor protection in the absence of clear regulations unleashed a vigorous debate among industry players.

The chief executive of crypto exchange FTX outlined what he called “Possible Digital Asset Industry Standards” in an online post on Oct. 19. Among other things, it suggested the use of blocklists to prohibit illegal transfers and freeze funds associated with financial crimes, the creation of an on-chain list of sanctioned addresses to respect sanctions imposed by the US Treasury’s Office of Foreign Assets Control (OFAC), registration for any decentralized finance (DeFi) protocol that markets products to US retail investors, and full reserve backing and know-your-customer controls for stablecoins.

The proposal attracted swift criticism from many industry participants, particularly DeFi advocates who contend that DeFi protocols are software code that should be protected by the First Amendment’s guarantee of freedom of speech. Brian Armstrong, the CEO of exchange Coinbase, responded by welcoming the idea of greater use of voluntary industry standards but said the industry should resist any effort to enforce blacklists or US sanctions.

BNY Mellon Launches Digital Assets Custody Platform

BNY Mellon, the world’s largest custodian by assets, announced on Oct. 11, that its new Digital Assets Custody platform was live and able to hold and transfer Bitcoin and Ethereum for select clients.

A recent survey sponsored by BNY Mellon found that 91% of institutional investors were interested in investing in tokenized assets while 41% currently hold cryptocurrencies in their portfolios and another 15% plan to add them within the next five years. The bank joins other traditional financial institutions including Nasdaq and Fidelity in offering custody services for digital assets.

Crypto Venture Funding Decline Continues in Third Quarter

Venture funding for crypto startups declined for the second consecutive quarter in the July-to-September quarter, the first time that has happened since 2018, according to the Block Research.

Funding fell by 35% in the third quarter from the second, to $6.2 billion, and the number of deals fell by 22%.

Legal Briefs

Over 20% of CFTC Enforcement Actions Concerned Digital Assets

The US Commodity Futures Trading Commission brought 18 enforcement actions involving conduct related to digital assets, representing more than 20% of all actions filed during the fiscal year that ended on September 30, 2022, the agency announced on Oct. 20.

Crime Beat

Hackers Step Up Attacks in DeFi

A spate of hacks on decentralized finance (DeFi) protocols stole a total of $718 million in early October, representing the largest loss of any month in what is likely to be a record year for hacking theft in cryptocurrency markets, blockchain data specialist Chainanalysis reported in a tweet stream on October 12.

More than 80% of the stolen funds were taken from DeFi protocols, underscoring a significant shift in hacking activity. Three years ago, most hacking exploits targeted centralized crypto exchanges.