#41 The Context: Regulators, prosecutors and vigilantes

The fallout from Celsius and Terra continues, with Do Kwon surfacing briefly for an interview

Oct 20, 2022

Hi, hope you had a good week. At the time of writing Do Kwon is still out of the clutches of the police and a band of crypto vigilantes, though we shouldn’t be distracted from more important developments elsewhere. Prosecutors are on the case, and regulators are on the move. We also pull together two other interesting themes du jour: is DeFi’s becalmed state misleading? And how ‘professional’ should web3 be, or is that a contradiction in terms?

This was put together by a team led by founder Samantha Yap, and Jeremy Wagstaff, formerly of the journalism parish. Thanks to Ruby Wu, Sam O’Donohoe, Ewan Brewster, Becky Corbel and Delon Chan for contributions. Your feedback is as always welcome. Ping us at thecontext@yapglobal.com. Old newsletters can be found here.

[tl;dr]

Beyond the hunt for Do Kwon, regulators and prosecutors are marching on
DeFi might not be in as bad a state as you think; it depends how you measure it
web3 is proudly decentralised, but does it mean it shouldn’t be ‘professionalised’?

[Regulators, prosecutors and vigilantes]

Do Kwon continues his impersonation of Where’s Waldo in evading South Korean prosecutors, but it turns out that at least with Celsius, their U.S. counterparts were on the case earlier than previously thought. And there’s movement on regulating NFTs, and the EU pushing for global regulation of crypto.

The saga of Terra’s Do Kwon is fast turning into a Hollywood script. Laura Shin got a scoop of an interview with him, where he said South Korean charges against him were politically motivated and that the whole thing was never really about money, fame or success. And he denied he’s on the run. Retail investors may not see it the same way, having turned vigilante in the hunt for what the FT called “crypto’s most wanted man”. They need to turn their efforts towards the Middle East, as when he left Singapore, Do Kwon apparently flew to Dubai. That may have been a stopover though, so by the time you read this he may be somewhere else. Or not.
Celsius’ collapse may be less dramatic but it’s still on the boil: 40 states are chasing it for possible securities fraud, while Texas is chasing Voyager and FTX for possible securities fraud — a summary (albeit reproving) by Amy Castor. Indeed, it's now clear that US prosecutors were on the case earlier than assumed, subpoenaing Celsius three days after it blocked withdrawals. Regulators are also investigating Three Arrows Capital, which could lead to monetary fines and other penalties for both firms and individuals. (Stories by Kadhim Shubber of the FT, and Allyson Versprille and Lydia Beyoud of Bloomberg)
NFTs and securities: What are they, and how should they be regulated? A commissioner of the U.S. SEC told the FT that the body must clarify which NFTs will be regulated. But the problem is figuring out which part of NFTs to regulate, given that a token can carry multiple functions (You can find a handy summary of the issues here, courtesy of Ledger Insights). (Stories by Stefania Palma and Patrick Temple-West of the Financial Times)
We've talked before (eg, #38) about how regulators in one jurisdiction are reluctant to be the first to construct a regulatory tableau, partly for fear of snuffing out innovation. Even the EU, which has been the boldest and clearest in its regulatory ambitions and moves, wants others to pull up alongside (Here's a useful summary of the state of crypto in Western Europe). The EU financial services chief, Mairead McGuinness, has called on the US to follow its lead, with the same objective: "We need to look at global regulation of crypto." It's hard to see this happening, given the wrangles within the U.S. system, but even then, governments might be averse to treating crypto as a threat rather than an opportunity. Open banking might make for an interesting parallel: governments pushed banks into opening up their data and allowing a more dynamic ecosystem to evolve, recognising the importance of innovation. DeFi is as potentially disruptive, if not more so, leaving governments trying to balance between red tape and red carpet. (Stories by Mat Di Salvo of Decrypt, David Attlee of Cointelegraph and Kiran Stacey of the Financial Times)

[DeFi’s doldrums in perspective]

DeFi is in the dumps right now, but it’s worth putting it in a little context. How deep really are those dumps, and how do they compare to other sectors’?

We tend to focus on prices in crypto because that's the most obvious measure of health. But crypto research company Blockdata has gone beyond price to understand the sector’s vital signs. Looking at volume, liquidity, wealth distribution and other metrics collected by Chainalysis, “by and large, the ecosystem today actually looks very similar to the ecosystem one year ago,” according to Chainalysis’ Kimberly Grauer. Indeed, the lack of price volatility in the market has driven investors and traders to pursue other strategies to make money from DeFi, including options, staking and persuading DAOs to liquidate distressed assets in their treasury. (Story by Vildana Hajric and Muyao Shen of Bloomberg)
Interesting piece called The FinTech Bloodbath by Chris Skinner, which (citing the Economist) notes that Fintech is having a hard time as well as crypto and markets. Fintech startups have been particularly hard hit because many have been exposed to the risk of recession -- anything that was counting on growth in retail finance, be it borrowing or investing money. For some startups, though, things look rosier: those reducing inefficiencies, those creating new revenue lines for clients, and financial plumbers. At least two of those categories include DeFi players, suggesting that we might see more DeFi players surviving the current ice age than we do fintech ones. The recent decision by Coinbase to hire former Solarisbank CEO Daniel suggests that crypto sees an opportunity to exploit fintech's difficulties to poach some talent. (Cindy Tan of NFTgators)
Bill McKibben, an environmental activist, has penned a piece titled: If you think Bitcoin Spews Carbon, Wait Till You Hear About...Banking. He doesn't let crypto off the hook, but he makes two important points: DeFi is trying to address the carbon problem, and if you're going to have a pop at DeFi's environmental problem, you also need to look at how regular banking is, just eight of the big banks and 10 of the big asset managers produced 79 times more carbon than crypto mining through the money they provided to the fossil fuel industry and other lending and investing activities in 2020. It's not that crypto doesn't have a carbon problem, but it's not alone in that.
And while we’re all looking at DeFi, the underlying technologies are already making inroads on one of the most inefficient processes on the planet — trade. A UK-introduced bill for digital trade documents may be technology agnostic, but could open the door to trade finance blockchain platforms such as Contour and komgo. Presently only 1.2% of bills of lading were digital last year. If there are blockchains under the hub of trade finance and documentation, a bridge to DeFi can't be far behind. (Story from Ledger Insights)
That said, not everyone sees positives in the adoption of blockchain technology beyond web3. The development of central bank digital currencies, or CBDCs, “threatens to betray crypto's founding principles” argues Alex Shipp, chief strategy officer at Offshift, which bills itself as the ‘World's First Private Derivatives Platform.’ In agreement is Layah Heilpern, explaining the dangers of CBDCs to Nigel Farage. (Story by Layah Heilpern)

[Can ‘decentralised’ be professionalised - and should it?]

The building blocks of web3 may have their roots in the cypherpunks of the 1990s, and the big crash of 2007, but they are constantly evolving, adding or defining roles and procedures on the fly. It doesn’t always make for pretty viewing, but no one could argue the world of DeFi is not dynamic. Some examples:

The adoption of proof of stake by Ethereum is sharpening the focus on a debate about whether the hardware used to secure the ETH network could be run by anyone, whatever their motivation and resources. The co-founder of Lido (a Yap Global client) sparked debate when he said the hardware used to secure Ethereum should be professionally managed. That prompted the question: what does ‘professional' even mean in DeFi terms? (Story by Aleksandar Gilbert of The Defiant)
Data from MEV Watch appears to show that more than half of the Ethereum network is excluding U.S.-sanctioned wallets, raising questions about Ethereum’s claims to be 'censorship resistant’. Here's some detail on how this works, and why it's controversial. (Story by Margaux Nijkerk of CoinDesk)
A key moment: will MakerDAO, the no.1 DeFi protocol, going to be broken up into 'MetaDAOs’? The result - decided by a vote - will provide insight into how to address one of the most challenging problems of DeFi: how do you efficiently run and grow a cooperative that runs on a blockchain? Driving the move is co-founder Rune Christensen, who has argued that voter apathy and competing interests hinder the DAO's ability to manage complex financial agreements. (Story by Samuel Haig of The Defiant)
DAOs have to make difficult decisions: One ‘hacker’ got $50 million after raiding DeFi’s Mango, forcing members of the DAO to make a difficult decision and allow him to keep around half of the amount he had stolen. The user claimed they had merely exploited a weakness in Mango’s 'risk engine' which had failed to interpret its data. (Stories by Jeff John Roberts of Fortune and Olga Kharif of Bloomberg)
A DAO’s legal status is also in the spotlight: DAOs aren't people, argue lawyers in the Commodity Futures Trading Commission’s (CFTC) lawsuit against Ooki, and so its members must be served individually. Attorneys and their clients worry that allowing the CFTC to serve the entire DAO at once merely by posting the lawsuit on a public forum would set a dangerous precedent. (Stories by Nikhilesh De of CoinDesk)
Should NFT artists be paid royalties when their artwork is traded on secondary markets? That was the idea, originally, but now that Magic Eden, one of the biggest marketplaces, has caved, making paying artists a fee when trading an NFT, it's now the norm. The payment of royalties, though set in a smart contract encoded in the NFT, can be bypassed by tweaking settings. The resulting debate is as much a philosophical one as a financial one, with many drawn to NFTs and web3 because they saw it as a departure from "Web 2.0 values", honouring and rewarding creativity by providing artists with the potential to enjoy a revenue stream beyond the first sale of their creations. (Stories by Andrew Hayward of Decrypt)

[Tidbits]

[Events]

CoinAgenda Global | October 21st - 23rd 2022 | Las Vegas, USA
3rd Blockchain Expo | October 26th - 28th 2022 | Makuhari Messe, Japan
ETH Panama | October 26th - 28th 2022 | Panama City, Panama
ETH Lisbon | October 28th - 30th 2022 | Lisbon, Portugal
Web Summit 2022 | November 1st - 4th 2022 | Lisbon, Portugal
Singapore Fintech Festival | November 2nd - 4th 2022 | Singapore, Singapore
Solana Breakpoint | November 4th - 7th 2022 | Lisbon, Portugal
ETH San Francisco | November 4th - 6th 2022 | San Francisco, USA
Token2049 London | November 9th - 10th 2022 | London, UK

[DeFi Definitions]

An occasional segment exploring one particular aspect of DeFi.

This Week: “Over-the-counter” by Debra Nita.

Over-the-counter (OTC) can be understood as the process of trading “off market” or outside of a crypto exchange. Unlike typical trades which consist of automated buy/ sell orders on exchanges, OTC trades are done directly between a buyer and seller, or facilitated by an intermediary like a trading desk or a broker.

OTC trades are usually utilised by parties who want to trade large sums of money and can benefit from better pricing available in these private deals. Large orders on exchanges can move market prices. With OTC, buyers do not have to rely on multiple sellers to fulfil their large order which has the effect of moving prices upwards, making it more expensive for the buyer.

OTC trades are not only limited to large buyers, but also enable traders who do not have access to crypto exchanges (e.g. in jurisdictions where it is not permitted) to purchase cryptocurrencies, or to obtain financial instruments that are not typically available on exchanges. Buyers or sellers who want to avoid being monitored by banks or other entities that may block or freeze large transactions may also utilise OTC trades.

(References: CMC, Cointelegraph, Investopedia)