Global Digital Assets Digest: September 2023

Welcome to this month's Global Digital Assets Digest. There have been a number of important publications from the regulators, notably the IOSCO's draft recommendations for the regulation of DeFi. The topic of digital assets also featured at the recent G-20 summit.

In Australia, the Reserve Bank and Digital Finance Cooperative Research Centre published a report on CBDC. A report has also been published in relation to Digital Assets (Market Regulation) Bill 2023.

In the UK, the FCA has been indicating that cryptoasset service providers may not be fully ready for the new financial promotions regime coming into force in October 2023. Stateside, there have been some interesting developments in relation to NFTs.

UPDATES AND GUIDANCE: INTERNATIONAL BODIES

1. IOSCO: Consultation report: Policy Recommendations for DeFi

2. G20 Leaders' Summit 2023

3. BIS Bulletin: The oracle problem and the future of DeFi

4. FSB: IMF-FSB Synthesis Paper on policies for cryptoassets

5. IMF: Technical Assistance Report on Fintech Regulation and Legislation in Trinidad and Tobago

6. IMF: Staff Discussion Note: Transforming Public Finance Through GovTech

7. World Federation of Exchanges: Report: A review of crypto trading infrastructure: Exchanges' engagement with crypto market functioning & development

8. FSB: Letter from Klaas Knot on Cross-Border Payments Roadmap

9. FSB: Letter from Klaas Knot to G20 leaders

10. European Parliament: Exchange of views with Fabio Panetta, Member of the Executive Board of the ECB

11. ESMA: Report on Trends, Risks and Vulnerabilities, No. 2, 2023

12. ECB: Publication: A big future for small payments? Micropayments and their impact on the payment ecosystem

UPDATES AND GUIDANCE: UK

13. FCA: Findings of review on firms' preparedness for crypto marketing

14. Bank of England Quarterly Bulletin 2023: Enabling innovation through a digital pound

15. ICMA: Response to HM Treasury’s Consultation on the first Financial Market Infrastructure Sandbox – The Digital Securities Sandbox

UPDATES AND GUIDANCE: EUROPE

16. Speech of Burkhard Balz on the digital euro

17. German Banking Industry Committee: Comments on the digital euro

UPDATES AND GUIDANCE: APAC

None

UPDATES AND GUIDANCE: AUSTRALIA

18. Reserve Bank and Digital Finance CRC: Central Bank Digital Currency Report

19. Economics Legislation Committee of the Senate: Report on Digital Assets (Market Regulation) Bill 2023

UPDATES AND GUIDANCE: NORTH AMERICA

20. CFTC: Orders against operators of three DeFi protocols

21. FASB: Approval for standards for cryptoassets

22. CFTC: Speech by CFTC Commissioner Caroline D. Pham before the Cato Institute

23. CFTC: Dissenting statement of Commissioner Summer K. Mersinger regarding enforcement actions

24. SEC: Charges in relation to unregistered offering of NFTs

25. Federal Reserve: Communications on Novel Activities Program and banks engaging in stablecoin activity

26. US Treasury: Proposed changes to regime governing sales and exchanges of digital assets by brokers

27. NIST: Report on American competitiveness in critical high-tech industries

UPDATES AND GUIDANCE: MIDDLE EAST

None

PRESS/ARTICLES

28. FT: LSE draws up plans for a blockchain-based digital assets business service

29. FT: Launch of a USD stablecoin

UPDATES AND GUIDANCE: INTERNATIONAL BODIES

1. IOSCO: Consultation report: Policy Recommendations for DeFi

On 7 September 2023, IOSCO published a consultation report containing policy recommendations to address market integrity and investor protection concerns in relation to DeFi. This follows a March 2022 IOSCO report on DeFi.

Areas covered include the following: overview of DeFi's common products and services; recent developments and trends; DeFi exploits, attacks and illicit uses; data gaps and challenges; and key risks and considerations.

IOSCO notes the absence of a generally accepted definition of DeFi but defines it as "financial products, services, arrangements and activities using distributed ledger or blockchain technologies, including smart contracts". Use cases for DLT cited include primary market issuance; secondary market trading; asset servicing and lifecycle management.

IOSCO's recommendations are principles aimed at DeFi products, services, arrangements and activities. They cover six areas: understanding DeFi arrangements and structures, achieving common standards of regulatory outcomes; identification and management of key risks; clear, accurate and comprehensive disclosures; enforcement of applicable laws; and cross-border cooperation.

The recommendations are intended to complement IOSCO's Policy Recommendations for Cryptoassets published in May 2023

The deadline for comments is 19 October 2023. IOSCO plans to publish a final report towards the end of 2023, in accordance with its cryptoasset roadmap for 2022-23.

2. G20 Leaders' Summit 2023

G20 leaders met in New Delhi for a two-day summit hosted by the Indian G20 presidency. The G20 leaders stressed the importance of technology in bridging existing digital divides. Among other things, the leaders committed to: monitoring the risks of the cryptoasset ecosystem developments; and promoting safe and resilient digital ecosystems. A common declaration has also been published which confirms that the G20:

• endorses the FSB’ high-level recommendations for the regulation, supervision and oversight of cryptoassets activities and markets and of global stablecoin arrangements;
• welcomes the shared FSB and SSBs workplan for crypto assets and the IMF-FSB Synthesis Paper on cryptoassets; and
• welcomes discussions on the potential macro-financial implications arising from the introduction and adoption of CBDCs, notably on cross-border payments.

3. BIS Bulletin: The oracle problem and the future of DeFi

On 7 September 2023, BIS issued a bulletin titled "The oracle problem and the future of DeFi". The paper notes the increasing prominence of oracles and argues that centralised oracles with decentralised blockchains pose challenges, citing instances of oracle manipulation in DeFi.

Key points

• DeFi uses oracles to import real world date into blockchain environments for use in smart contracts.
• It is still unclear whether oracles can truly observe decentralisation ethos. Aiming for full decentralisation leads to complex consensus protocols that can undermine blockchain efficiency.
• Introducing centralisation means adding more trusted parties to a system designed to be trustless.

4. FSB: IMF-FSB Synthesis Paper on policies for cryptoassets

On 7 September 2023, the FSB and IMF published a joint paper containing policy and regulatory responses to cryptoassets. The report considers the macroeconomic and financial stability issues associated with cryptoassets. It does not create new policies, recommendations or expectations for member authorities. It follows recent FSB output, such as its Global Regulatory Framework for Cryptoasset Activities. The report includes a roadmap for implementing the recommendations of the FSB and the IMF. The report suggests that emerging markets and developing economies may wish to adopt additional targeted measures in order to address specific risks.

Annex 3 of the report contains an FSB-SSB workplan, which includes the timelines of cryptoasset-related initiatives being taken forward by the FSB, the International Association of Insurance Supervisors, the CPMI, IOSCO and BCBS.

5. IMF: Technical Assistance Report on Fintech Regulation and Legislation in Trinidad and Tobago

On 7 September 2023, the IMF published a technical assistance report on Trinidad and Tobago. This follows a request from the Trinidad and Tobago government for the IMF to assist the Central Bank of Trinidad and Tobago improve its licensing and supervisory regime for e-money, and improve its institutional arrangements for Fintech regulation.

Notable points

• The impact of Fintech in Trinidad and Tobago is currently concentrated in the payments sector.
• The current e-money framework and licensing process can be further improved.
• The existing legal regime does not cover new fintech developments, such as cryptoassets activities. The authorities should undertake an impact assessment for legal and regulatory reforms to help inform a strategy for cryptoassets.

6. IMF: Staff Discussion Note: Transforming Public Finance Through GovTech

On September 2023, the IMF published a Technical Note examining the potential of digitalisation. The paper looks at public finance and the role of government policies in addressing the digital divide. The report argues that digital technologies are transforming societies in a similar manner to previous major breakthroughs in communication and transportation.

7. World Federation of Exchanges: Report: A review of crypto trading infrastructure: Exchanges' engagement with crypto market functioning & development

On 5 September 2023, the World Federation of Exchanges published a report containing a review of crypto trading infrastructure. The report has been published as part of the WFE's work on improving understanding of crypto market infrastructures and associated risks and benefits. The report summarises the evolution of crypto trading platforms and the engagement of exchanges with these platforms. The report also contrasts the workings of the Central Limit Order Book model used by centralised platforms with Automated Market Making models. It summarises the impact of model design on liquidity provision, price discovery and the custody of assets. The report also looks at how differences in crypto trading structures impact AML/CTF; prudential regulation; and financial stability.

8. FSB: Letter from Klaas Knot on the Cross-Border Payments Roadmap

On 5 September 2023, the FSB published a letter to G20 Leaders in relation to the Cross-Border Payments Roadmap. The letter sets out achievements made to date during the first phase of implementation and also refers to quantitative targets to be achieved by 2027 (Phase 2). It notes that three priority themes were set out in relation to Phase 2: payment system interoperability and extension; legal, regulatory and supervisory frameworks; and cross-border data exchange and message standards.

The letter refers to taskforces established that will be focussing on: practical changes for reducing unnecessary legal, regulatory and supervisory frictions; and projects to enhance payment systems. It confirms that this will be complemented by work undertaken by public sector groups looking at practical actions to enhance cross-border payments (e.g. the adoption of ISO messaging standards). The FSB confirms that it will issue a progress report for the October G20 Finance Ministers and Central Bank Governors meeting.

9. FSB: Letter from Klaas Knot to G20 leaders

On 5 September 2023, the FSB published a letter from Klaas Knot, FSB Chair, to G20 leaders. The letter provides an overview of the FSB's response to digitalisation. The letter states that recent scandals and vulnerabilities in the cryptoassets sector underscore the importance of an appropriate regulatory framework. The FSB confirms that it is working with standard setting bodies and international organisations to ensure that the recommendations contained in the July 2023 FSB frameworks for cryptoassets and stablecoins are implemented.

The letter also refers to a Synthesis Paper delivered by the FSB and IMF in relation to macro-financial risks concerning cryptoassets faced by emerging market and developing economies.

10. European Parliament: Exchange of views with Fabio Panetta, Member of the Executive Board of the ECB

On 4 September 2023, the European Parliament published a transcript of an exchange of views between Fabio Panetta, Member of the Executive Board of the ECB, and the European Parliament. Mr Panetta informed ECON members about the progress made on the digital euro project.

11. ESMA: Report on Trends, Risks and Vulnerabilities, No. 2, 2023

On 31 August 2023, ESMA published its second Trends, Risks and Vulnerabilities Report of 2023. The report notes that financial markets are adapting to the new economic environment, but warns of risks in light of fragile market liquidity in the equity, bond and crypto markets. The report notes a rebound in the cryptoassets sector following a drop in trading volumes.

Notable points

• Outstanding volumes of exchange traded products with cryptoassets as underlying increased in line with market valuations to a total of EUR 30 billion globally.
• Open interest in Bitcoin futures at regulated exchanges increased by approximately 15% during the H1 2023.
• Total value locked in DeFi protocols increased from around EUR 40 billion in January to EUR 45 billion in June 2023.

12. ECB: Publication: A big future for small payments? Micropayments and their impact on the payment ecosystem

On 23 August 2023, the ECB issued a report on micropayments. The report notes increasing attention prominence micropayments in the retail payments sector, citing the impact of digitalisation as chief cause.

Areas covered by the report include: potential implications of micropayments for the European retail payments market; requirements and challenges on the processing of micropayments; current and potential future business cases for micropayments; and different means of payment and technologies that could be used for micropayments.

The report argues that DLT technology could potentially reduce transaction costs (depending on the configuration of the underlying DLT arrangement), adding that its decentralised nature allows P2P transactions to interact directly without relying on a trusted central party.

UPDATES AND GUIDANCE: UK

13. FCA: Findings of review on firms' preparedness for crypto marketing

On 7 September 2023, the FCA published the findings of a review it had carried out on the preparedness of cryptoasset service providers for the new cryptoassets financial promotions regime. This follows the FCA's June 2023 Policy Statement PS23/6 setting out rules on financial promotions for cryptoassets (see our briefing here). The regime applies from 8 October 2023.

The FCA has published the review in light of engagement with MLR-registered firms. The review covered firms of various sizes and business models and sets out examples of good and poor practice.

Key findings include the following:

• most firms have faced significant challenges in preparing for the financial promotions regime;
• firms in global group structures are having to make significant changes to their business models to comply with the regime;
• firms have under appreciated the broad scope and nature of the financial promotions regime; and
• firms were not sufficiently considering how certain rules apply to the specifics of the cryptoasset services they provide.

The FCA also plans to introduce a modification by consent to the financial promotion rules for MLR-registered firms intending to communicate cryptoasset financial promotions and authorised firms intending to communicate or approve cryptoasset financial promotions.

The FCA raises concern about the lack of engagement from overseas, unregistered cryptoasset firms and promises to take robust action against firms illegally promoting to UK consumers.

For more information, please see our briefing here.

14. Bank of England Quarterly Bulletin 2023: Enabling innovation through a digital pound

On 24 August 2023, the Bank of England published its Quarterly Bulletin 2023, which contains an article on the digital pound containing a discussion on innovation and the design of the digital pound. Areas covered include the following: why innovation matters for the digital pound; and case studies of successful innovations in other sectors, and lessons for digital pound design.
The article concludes that the Bank of England and other central banks will have a number of factors to consider when entering the design phase for a CBDC.

15. ICMA: Response to HM Treasury’s Consultation on the first Financial Market Infrastructure Sandbox – The Digital Securities Sandbox

On 22 August 2023, ICMA issued its response to HM Treasury’s consultation on the first financial market infrastructure sandbox delivered under powers conferred by the Financial Services and Markets Act 2023, the Digital Securities Sandbox (DSS) (see our briefing here for background on FSMA 2023).

Key points

• ICMA members are broadly in support of the proposed approach to digital securities in scope and related activities outside the Sandbox but consider that the term "digitally native securities" could be clarified.
• ICMA members welcome the approach of making permanent changes to the UK legislative framework so as to remove any barriers for the use of particular technologies.
• ICMA members welcome a flexible approach for issuance and trading volumes of DLT-based securities, but call for transparency in relation to methodology and process for applying limits.
• Further guidance on settlement assets (e.g. tokenised commercial bank deposits) will be needed in light of the absence of wholesale CBDC/compatible central bank money arrangements.

UPDATES AND GUIDANCE: EUROPE

16. Speech of Burkhard Balz on the digital euro

On 17 August 2023, Burkhard Balz, Member of the Executive Board of the German Central Bank (Deutsche Bundesbank) held a speech on the digital euro.

According to Balz, it is necessary to create a digital payment solution in the Eurozone with rules and infrastructure "made in Europe" in the light of the progressive digitalisation. Balz emphasized that the digital euro will not replace euro cash and that amendments to the EU Commission's legislative proposal on the digital Euro are very likely. Balz welcomed the creation of a legal framework for the digital euro, arguing that it allows innovation around the digital euro and innovation around payments, which he notes was one of the objectives of the revised Payment Services Directive.

17. German Banking Industry Committee: Comments on the digital euro

On 14 August 2023, the German Banking Industry Committee (Deutsche Kreditwirtschaft, DK) published its First Comments on the EU Commission's legislative proposal on the digital Euro (Legislative Proposal). DK put the focus on two core issues: (1) key demands of the DK regarding the digital euro and (2) the assessment of the main contents of the Legislative Proposal. Demands include: the digital euro should be designed as the digital equivalent to cash; and it must not serve as a store of value, but should be limited to its function as a means of payment and should have a transaction limit in order to avoid fraud risks. In the assessment of the Legislative Proposal, DK argues amongst other things for a universal ban on interest, a legally secure holding limit and the permission of fair and market-oriented pricing for the provision of services related to the digital euro.

UPDATES AND GUIDANCE: APAC

None

UPDATES AND GUIDANCE: AUSTRALIA

18. Reserve Bank and Digital Finance CRC: Central Bank Digital Currency Report

On 23 August 2023, the Reserve Bank of Australia (RBA) and the Digital Finance Cooperative Research Centre released a report on the findings from a joint research project that explored potential use cases for a CBDC in Australia. The project involved the RBA issuing a limited-scale "pilot" CBDC that was a real legal claim on the RBA. The project was used by selected industry participants to demonstrate how a CBDC could be used to provide innovative payment and settlement services to Australian households and businesses. The purpose of the project was to both understand where a CBDC could enhance the operation of the Australian payments system, as well as the legal, regulatory, technical and operational issues that may be associated with a CBDC, requiring further research. The submissions made by industry participants illustrated that there are four key areas for further research/investigation:

• enabling "smarter" payments;
• supporting innovation in financial and other asset markets;
• promoting private digital money innovation; and
• enhancing resilience and inclusion in the digital economy.

19. Economics Legislation Committee of the Senate: Report on Digital Assets (Market Regulation) Bill 2023

In September 2023, the Economics Legislation Committee of the Senate (the Committee) published a report on the Digital Assets (Market Regulation) Bill 2023 (the Bill) proposed by opposition Senator Andrew Bragg earlier in 2023. The report provides an overview of the key issues raised by submitters and witnesses during the Senate Economics Legislation Committee's inquiry into the Bill. Ultimately, the Committee recommended that the Bill should not be passed because it lacks the required detail and certainty that investors, consumers and the industry should be provided with. The Committee was of the view that the Bill fails to work well in conjunction with Australia's already established regulatory landscape and notes that the regulatory burden of multiple licensing categories that may arise due to the differences between the Bill's proposed licensing regime and the current Australian Financial Services Licensing (AFSL) framework. Nevertheless, the committee acknowledged the need for further regulation for digital assets in Australia and has recommended that the Australian Government "continue to consult with industry on the development of fit-for-purpose digital assets regulation in Australia."

According to the Australian Financial Review, Treasury will soon release a consultation paper that will detail a plan to regulate the cryptocurrency sector, including creating rules for crypto custody and licensing for exchanges. Further legislation may follow once the paper has been published and further consultation has occurred.

UPDATES AND GUIDANCE: NORTH AMERICA

20. CFTC: Orders against operators of three DeFi protocols

On 7 September 2023, the CFTC announced that it had issued orders against the operations of three DeFi protocols for offering illegal digital assets trading. The orders require that the entities in question pay civil monetary penalties and cease and desist from violating the Commodity Exchange Act and CFTC regulations.

21. FASB: Approval for standards for cryptoassets

On 6 September 2023, the Financial Accounting Standards Board (FASB) announced that it had approved amendments to accounting standards concerning the accounting for and disclosure of certain cryptoassets. This follows a March 2023 Accounting Standards Update published by the FASB. FASB discussed the update to the standards in a meeting in September 2023.

22. CFTC: Speech by CFTC Commissioner Caroline D. Pham before the Cato Institute

On 7 September 2023, the CFTC published a speech by CFTC Commissioner, Caroline D Pham, given at the Cato Institute. In the speech, Ms Pham proposes a time-limited CFTC pilot program to support development of a compliant digital asset markets and tokenisation.

Ms Pham refers to her work in this area, including her keynote address on the ten fundamentals for responsible digital assets markets and the creation of a Digital Assets Markets subcommittee of the CFTC's Global Markets Advisory Committee.

In the speech, Ms Pham also provides an overview of past pilot programs, and then set out the features of the prospective digital assets pilot: a roundtable with stakeholder engagement leveraging off of the work of the CFTC GMAC Digital Asset Markets Subcommittee and other CFTC Advisory Committees; proposal of rules for the pilot program; and review by CFTC of data gathered from the pilot to inform changes to regulatory framework.

23. CFTC: Dissenting Statement of Commissioner Summer K. Mersinger regarding enforcement

On 7 September 2023, the CFTC published a statement by Commissioner Summer K. Mersinger regarding enforcement actions by the CFTC involving decentralised protocols. The statement refers to recent enforcement action against centralised exchanges operating in the digital assets sector. Referring to the three entities that are the subject of the statement, Ms Summer questions whether enforcement powers have been used correctly and states that the rapid development of DeFi protocols poses tricky questions for CFTC in terms of ensuring consistency with other CTFC initiatives, CFTC rules and the legislative framework.

24. SEC: Charges in relation to unregistered offering of NFTs

On 28 August 2023, the SEC announced that it was charging a media and entertainment company headquartered in Los Angeles with carrying out an unregistered offering of NFTs. According to the SEC’s order, the company offered and sold three tiers of NFTs. The SEC concluded that the NFTs were investment contracts and that the company violated federal securities laws.

25. Federal Reserve: Communications on Novel Activities Program and banks engaging in stablecoin activity

The Federal Reserve has issued more information in relation to the process to be followed by state banks supervised by the Federal Reserve before undertaking certain dollar token or stablecoin activity. The Federal Reserve has also set out more information in relation to its program to supervise Novel Activities. Novel activities includes activities involving cryptoassets and DLT. The Novel Activities Supervision program, which seeks to harness the benefits of financial innovation and address risks to ensure the safety and soundness of the banking system, will be integrated into the Federal Reserve's existing supervisory processes.

26. US Treasury: Proposed changes to regime governing sales and exchanges of digital assets by brokers

The US Treasury and Internal Revenue Service published proposed regulations on the sale and exchange of digital assets by brokers. The proposed regime would amend existing rules on reporting of information by brokers so that brokers for digital assets would be subject to the same reporting rules applicable to brokers for securities and other financial instruments and would require completion of new Form 1099-DA.

27. NIST: Report on American competitiveness in critical high-tech industries

On 17 August 2023, the National Institute of Standards and Technology announced that it had delivered a report to U.S. Congress on technologies deemed critical to the global competitiveness, economic growth and national security of the United States.

The report fulfils a requirement under the American COMPETE Act of 2021 and provides an overview of current research activities, public-private partnerships and standards development activities. In respect of blockchain technology, areas covered include: key technologies underpinning blockchain technology; application areas of blockchain technology; and interagency activities in the regulation of blockchain.

UPDATES AND GUIDANCE: MIDDLE EAST

None

PRESS/ARTICLES

28. FT: LSE draws up plans for a blockchain-based digital assets business service

This article reports on plans by the London Stock Exchange to offer trading of traditional financial assets on blockchain technology. The article reports that plans had progressed significantly and notes that the development is against the backdrop of increased enthusiasm for tokenisation of financial instruments. The article adds that if the plan comes into fruition, LSEG would be the first global stock exchange offering end to end blockchain-based infrastructure across the whole lifecycle of a financial instrument.

29. FT: Launch of a USD stablecoin

This article reports that on the recent launch of a dollar denominated stablecoin. It states that the stablecoin would be issued by Paxos and "would be redeemable one-to-one for US dollars" and that its reserves would be held in US dollar deposits and short-term treasuries (among other things).

Contributors: Tobias Bauerfeind, Senior Associate; Cornelius Hille, Associate; Gréta Müller, Junior Associate; Ankita Rao, Trainee