Understanding Stablecoins in a World of DeFi

Introduction

Many know of Bitcoin as the first mainstream application of Blockchain Technology. Few are aware of the intricate underlying mechanics that give its form. Unfortunately, it is best known for its volatility. Ranging from nearly 1,000 USD to 20,000 USD in less than a year and back to 4,000 USD a year later, the digital coin has had a hard time fulfilling one of the objectives it set out in the beginning; that is, to “fix” the shortcomings of fiat currencies (such as ease of globalization) without losing its benefits (being a means of payment, value reserve, and maintaining a stable relative quotation). Stablecoins are the next step in the technology evolution ladder, and have come to address Bitcoins’ shortcomings. 

But what is a stablecoin?

A stablecoin is a Blockchain application in the new world of Decentralized Finance (DeFi). Much alike Decentralized Exchanges (DEX) and innovative decentralized lending and borrowing platforms, stablecoins are an improvement over established systems. 

Stablecoins are cryptocurrencies whose architecture enables them to be pegged to another asset. Essentially, their price is set to follow the price of another asset. Stablecoins pegged to USD are the most popular, but there’s no limit to the possibilities and we’ll be exploring more below. It achieves its quotation through a straightforward process. The issuer (Tether, for example), acquires in collateral (USD) the amount of stablecoin that should be issued, and every time the circulating supply has to be increased, a proportionate increase in collateral is required. 

What types of stablecoins are out there?

There are two things we need to keep in mind to understand this: the pegged asset and the collateral. As we mentioned, the most common type of stablecoin has a 1:1 ratio with fiat currency, such as USD. There are, nonetheless, other types of stablecoins with different pegged assets (Euro/Franc, Gold, other cryptocurrencies, etc). On the far side of the range, we can find uncollateralized coins that use blockchain-based algorithms as a kind of central bank, whose sole purpose is to control the ‘money supply’[1] to make sure the coins will always trade at the same ratio. 

Among the most popular in the vast realm of stablecoins, we can find Tether (USDT) by Tether Limited, TrueUSD (TUSD) by TrustToken, and Paxos Standard (PAX) [2]. Also worth mentioning we encounter DAI, a non-fiat collateralized cryptocurrency whose transparency can be seen on-chain at all times. It manages to hold its stability by locking Ether (ETH) into a contract in a system called a Collateralized Debt Position (CDP), where a user wanting to acquire DAI sends the ETH to a CDP and can withdraw DAI from there. Additionally, EOSDT, a dollar-pegged, collateral-backed currency that leverages underlying EOS and BTC has recently come to life. The stable currency is insured by Equilibrium and adds extra liquidity to the market.

Benefits of stablecoins:

  • Most cryptocurrency exchanges in the world only allow users to trade one digital token for another. That is because converting fiat currencies into cryptocurrencies is a relatively complicated process, which involves dealing with banks and regulators in different jurisdictions, so stablecoins serve as a gateway for investors to enter the crypto-asset market. 
  • Not a long ago, the only alternatives to hedge volatility (daily price volatility of cryptocurrencies can range from 5% to 160%) [3] in digital asset markets were insurance policies and derivative contracts. With the appearance of stablecoins, participants can now instantly switch to stable assets.
  • Stablecoins can be used for everyday transactions, such as buying coffee, paying salaries, or buying real estate — thus facing fewer barriers to mass adoption than traditional cryptocurrencies, which often come with low transaction speeds and high fees in addition to current volatility.
  • The best of both worlds: stablecoins leverage the benefits of cryptocurrencies — such as transparency, security, immutability, digital wallets, fast transactions, low fees, and privacy — without losing the guarantees of trust and stability that come with using fiat currency (like the US dollar or Euro).

Disadvantages of stablecoins:

  • The harsh truth is that most stablecoins fail [4] (though this is historically true, it doesn’t speak to the current ones. Fiat/Crypto-based stablecoins have a higher chance of survival, while commodity-backed stablecoins have the highest closing rate). When they fail, they may or may not be redeemable for the promised amount. Some projects even allow issuers to freeze funds. Tether for example at one point had “We do not guarantee any right of redemption or exchange of Tethers by us for money” in its Legal Section [5].
  • Stability versus centralization: The majority of stablecoins are centralized, which opposes the nature of decentralization in blockchain itself. Fiat-backed stablecoins require trust in a centralized entity (i.e. a bank). Recent case examples include the KuCoin hack [6], where stablecoins issuers Bitfinex and Tether froze up to 33 million USD in USDT, and BitMEX facing federal charges [7] by the Department of Justice and Commodities Future Trading Commision, possibly following the same actions.
  • A secondary issue with these assets is inherent to how they are established. The common fiat-pegged currencies tend to suffer the loss of power of purchase in conjunction with the pegged asset. To set an example, the US economy has been presenting an annual average inflation rate of 3.22% [8] for the last 100 years, and the USD has fluctuated between EU 0.67 – 0.956 over the last ten years. In the case of another cryptocurrency as the collateral asset, one could also be exposed to its volatility.
  • One of the biggest challenges for stablecoins is “scaling”. It is difficult for reserve-backed stablecoins to reach a level where liquidity is deep enough to support interesting applications of the technology. Backers will have to invest millions or even billions in each coin. It could potentially create a cap on how fast a stable coin can grow.

For a further analysis of stablecoins and what influences their success (particularly a view on oil), consider the following article

What can SCALABLE do for you?

SCALABLE provides professional white-label digital asset exchange technology, which allows users to trade over 500 digital assets against every major stablecoin, with the possibility to list trading pairs against fiat currencies through seamlessly integrated banking and payment processors. Moreover, the custodial or non-custodial white-label Wallet infrastructure allows users to securely store, send and receive all major stablecoins. Our liquidity solution also provides the deepest books and top liquidity, allowing successful trading without risk of slippage.

 

References

[1] Also known as elastic supply or adaptive money. Currencies under this model include Ampleforth (AMPL), Yam.finance (YAM), Based.Money (BASED), etc.

[2] “Stablecoin Cryptocurrencies.” CryptoSlate, cryptoslate.com/cryptos/stablecoin/. 

[2] Emily Perryman et al. “A List of Stablecoins You Need to Know About.” Coin Rivet, 17 Jan. 2020, coinrivet.com/a-list-of-stablecoins-you-need-to-know-about/.

[3] “STABLECOINS: An Overview of the Current State of Stablecoins.” Blockdata. https://download.blockdata.tech/blockdata-stablecoin-report-blockchain-technology.pdf

[4]  See https://www.coinopsy.com/dead-coins/ for an updated list of active and dead coins. 

[4] Boddy, Max. “Research: Only 30% of Known Stablecoins Are Live and Operational.” Cointelegraph, Cointelegraph, 28 June 2019, cointelegraph.com/news/research-only-30-of-known-stablecoins-are-live-and-operational.

[5] Dinkins, David. “Tether Really Isn’t a Scam, Company Promises.” Cointelegraph, Cointelegraph,5 Sept. 2017, cointelegraph.com/news/tether-really-isnt-a-scam-company-promises. 

[6] “Kucoin Hacked for $150 Million in Bitcoin; Bitfinex and Tether Freeze $33 Million of the Stolen Funds: Exchanges Bitcoin News.” Bitcoin News, 9 Oct. 2020, news.bitcoin.com/kucoin-hacked-for-150-million-in-bitcoin-bitfinex-and-tether-freeze-33-million-of-the-stolen-funds/.

[7] “Bitmex Charged With US Rules Violations – Owners Face Criminal Charges, Prison: Regulation Bitcoin News.” Bitcoin News, 3 Oct. 2020, news.bitcoin.com/bitmex-criminal-charges-prison/.

[8] McMahon, Tim. “What Is Quantitative Tightening?” US Inflation Long Term Average, 1 Apr. 2014, inflationdata.com/Inflation/Inflation_Rate/Long_Term_Inflation.asp.

[9] “Board of Governors of the Federal Reserve System.” The Fed – Foreign Exchange Rates – H.10 – October 13, 2020, www.federalreserve.gov/releases/h10/hist/dat00_eu.htm. 

[9] ECB. “Stablecoins – No Coins, but Are They Stable?” IN FOCUS, no. 3, Nov. 2019, www.ecb.europa.eu/paym/intro/publications/pdf/ecb.mipinfocus191128.en.pdf.

The Decentralization of Finance (DeFi)

Introduction

Financial institutions [1] were created to fulfil various societal needs and mechanisms to facilitate certain transactions. The primary role of financial institutions is to provide liquidity to the economy and permit a higher level of economic activity than would otherwise be possible.

From providing funding, lending, and exchanges, to enabling money to move around the world by arranging deposits, withdrawals and transfers, interactions with financial institutions are an everyday reality for a large part of the population. But what at the time seemed like an evolution to a new, better scenario, could now be viewed as another actor being replaced in the chain of innovation.

Centralized Finance

Traditional (centralized) finance can be defined as a system where centralized actors (financial institutions) offer a range of services that aim to provide efficient resource allocation, whether between actors or through time. It accomplishes this by serving as intermediaries between parties, while keeping users’ private data.

Compared to its previous state, traditional finance created massive wealth and connections that would otherwise not exist. Additionally, it exponentially increased the speed of globalization and brought with it all its benefits (“free” trade, labour movement, capital flows and better communication, among others)[2]. Unfortunately, its centralized nature means the benefits have gone to individuals with easier access to this system (i.e developed economies with proper connectivity, infrastructure, transparent institutions, etc). 

Some of the societal needs it fills – at least partially – include, but are not limited to:

  1. The safeguarding of savings
  2. Facilitating efficient allocation of capital to support economic growth
  3. Providing broad access to ­financial services products and services
  4. Providing ­financial protection, risk transfer and diversification
  5. Collecting, analysing and distributing information for better economic decision-making
  6. Providing effective markets and financial resilience

 

Nevertheless, these attributes of the classic model of centralized finance carry certain disadvantages, such as:

  • Not accessible worldwide. Rising inequality and filter mechanisms (credit ratings, for example) prevent it from achieving universal inclusion.

 

  • High costs and low transactions. Even though today’s processes are the most efficient historically speaking, large friction inconvenients still exist. Delays of several days on money transfers abroad, as well as clearing and settlement processes do not provide an ideal timeframe. On the borrowing side, it can even take months and endless paperwork before an entrepreneur gets the funds to start a business.

 

  • Low trust in financial institutions and governments. The financial crisis exposed the shortcomings of the traditional financial system and resulted in diminishing users’ trust in the capacity – and willingness – of both governmental and financial institutions to act correctly. It highlighted the need for it to be better.

 

  • Reactive regulation. Regulatory uncertainties are some of the major issues plaguing the current financial system, and don’t provide an appropriate incentive structure to participants.

 

  • Risks. The structural way financial institutions are interconnected impedes the mitigation of systemic risk and cascade effects. Analogously, major risks faced by banks and related financial institutions include credit risk, interest rate risk, market risk, and operating and liquidity risks. Even though there are instruments for estimating and quantifying each risk (such as VaR, duration, sensitivity analysis), many of them produce very sensitive results and are subject to the user’s judgement [3].

 

  • Centralized. Each transaction, independent of its type, must go through at least one intermediary (or institution) before reaching a destination, automatically allowing third parties to access personal information. Moreover, this attribute implies that centrally stored information can suffer multiple damages caused by external attacks, internal inefficiencies, etc.

 

The Decentralization Process

With the revolution of present finance systems in mind, technological advances resulted in Blockchain, the ground-breaking decentralized technology concept that aims to bridge existing gaps and make finance accessible to everyone. It achieves true decentralization by distributing and storing identical ledgers (of transactions made) in each participant node of the network (chain), and securing them through high-end cryptography. Additionally, consensus protocols are in place to ensure fault tolerance and security of the chain. Instead of financial institutions, “smart-contracts” act as intermediaries in peer-to-peer transactions.

The superior factors that differentiate DeFi from traditional finance can be grouped into:

 Autonomy: There is no centralized authority or intermediaries, such as a bank, with the ability to freeze your account, seize your assets, or block your transactions. There is a note to be made on this point; even though DeFi ultimately aims for full decentralization, current applications always carry a modest degree of centralization. Stablecoins, for example, can freeze.

Accessibility: Virtually every person with a mobile phone and internet connection can benefit from the advantages of decentralized finance. Of the approximate 1.7 billion adults that remain unbanked, roughly two-thirds of them have access to mobile phones [4].

Tradability: Every non-digital asset traded in the traditional finance realm can be tokenized and traded (cheaper and faster) through decentralized finance. Every-day shrinking fees and faster transactions also set the basis for mass adoption and easier tradability.

Transparency: DeFi data is publicly available. Reserves on a DeFi bank can be easily checked, or research for accurate loan rates be carried out. 

But the predominant factor of Blockchain technology resides in that anyone can develop decentralized applications within open networks (such as Ethereum). For every application traditional finance can have, decentralized applications share its benefits without their main disadvantages (there are, however, some aspects that are seen as drawbacks uniquely associated with decentralized apps) [5]. 

 

Major DeFi Apps (DApps) [6]

StablecoinsDecentralized Insurance
Decentralized ExchangesDecentralized Lending & Money Markets
Asset TokenizationAsset Management tools
Staking Collateralization
Risk ManagementAlternative Savings
KYC & IdentityMarketplaces 

 

Conclusion 

The applicability and versatility of DeFi provides a tempting alternative path to centralized finance. This can be verified by the growth this system has had since its inception – actual total value locked in DeFi amounts to 10.5B USD [7]. Nevertheless, both centralized and decentralized structures have a role to play in our daily lives, each with their benefits and shortcomings. We will further explore key decentralized applications mentioned above in future articles – subscribe and stay updated.

 

SCALABLE – Our Solutions

At SCALABLE we provide a wide range of white-label services that include Exchanges, Liquidity, Asset Tokenization, Custody and Wallets. We know how daunting the shift to new technologies can be and thanks to our teams’ vast experience in both traditional finance and the blockchain industry, we can help bridge the gap between the two industries. Schedule a DEMO to find out more.

 

 

 

References 

[1]  Financial institutions include banks, insurance companies, brokers, pension plans, funds, exchanges, etc.

[2] For an in-depth academic survey of globalization, see Kose, M. A., Prasad, E., Rogoff, K., & Wei, S. J. (2009). Financial globalization: a reappraisal. IMF Staff papers, 56(1), 8-62.

[3] Carey, M., & Stulz, R. M. (2005). The risks of financial institutions (No. w11442). National Bureau of Economic Research.

[4] Demirguc-Kunt, A., Klapper, L., Singer, D., Ansar, S., & Hess, J. (2018). The Global Findex Database 2017: Measuring financial inclusion and the fintech revolution. The World Bank. Chapter 2: The unbanked.

[4] “Financial Inclusion on the Rise, But Gaps Remain, Global Findex Database Shows.” World Bank, www.worldbank.org/en/news/press-release/2018/04/19/financial-inclusion-on-the-rise-but-gaps-remain-global-findex-database-shows. 

[5] Including lack of oversight, assistance or legal framework.

[6] A list of DApps can be found on the Ethereum DeFi Ecosystem. This list is by no means comprehensive.  https://defiprime.com/ethereum

[7] “DeFi Pulse: The DeFi Leaderboard: Stats, Charts and Guides.” DeFi, defipulse.com/.

General Sources

Campbell, Lucas. “DeFi Market Report for 2019 – Summary of DeFi Growth in 2019.” DeFi Rate, 12 Feb. 2020, defirate.com/market-report-2019/. 

Desjardins, Jeff. “The 7 Major Flaws of the Global Financial System.” Visual Capitalist, 11 Sept. 2019, www.visualcapitalist.com/7-major-flaws-global-financial-system/.  

CoinGecko, Ong, B., Lee, T. M., Lau, D., Azmi, E., Kho, K., Jin, T. S., … Gries, M. (2020). How to DeFi.

The Impact of Liquidity for a Successful Exchange

Overview

Useful and comprehensive information is paramount before setting out to navigate any financial objective. Whether you are a retail trader, an established institution, or simply a non-professional investor, there are certain concepts to grasp and research to carry out. From finding or setting up an exchange or broker to defining asset classes, there is an abundant set of decisions to be made. We will further explore the impact of liquidity for a successful exchange and the relevant processes it affects. 

Exchange Characteristics and Blockchain: A brief introduction 

Embedded deep into every transaction we partake in, trust is the fundamental currency of commerce. Whether it’s on counterparty risk, a clearing procedure or other interactions, trust is the foundation of our economic system. We manufacture trust by creating intermediaries and adding layers upon layers of verification. Fortunately, newly incorporated Blockchain technology [1] provides us with a method to directly eliminate synthetic trust and improve each and every aspect discussed below.

Some concepts have proved to be fundamental for making informed decisions and obtaining effective results in building an exchange:

  • Operational features such as speed, security, connectivity, surveillance, and scalability are definitely a necessary condition but by no means sufficient to obtain the best performance. 

  • Other factors, such as (deposit and withdrawal) fees, exchange trading commissions, licenses, time in business, and liquidity provide a sound complement and the basis for a successful exchange. 

Liquidity, liquidity, liquidity

One particular aspect we believe to be key in the outcome of a successful undertaking is liquidity. It bears revising what liquidity means and its different classifications. Asset liquidity (as opposed to market liquidity) can be defined as whether an asset can be readily sold and converted into a base asset without causing a material impact on the asset price. To assess the liquidity of a digital asset, a base currency or asset must be selected against which to measure relative liquidity (BTC/USD for example). Market liquidity, on the other hand, is characterized by every other component in the system,  ranging from actors involved, size of transactions and so on.

There are usually a number of quantitative and qualitative ways to measure asset and market liquidity [2]:

Asset 

  • Slippage points for different size orders
  • Bid/ask spread

Market

  • Order book depth
  • 24 hr trading volume
  • Average number of trades
  • Number of participants
  • Heterogeneity of participants

Essentially, the bigger, deeper, and more secure exchanges are, the more lucrative results will be, all else equal.

There is a note to be made between liquidity and volume. Although sometimes mistaken for one to be a proxy of the other, they are different concepts. While one measures the liquidity of markets, the other tracks the amount of assets that change hands. They are, however, correlated to a certain degree. A highly liquid market can imply a high volume market as traders usually prefer to trade in exchanges that have a high amount of counterparties as that reduces the slippage on their trades.

Even though the global market for trading digital assets today is highly fragmented and has experienced notable pricing differences across global exchanges, an every-day closing gap between the liquidity provided by Centralized Exchanges and Decentralized Exchanges serves as strong evidence of the greater utilization of Blockchain technology (and its benefits), proposing a scenario where every company in the world today is at risk of having competition from a blockchain version of themselves.

What About SCALABLE?

The pool our clients connect to is among the deepest and most liquid in the industry. With an unparalleled heterogeneity of participants and a harmonious blend of experience between traditional and digital assets markets, every user can trade with minimal impact prices, regarding its order size. Find out more about Scalable Liquidity.

Conclusion

As discussed above, liquidity undoubtedly plays a crucial role in the success of an exchange. SCALABLE excels in every main metric used to measure exchanges’ liquidity, attracting order flow, and sorting the entrance barriers for newcomers. This practice can be extended to all of our future customers.

References

[1] Casey, Michael et al. The Impact of Blockchain Technology on Finance: a Catalyst for Change. ICMB International Center for Monetary and Banking Studies, 2018.

[2] Quinn, Steven. “If Blockchain Is the Door to the Future of Finance, Liquidity Is the Key.” Cointelegraph, Cointelegraph, 13 May 2020, cointelegraph.com/news/if-blockchain-is-the-door-to-the-future-of-finance-liquidity-is-the-key.

Scalable Becomes LUMI’s Official Partner

Press Release

This month multi-currency crypto wallet Lumi Wallet and white label exchange provider Scalable Solutions signed a partnership contract. Under this collaboration, the first wallet deployed under Lumi White Label, realized by Scalable Solutions, is scheduled for October. 

The LUMI wallet is available to use both on web and mobile platforms using Android and iOS. It supports BTC, BCH, ETH, EOS, Tether USDT, Binance USD, Paxos Standard Token, Celsius, Dai, and more than 1200 ERC20 tokens. For white label clients, full technical development and ongoing maintenance are available. 

Mark Berger, Founder of Scalable Solutions, shared:

“We believe our partnership with LUMI will prove to be a big success – both our companies have security at the core of our values and wish to make life easier for operators and end-users. LUMI is a very established product that has inbuilt Web 3.0 service and therefore simplifies transactions massively.” 

Scalable Solutions, founded by Mark Berger, has years of experience in the white label software industry, specializing in digital asset exchange and tokenization services. Their combined experience in this space, as well as knowledge of both blockchain infrastructure and traditional financial markets, ensures they can provide a wholesome experience to anybody looking for white label wallet solutions. 

Diana Furman, CEO of LUMI, commented:

“Scalable is a great team of professionals who are helping LUMI WALLET grow dynamically. We value their thoughtful teamwork that leads to visible results. We are looking forward to seeing a major wave of adoption on our technology with this partnership.

To build your own branded crypto wallet, get in touch here

 

 

About LUMI WALLET

LUMI WALLET, founded by CEO Diana Furman in 2017, offers secure and user-friendly crypto wallet solutions. It was made to meet the demands of both beginner and advanced users, combining a high level of security and complete anonymity with a simple, eye-catching interface. 

Lumi Wallet aims to build functional products for crypto users that will provide fulfilling and versatile experiences in the world of rapidly developing global financial systems.

We believe that by developing intuitive and versatile products we help to ease entry barriers to crypto for users and bring the mass adoption of new financial instruments closer.

 

 

About Scalable Solutions AG

Established nearly eight years ago with the mission to revolutionize financial markets and the digital assets space, Scalable Solutions offers white-label technology to launch your own professional digital asset exchange and blockchain infrastructure to tokenize any asset.

With a built-in liquidity pool, battle-tested digital asset security through Scalable VAULT technology, and 24/7 support from our Customer Success team, we ensure robust performance at all times.

The Fifth Anti-Money Laundering Directive

Introduction

The first Anti-Money Laundering Directive (AMLD) was adopted in 1990 to prevent money laundering within the financial system of the EU. This law is constantly being revised to reduce the risks associated with money laundering and terrorist financing. The fifth and last AMLD was introduced as the European Central Bank (ECB) claimed that AMLD 4 failed to effectively address recent trends in money laundering and terrorist financing, which have spanned multiple jurisdictions and fallen both within and outside of the traditional financial sector. AMLD 5 not only amends the 4th directive, but it also adds new provisions to the  European legal system. 

Overview of AMLD 5

The major changes to the directive are presented below :

  • Extending the directive scope to include virtual currencies. Virtual currency exchange platforms (“providers engaged in exchange services between virtual currencies and fiat currencies” [3, art 2, para. 1g] / exchange operators) – “VCEPs” and custodian wallet providers – “CWPs” (an entity that provides services to safeguard private cryptographic keys on behalf of its customers, to hold, store and transfer virtual currencies.” [3,  art. 1, para. 2d] / custodies) will be included as “obliged entities” subject to EU regulations. This means that VCEPs and CWPs now will face the same regulatory requirements as banks and other financial institutions.
  • Enhanced cooperation and information exchange between the EU financial intelligence units (FIUs). AMLD 5 requires Member States to implement centralized automated mechanisms at a national level to identify payment accounts and bank accounts held by a credit institution, thereby creating a central source for identifying all bank accounts for an individual [3, art. 1, para. 19]. Furthermore, the fifth directive reserves the right for each member of the EU to define and develop a central registry or data retrieval system for compliance.
  • Beneficial ownership registers. The main provision of AMLD 4 was the requirement for beneficial ownership registers, whereby member states will be required to obtain and hold adequate, accurate and current information on corporate and other legal entities, including trusts and similar legal arrangements, incorporated or administered within their respective member state [4, art. 3, para. 6]. AMLD 5 requires the implementation of these registers within 18 months of the implementation date.
  • Resolving anonymity issues regarding prepaid cards. EU member states will be required to identify a customer in the case of remote payment transactions where the amount paid is more than €50. After 36 months from AMLD 5 being entered into force, identification shall be applied to all remote payment transactions. Moreover, the maximum amount stored on prepaid cards  was reduced from €250 to €150 [3,art. 1, para. 7a] and the same limitations were made for monthly payment transactions.
  • Developing a coherent EU approach to high-risk third countries (e.g., Afghanistan, Iraq, Iran, Syria and DPRK). The AMLD 5 will require member states to apply a specific list of enhanced due diligence (EDD) measures for transactions involving entities on a list of high-risk countries as defined by the European Commission.
  • Prohibition of anonymous bank accounts and bank cells. Nameless bank accounts, savings accounts or safe deposit boxes will be abolished with the AMLD 5.

The AMLD 5 was published in the Official Journal of the European Union on June 19, 2018 [3] and entered into force on July 6, 2018 and according to the First Vice President of the European Commission – Frans Timmermans, these new rules “will bring more transparency to improve the fight against money laundering and terrorist financing across the European Union” [10]. Moreover, AMLD 5 was proposed as an “action plan” against terrorist attacks in Paris (2015) and Brussels (2016) and as a reaction to Panama Papers scandal (2016) [7], and in order to keep pace with recent trends in money laundering and terrorist financing more effectively. The full list of following deadlines is presented in below.

  • January 10, 2020 – Registers of Corporate and Legal Entities (Article 30)
  • March 10, 2020Registers of Trust Arrangements (Article 31)
  • September 10, 2020Centralized Automated Mechanisms, Member States should set up centralized automated mechanisms allowing the identification of holders of bank and payment accounts and safe-deposit boxes (Article 32a)
  • March 10, 2021 – Interconnection of Registers, Central registers should be interconnected via the European Central Platform (Article 30-31)
  • December 31, 2021Real Estate Register Interconnection Report (Article 32b)

Cryptocurrencies and AMLD 5

The fifth directive names cryptocurrency as virtual currency and defines them as follows: “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically.” [3, art. 3, para. 18]. In 2014, EBA (European Banking Authority) claimed that cryptocurrencies are especially vulnerable to criminal misuse because they make transacting parties rather anonymous and are not limited by jurisdictional borders and until AMLD 5, these transactions have not been regulated [6]. In other words, the fifth directive:

  1. Considers VCEPs and CWPs as “obliged entities” and this view includes obligations to register with national anti-money laundering authorities, implement customer due diligence controls, regularly monitor virtual currency transactions, and report suspicious activity to government entities (same requirements as for banks and other financial institutions in the EU). It is interesting that these obligations look very similar to anti-money laundering rules posed upon virtual currency exchanges in the United States , which consider cryptocurrency exchanges as entities subject to the Bank Secrecy Act 1970 and require registration as a Money Services Businesses (MSB) with FinCEN;
  2. Obligates member states of the EU to create central databases that comprise identity information and wallet addresses of cryptocurrency users who interact with VCEPs or CWPs. Furthermore, it authorizes national FIUs (Financial Intelligence Units) to access these databases if it will be necessary;
  3. Optimizes the regulatory framework of EU member states regarding cryptocurrencies by defining the main terms and instructing member states. For example, definitions of CWPs, VCEPs and virtual currency/cryptocurrency, that were performed before, were taken from AMLD 5.

Therefore, under the new legal framework, Europol could much easier gather the information about suspicious cryptocurrency transactions by requiring central databases to provide all information about the owner of certain wallet and then by utilizing special software (e.g., Elliptic, Chainalysis, Crystal), track all funds flows and after that, if it will be necessary,  start a standard investigation. 

The main implications of the enactment of AMLD 5 for EU’s CWPs and VCEPs can be summarized as follows: 

  1. CWPs and VCEPs will be regulated as “obliged entities”, hence they must meet the same AML and KYC standards as banks and other financial institutions in the EU; 
  2. All addresses and transactions will be absolutely transparent for FIUs; 
  3. Such terms as CWP, VCEP, and cryptocurrency finally get necessary legal definitions.

The Response of Cryptocurrency Companies

According to Chainalysis (transaction auditor, whose clients are include giants such as Binance, Bitstamp, EUROPOL, and Barclays), the implementation of AMLD 5 will be positive for the digital assets industry, because the new legal framework will attract institutional investors, which had low-risk appetite due to the absence of fully-fledged regulation [11]. Moreover, Ulli Spankowski, the director of digital technology at Stuttgart Stock Exchange, confirmed that AMLD 5 had a positive effect on the interest of traditional financial institutions in cryptocurrencies [8].

Nevertheless, we can observe several examples of companies that left the EU or closed down because of the introduction of AMLD 5. 

  1. Deribit – provides a platform for digital assets futures and options trading, has moved from the Netherlands to Panama [5]; 
  2. KyberSwap – one of the biggest non-custodial exchanges, changed its jurisdiction from Malta to the British Virgin Islands [2];
  3. BottlePay (platform for Bitcoin payments), Simplecoin (a crypto mining pool), Chopcoin (bitcoin gaming platform), have all closed due to AMLD 5 [1].

EU and US approaches to regulating cryptocurrency

The regulatory approaches in the European Union and the United States are largely similar when speaking about cryptocurrencies. Both the EU and US recognize the significance of cryptocurrency regulation in fighting against terrorist financing and money laundering. Companies that provide digital assets services face the same rules as financial institutions (e.g. banks) when it comes to KYC, AML, and suspicious activity reporting. Moreover, members of the EU and  the states in the US have the right to implement stricter laws in their domestic legislation.However, both jurisdictions seek to balance monitoring so as not to limit innovation. However certain differences exist, as described below:

  • Both legislations have different definitions of companies that provide crypto services. In the EU such companies  are defined as “obliged entities” (AMLD 5), while in the United States companies that provide digital assets services are defined as “covered financial institutions” (FinCEN). Nevertheless, these terms have the same aim, which is to make crypto service providers comply with the established banking rules in each regulatory jurisdiction.
  • AMLD 5 focuses on regulation of VCEPs and CWPs, whereas the United States federal regulatory regime refers to services exchanging or transmitting crypto regardless of fiat currency involvement [9].
  • The United States has two levels of regulation (federal and state), hence providers of crypto services are obligated to guarantee both levels of compliance, however it is possible to be free from local laws in some states. While, in the EU each level of regulation has to be equal or stricter than AMLD 5.
  • In the EU, the data protection laws apply to the processing of personal data collected for AML and counter-terrorism financing purposes under AMLD 5, which means that VCEPs and CWPs are required to provide appropriate measures to protect the information that they collect about their customers. No federal privacy or data collection rules have been enacted in the US, although privacy laws have begun to appear in certain states of the US [9].
  • AMLD 5 obliges EU members to make public registry information on beneficial owners available, which should be integrated at EU level to promote cross-border collaboration and information access by regulators and FIUs. On the contrary, the USA’s states may soon follow and create in future a national database that tracks the beneficial ownership of entities [9].

Conclusion

Nowadays, with the introduction of AMLD 5, digital assets companies (CWPs and VCEPs) in the EU qualify as “obliged entities” that must be licensed by a national financial services authority (e.g., Germany’s BaFin, or the UK’s FCA) and perform the same KYC/AML requirements as a bank or other financial institutions. 

In addition, they are obligated to store personal data of their clients along with their digital assets addresses/wallets and transactions to provide this information to FIUs if it will be necessary. AMLD 5 is not destructive for the industry, because regulatory bodies require crypto companies to comply with the same AML/KYC standards as from other financial institutions to prevent terrorist financing and money laundering. Cryptocurrency industry will be joined to the existing financial system with accepting common laws to continue its development, it was just a matter of time. Similar KYC/AML requirements for cryptocurrency companies had been existing in the USA for several years, however, the United States is currently considered one of the most crypto-friendly jurisdictions.

References

  1. 2020: The Year of EU Regulation of Crypto-Assets? // Lexology URL: https://www.lexology.com/library/detail.aspx?g=7cad051e-fdd9-4195-ba0c-1f70e2c18966 (accessed: 01.04.2020).
  2. Another crypto firm moving out of the EU in response to 5AMLD, this time non-custodial exchange KyberSwap // The Block URL: https://is.gd/bJlnao (accessed: 01.04.2020).
  3. Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU // Official Journal of the European Union. 2018 . OJL 156. Vol 61.pp. 43–74 .
  4. Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC // Official Journal of the European Union. 2015. L 141. Vol 58.pp. 73–117.
  5. Dutch Derivatives Exchange Deribit to Move to Crypto-Friendly Panama // CoinDesk URL: https://www.coindesk.com/dutch-derivatives-exchange-deribit-to-move-to-crypto-friendly-panama (accessed: 01.04.2020).
  6. EBA Opinion on ‘virtual currencies’ PDF // EBA URL: https://is.gd/72397n (accessed: 06.01.2020).
  7. EU: 5th EU Anti-Money Laundering Directive published // Global Compliance News URL: https://globalcompliancenews.com/eu-5th-anti-money-laundering-directive-published-20180716/ (accessed: 06.01.2020).
  8. Europe’s New AML Rules Made Crypto More Attractive to Institutions, Says Boerse Stuttgart Exec // CoinDesk URL: https://is.gd/nwdUIY (accessed: 01.04.2020).
  9. European AML Regulations Follow the US Path With a Six-Years’ Delay // CoinTelegraph URL: https://cointelegraph.com/news/european-aml-regulations-follow-the-us-path-with-a-six-years-delay (accessed: 09.01.2020).
  10. Statement By First Vice-President Timmermans // European Commission URL: https://ec.europa.eu/commission/presscorner/detail/en/STATEMENT_18_3429 (accessed: 06.01.2020).
  11. What European Cryptocurrency Exchanges Need to Know about 5AMLD // Blog of Chainalysis URL: https://blog.chainalysis.com/reports/5amld-cryptocurrency-exchanges-europe (accessed: 01.04.2020).
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