@ the IERP® Global Conference, August 2024
The views and opinions expressed in this article are solely those of the featured speakers and do not necessarily reflect the official view or stance of the IERP®. The content is provided for informational purposes only.
The focus of this session by Ave D King, Chief Compliance Officer & MLRO, FalconX, was the development of digital assets or cryptocurrency, what these may be used for, benefits and challenges, ESG aspects and benefits of digital assets, and how sustainable they are. Noting that a lot of institutional buying of cryptocurrency has been happening over the past two years, King said that the concept of cryptocurrency was first mooted in 2008 in a paper by one ‘Satoshi Yakamoto’ about a form of purely electronic cash.
This electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. “That laid the foundation of what has developed into a cryptocurrency system,” King said. “This paper caused a stir among technologists, particularly those who were looking for alternative means to grow their wealth without the use of financial intermediaries.” In fact, cryptocurrency was considered an alternative lifestyle in the initial days, before institutions started adopting it.
Blockchain was created a little over a year later, enabling the digital asset to travel. “Basically, blockchain is an audit trail that is identified from the beginning, and cannot be manipulated,” she explained. “Data cannot be altered.” This was followed by the first commercial transaction in 2010 – someone in Florida bought two pieces for 10,000 Bitcoin, just to try and make a use case. One of those pieces today is worth US$700 million. However, in 2011, the largest Bitcoin exchange in the world, Tokyo, was hacked and 85,000 Bitcoins were stolen.
Cybersecurity issues led to the downturn in Bitcoin price, and the shutdown of the Silk Route , where buyers could remain anonymous while using Bitcoin for payment. There were other issues as well, such as losing your Bitcoin if you could not remember your password, but it was basically reputational and trust issues which led to a crackdown by the FBI. However, this spurred people to start understanding more about the need for a better regulatory framework. Financial institutions themselves started looking at Bitcoin as a potential asset class.
Bitcoin went on a bull run, rising to US$1,000, then 17 years later, to US$17,000, becoming what Forbes described as the best-performing asset class in 2023. “A brief history of Bitcoin’s price: in 2012 it was US$16 for one Bitcoin,” King said. “It then went up to US$73, and is now US$59,000 for one Bitcoin.” In June 2023, it was found that a large number of people owned Bitcoin in countries like Nigeria, Brazil, Argentina and Turkey – countries where there had been a run on their currencies. This could be due to many reasons.
“The problem is that in some countries, the uptake of cryptocurrencies is higher due to the lack of regulatory regimes, and understanding of how crypto works,” she explained. While regulatory development has focused primarily on the anti-money laundering space due to the high levels of anonymity afforded by cryptocurrency, many countries are already looking at strengthening regulatory measures. Singapore has started, followed by Switzerland, and recent developments have also made people more wary and aware, particularly with the use of smartphones.
Commenting on the advantages of using cryptocurrency, she said that sending it outside a financial institution was still a cheap and speedy method which did not rely on international wires. “It’s basically instantaneous, and can go across borders provided you do it correctly, and at your own risk, of course,” she cautioned, adding that it also depended on the situation. “It is a volatile currency, but for example, if you speak to somebody in Argentina who sees the price of very basic staple food items rising by 50,000%, then using something like Bitcoin makes a lot of sense.”
Besides this, discussions of centralising vs non-centralising were ongoing. Explaining that centralising meant having typical banking functions which used the usual financial routes, she said that trust in institutions was dwindling because of the numerous examples of bank failure, and increases in bank costs. “Some people believe that crypto(currency) gives economic freedom, ensures better access to their own money, and fair access to participation in the economy,” she said. “If you go on the biggest crypto exchanges, you see this in their business plan: giving economic freedom to the whole world.”
But the digital asset industry is still a nascent one and is challenging for risk professionals and especially for compliance professionals. “One of the biggest issues in the compliance or regulatory space is understanding where the bitcoins come from, and where they are going,” she said. A lot of banks are now using Chainalysis, a blockchain analytical tool that helps them look at the movement of assets across the blockchain. As an example of what not to do, she cited FTX, the second biggest cryptocurrency exchange, which went bankrupt because of a lack of proper governance.
“The core issue was absolute lack of governance within the company itself,” she said. “It also created its own coin and used this as collateral against more stable assets which was again a lack of governance and trading mandates. Trading mandates are important to ensure there is no conflict of interest; FTX didn’t have any of that. They also had a complex legal structure and created another company supposedly to do research but it had the same governance, and owner, instead of separate teams.”
She said that an article on the cryptocurrency website Coin Desk reported that the coin FTX had created was basically the only collateral they had, which caused people to liquidate their positions, resulting in a run which bankrupted FTX. “Not only did it go down itself, other banks like Silicon Valley Bank went into bankruptcy because of it,” she said. There were other repercussions too. “When companies go bankrupt, their social funds are wiped out, affecting many people who were banking on those funds to pay for their pensions and education loans.”
Discussing the environmental impact of cryptocurrency, she said that Bitcoin mining, which does not produce emissions like electric vehicles, consumed approximately 100 kW/h per year, the equivalent of running a household air conditioner or tumble dryer. However, it was not about the energy, but the emissions associated with the production of the energy and the burning of fossil fuel, and with industries aiming to achieve Net Zero emissions in the coming years, any emissions are bad. Miners may thus move to different countries and sources of energy.
Explaining the blockchain concept called Proof of Work or Proof of State, she said Ethereum is often considered more sustainable than Bitcoin and is linked to Proof of State, which requires less electricity consumption. From the social benefit perspective, cryptocurrency can be a major factor in wealth creation, particularly in countries that have experienced destabilisation of their own currencies. Citing the case of the Turkish Lira, she said that in 2022, the crypto transaction volume in Turkey ranked fourth globally.
“There is definitely evidence here for (cryptocurrency) being an exit for hyperinflation,” she said but reiterated that it was still very much a nascent industry. “Decentralisation is its most prominent feature. The idea is that you don’t need government or financial institutions. You don’t need to be told what to do or when to do it.”
