If you were in London over the last couple of weeks, you wouldn’t have missed the activities of the extinction rebellion. While I don’t condone all their actions, they are making a valid point and it is being heard at the highest and the lowest levels. A week ago, I explained to my five year […]
The post BoE Mandates Climate risk stress tests, can Fintechs help? appeared first on Daily Fintech.
Move fast and break Facebook. It will soon be conventional wisdom that Facebook Libra will fail and you only make money before the herd catches on. In this article, Daily Fintech Subscribers learn why Facebook Libra will likely fail and who/what will win if Facebook Libra fails and how to profit from that. Bernard Lunn […]
The post How to profit from the now likely failure of Facebook Libra. appeared first on Daily Fintech.
TLDR. Napster blew up the music business with free and illegal. Then we had low cost and legal like Spotify, Pandora and iTunes. The same is happening to innovation capital. The summer of 2017 ICO, kicked off by Bancor, was the now illegal way to raise a lot of money easily and at virtually no cost. That was a lousy deal for investors and naturally then regulators jumped in.
This update to The Blockchain Economy digital book covers:
- What is broken in the legacy innovation capital business
- Why the ICO went too far in the opposite direction
- The news about Blockstack and Reg A
- Reg A Basics
- Blockstack Basics
- Jurisdictional competition will continue
- Context & References
What is broken in the legacy innovation capital business
In March 2017, in Crypto equity via ICO and the other innovation chasm we wrote that:
“Most entrepreneurs understand the chasm between MVP (Minimum Viable Product) and PMF (Product Market Fit). The low cost to build MVP increases supply, but real demand does not change that fast, so lots of MVP ventures fall into the chasm (i.e. they fail).
The next chasm is less well understood. This is the chasm between PMF and Liquidity (via an IPO on the Public Markets and failing that via trade sale).
Today, we don’t see this chasm so clearly because there is a very expensive bridge across it – in a few locations. The very expensive bridge is provided by the big PE/VC Funds.”
Why the ICO went too far in the opposite direction
In 3 hours that shook my world: the Bancor ICO in June 2017 we described Bancor raising over $150 million in 3 hours in an ICO that kicked off the ICO craziness in 2017 when ventures could raise huge sums on not much more than a “minimally viable white paper”. The ICO went too far in the opposite direction – good for the entrepreneur and bad for the investor.
The news about Blockstack and Reg A
The news as reported in many media outlets was that the SEC gave Blockstack the go-ahead to conduct a $28 million digital token offering under Regulation A (which enables smaller companies to raise money from the public with less strenuous accounting and disclosure standards than a traditional IPO).
This is big news because the SEC is creating a new protocol for token offerings under Reg A. This is tokenized early stage crowdfunding. While neither tokens nor crowdfunding are new, this the first time they have been combined in a global market that US public investors can participate in.
America has been losing ground in crypto as it was not perceived as a friendly regulatory environment. This news is a big win for American entrepreneurs and investors.
Reg A Basics
“is an exemption from registration for public offerings. Regulation A has two offering tiers: Tier 1, for offerings of up to $20 million in a 12-month period; and Tier 2, for offerings of up to $50 million in a 12-month period. For offerings of up to $20 million, companies can elect to proceed under the requirements for either Tier 1 or Tier 2.
There are certain basic requirements applicable to both Tier 1 and Tier 2 offerings, including company eligibility requirements, bad actor disqualification provisions, disclosure, and other matters. Additional requirements apply to Tier 2 offerings, including limitations on the amount of money a non-accredited investor may invest in a Tier 2 offering, requirements for audited financial statements and the filing of ongoing reports. Issuers in Tier 2 offerings are not required to register or qualify their offerings with state securities regulators.”
Blockstack describe themselves as the” easiest way to build decentralized apps that can scale” and claim over 120 independent developer teams that have built apps on Blockstack.
Like Ethereum and many ICOs, Blockstack is a developer-focussed open source platform. It is the sort of innovation that the crypto community needs.
Jurisdictional competition will continue
In Some Governments Want To Shut Down Bitcoin But They Don’t Know How we wrote that:
“For a long time, entrepreneurs faced competition and regulators sent them the rule book. Regulators were government employees who thought about competition only in the abstract; competition was something that other people had to worry about.Today, the environment is more fluid as governments recognize the economic return on innovation in terms of jobs and GDP growth. The regulators now face real competition because their political masters have to keep citizens happy and citizens care about jobs and GDP growth. Both Fintech upstarts and incumbent global banks are increasingly mobile; so jobs can disappear fast if regulators get it wrong. Plus, innovation is the primary driver of productivity which drives GDP per capita. Pity the poor regulator who must balance that with protecting citizens from fraud and enforcing existing laws.”
This jurisdictional competition is a good thing because while, the SEC may have got it almost right with Reg A and the Blockstack token offering, there is still room for improvement. If you look at the details, you will see that accredited investors get in early and the public get in later. The public gets in earlier than they do in a traditional IPO, but this is still a two tier market. In a global market with jurisdictional competition, expect big moves by Singapore, Hong Kong, UK, Switzerland the EU and other tech/finance centers.
Context & References
I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.
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The 2019 Cryptovalley Conference remains true to its nature. Three days, three stages, and overweight technical and economics content. I attended for two days and became A cool kid on the Blockchain.
The narrative has clearly changed. Lots of evidence around us. Yesterday the BIS, the umbrella organization, announced the launch of a global innovation hub in Basel,Hong Kong, and Singapore to help Central Banks to “identify relevant trends in technology, supporting these developments where this is consistent with their mandate, and keeping abreast of regulatory requirements with the objective of safeguarding financial stability”.
The EU is very serious about supporting Blockchain technology. Tom Lyons announced the Convergence conference this coming November sponsored by the European Commission, the EU blockchain observatory & Forum, Consensys, Alastria, and INATBA.
Several speakers and panelists participated at the Cryptovalley Conference from Central banks around the world. Of course, they repeatedly stated that they share personal opinions and not the CBs official position. Between the BOE, the Fed, the SNB, and the Bank of Italy, the conversations went deeper.
We were reminded that unconsciously we are going back to the 19th century when multiple entities issued money. I like to add to that observation that we are also going back to bearer instruments. Tomaso Atse, director of the UCL Center for Blockchain Technologies, pointed out that what is new in our era is programmable money and the creation of hybrid types of value (like combining digital identity with money or some other value) and the ability to exchange it).
Alexander Lipton, the EPFL visiting professor and founder of SILAmoney, poked and provoked and defended his point of view. In a nutshell, he is the godfather of the DLT version of Narrow Banking concept. This is a way for Central banks to deploy DLT technology by issuing a fiat-backed digital coin (FBDC). The idea is that the central bank will allow and work (indirectly) with a consortium of validators that manage the issuance of the FBDC. It is worthwhile reading about this concept `Narrow Banks and Fiat-backed digital coins` by Alexander Lipton, Alex Pentland, Thomas Hardjono (MIT). What jumps out of it is that right now, we are faced with Facebook intending to implement this kind of concept through the LIBRA association. While each Central bank is doing its in-house due diligence, concerned only with its local country monetary policy and reserves; there is a clear need for Central banks to get together. They should be designing a Central bank coordinated narrow bank consortium.
This is a wakeup call to nightmares of whether Central banks will be able to control reserves and rates on reserves if LIBRA scales. LIBRA`s adoption in countries with currency instability, is troublesome if it really scales. Can LIBRA create hyperinflation in Venezuela? Alexander Lipton, says yes.
The narrative has clearly changed, and we are shifting in a phase where understanding monetary economics is becoming important.
When I raised the question last week about the governance of the LIBRA association (see here) and whether there could be collusion; I didn’t mean in the DAO technical sense (i.e. more 50% of validators collude and validate an invalid transaction). I meant collusion in terms of decisions about, for example, the management of the LIBRA reserve fund. Which currencies will be included, will the fund become a significant holder of US debt, how much government debt versus currencies, why share the interest of this cash cow by accepting new members, how to deploy the profits of the reserve?
Once the LIBRA reserve scales to $100billion (Ant Financial`s money market fund is currently $168billion down from a high of $250billion), the interest will be in the order of $1.5billion (assuming an average 1.5% interest rate). That is huge for an association with no reporting requirements.
We live in very interesting times.
Monetary policy issues need to be understood better.
Moral hazards are lurking everywhere.
Those that have been working on financial inclusion, self-sovereign identity, P2P protocols are feeling looted.
- Why didn`t Facebook join the Decentralized Identity – DID- project (media report that they were invited and rebuffed an invitation)?
- Why isn’t Facebook`s Calibra, the ID part of the LIBRA ecosystem, respectful of the open standards for verifiable credentials developed already by DID under the auspices of the World Wide Web Consortium (W3C)? Why do they want to design new ones?
- Will this world domination-ish attitude, shoot them in the foot?
Back to the native people, Lisa Nestor from the Stellar foundation, shared a great overview of the global P2P network that can be used by banks to work directly with each other, without the need for correspondent banks. Stellar is decentralized and open with 28 nodes currently. Their aim is to optimize cross-border payments and work with all currencies. They launched in 2014. In 2016 they had 9,000 accounts and today they have 3.2million. Their daily volume has reached $350k with a total cost of processing of $1.50! During the conference, they reported that the first Swiss node was launched.
Bitcoin Suisse announced that they are seeking a banking license and they will be expanding in Europe. Ficas, a Swiss crypto asset management group for HNW, was a platinum sponsor. They are based in Zug with presence in Turkey, Greece, Spain, and Australia. Flovtec and Ovrium shared the award of the best Swiss Blockchain company at the SICTIC investor event during the conference. Orvium is a decentralized scientific collaboration platform for deploying blockchain and artificial intelligence technology. Flovtec is a liquidity provider for tokenized assets.
My opinion is that we will be seeing an explosion of stable coin issuance. CNNmoney Switzerland was at the Cryptovalley conference taking a pulse on LIBRA (watch here).
The GOSCI – Global Open Source Currency Index- is a novel independent volatility benchmark for Stablecoins. Launched by Bernard Lunn the same day the LIBRA white paper hit the market. Become part of it.
The Stablecoin.foundation was launched in October 2018 with 25 Stablecoin issuers from 16 countries. Its mission is to represent the collective interests of Stablecoin issuers to unify the industry.
The narrative is now, about financial stability with privately issued coins. Several factors are forcing everyone to the table. These conversations are hard and consensus is not given.
Stable coins are creating a very collateral hungry market situation.
 INATBA is the new International Association for Trusted Blockchain Applications, offers developers and users of DLT a global forum to interact with regulators and policy makers and bring blockchain technology to the next stage.
 “That’s very world domination-ish of them,” said Kaliya Young, a co-author of “A Comprehensive Guide to Self Sovereign Identity” and co-founder of the Internet Identity Workshop. “Some of us have been working on that problem for a really long time. You already have a set of open standards for verifiable credentials that are basically done and working.” From the article `Buried in Facebook`s LIBRA paper, a Digital Identity Bombshell`
I have a commercial relationship with Flovtec. I have no positions or commercial relationships with any other company or the people mentioned. I am not receiving compensation for this post.
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In January 2008 I started writing a book called Crumbling Behemoths. I should have finished it. In October of that year, after the Lehman collapse, it could have been a bestseller. My experience in the Fintech engine room of core banking helped me see the fragility in what looked like an invulnerable system of giant global banks. Here is the TLDR version that book, just after the 10 year anniversary of the Lehman collapse and just before the 10 year anniversary of Satoshi Nakamoto’s White Paper (January 3rd).
Banks are vertically integrated, tightly coupled, politically dependent entities. Most have been in business for hundreds of years. Their decline is inconceivable; like the decline of car manufacturing in Detroit, Blockbuster, bookshops, Kodak, etc, etc. Size gives some Banks great power today and size looks like an obvious asset on their balance sheet. However in the network age, their size is actually a liability. This post explains why, with a focus on:
- Legacy IT meltdowns and the liability of “technical debt”
- Wells Fargo and the Creative Destruction 7 Act Play
- Why Blockchain is the realisation of Coase’s post-Corporate vision
- Satoshi’s vision of 7 billion banks is the long term threat
- The networked small bank is the imminent threat
- Regulators typically arrive about the time that technology is doing the job for them
Why Bailouts will not be possible next time
- How Analog Scale is fundamentally different from Network Scale
- Trading Takeaway – how to profit from this insight
Legacy IT meltdowns and the liability of “technical debt”
Hello, my name is Bernard and I am a core banking system salesman. Yes that sounds like the intro to an AA meeting. i should say “was”, but in honour to AA I use the present tense. My days in the engine room of Fintech, selling core banking systems to the biggest global banks for companies such as Misys, meant I was not surprised to witness the Legacy IT meltdowns and the gradual crumbling of the Bank Behemoths.. Those of us selling replacements for paper-based systems decades ago never imagined that those systems would still be operational in the 21st century. They are and now they have moved from the asset to the liability side of the Bank’s ledger.
Bankers often talk about the millions invested into IT as an asset. Anybody who writes code knows that software degrades over time and at a certain point that “technical debt” becomes a liability and not an asset. It is now cheaper to build the IT infrastructure for a startup bank, using open source and APIs, than it is to adapt Legacy IT for a modern world. The $ millions invested in IT now have a negative ROI.
I use terms such as assets, liabilities, technical debt and negative ROI is to make this accessible to non-technical bankers and investors. There is one technical concept that is critical but also easy for non-technical bankers and investors to understand, which is tight vs loose coupling.
Any programmer will tell you that a loosely coupled architecture via APIs accessible via networks is better than tightly coupled systems (aka “spaghetti code”).
The programming cost is not the issue. The big issue for the Behemoths, the reason they are crumbling is:
- The banks cannot change their business model fast enough. Bank CXO teams are perfectly away of the threat of disruptive technology and that they must change their business model at a fundamental level. They know what they should do. The problem is that they send instructions to the engine room of their ship to go faster and to change direction to due West and the person in charge of the engine room tells them that if they shovel in a lot more coal they can increase speed by 10% and will take two hours to change direction to due West, but warn them that this means they will run out of coal before they arrive at the next port. Meanwhile the Bank CXO team in the captain’s tower sees a flotilla of small boats going due West at 10x their speed.
- Loss of consumer trust. Consumers might be enraged by bailouts, but they still assume that banks are at least reliable and the only game in town. Some consumers read about Cyprus where the government unilaterally took money from their bank; this is “bailout in your face” (strangely described as a “bail-in”), but at least one can think “that is in some tiny far away island”. Closer to home, a series of IT Meltdowns, such as at TSB and RBS, mean that consumers have days when they cannot get cash from an ATM or use their credit cards; banks are no longer “reliable”. Finally they hear from a friend who is raving about one these startup banks; the big old banks are no longer the only game in town.
- Aggressive action that only makes it worse. This is what we saw in the Wells Fargo scandal.
Wells Fargo and the Creative Destruction 7 Act Play
The Wells Fargo fake accounts scandal was a more subtle version of the Cyprus bail-in. Money was taken out of your account, not by the government, but by your bank via a fee that you never actually authorised. This is Act 3 in the Creative Destruction 7 Act Play (described in Part 2, Chapter 1 of The Blockchain Economy book):
“Act 3. Denial. The changes are now real and the old guard management can see it, but they don’t know how to react so they reach for high pressure management to make the numbers work. In some cases, management also reach for creative accounting tricks to smooth out earnings and make it look as if nothing has changed (known as fraud in most circles). This Act can go on a long time as most investors work on surface numbers. A famous example of the Denial Act 3 was subprime mortgages that blew up in the Global Financial Crisis in 2008. For a long time the surface numbers looked good until a few nonconformists looked below the surface (watch The Big Short movie for an entertaining take on that story). A more recent example in Finance was the Wells Fargo fake accounts scandal (which was going on for a long time before it was uncovered). “
To understand why big Banks like Wells Fargo are under such pressure, one has to dig back to an obscure academic paper written in 1937.
Why Blockchain is the realisation of Coase’s post Corporate vision
Part 1, Chapter 14 of The Blockchain Economy book describes why Blockchain is the realisation of Coase’s post Corporate vision. Coase’s 1937 essay The Nature Of The Firm asked why hire employees instead of contracting tasks? His answer – a company exists because it is cheaper to do transactions within a company than outside. Blockchain has resurfaced this theory by dramatically reducing transaction costs.
The Internet seemed to be the realisation of Coase’s post Corporate vision. However, although Dot Com and Social Media changed our world, that change was limited to exchanging content online. The Internet was the perfect free copy copy machine. Blockchain enables us to exchange value online – where copying is not allowed (if I send you that asset I no longer have it).
This enables literally everybody on the planet to be their own bank. Satoshi’s vision of 7 billion banks (one for each person on the planet) is outrageous but not impossible.
Satoshi’s vision of 7 billion banks is the long term threat
Anybody can be their own bank. All you need is a wallet that can hold cryptocurrencies.
The Central Bank is encoded in the math (whether Deflationary for Bitcoin or mildly inflationary for Ethereum). You no longer need to trust a Central Bank and whoever guides their actions. You trust the math and the code, both of which you can verify.
Although most people won’t choose to be their own bank, it is the fact that it is possible that is such a wake-up call for big banks. This is the Napster moment. Napster proved that digital audio/video was possible. It was free and illegal. After that came cheap and legal in services such as iTunes and Spotify. Those services were only possible because the alternative of free illegal services such Napster and Kazaa was possible.
This is why a network of small banks is the imminent threat
The networked small bank is the imminent threat
SIBOS is the big annual gathering of bankers organized by SWFT. At SIBOS 2016 in Geneva I attended a session on Blockchain and correspondent banking – The way to go? This was standing room only. My observation at the time (recorded on Fintech Genome) was that:
“The problem of the current dialogue about a Blockchain replacement of today’s correspondent banking network is very simple – correspondent banks are being written out of the script. Look at the panelists and you see a) technologists and b) global banks. Both agree that the future is bright.
Elsewhere in the conference there was a lot of talk about reducing the number of Correspondent Banks in your network. The driver was Compliance. You cannot have a Correspondent Bank in your network who does not comply with the latest regulations from governments related to tax, money laundering, terrorist financing and all the other bad actors who use money alongside the good actors – and these regulations get more onerous every day.
It is fashionable to say that Correspondent Banking is dead. This conflates the current incarnation of Correspondent Banking which is batch based with the concept of Correspondent Banking itself. I am convinced that Correspondent Banking will survive the transition to real time and that SIBOS will always be key to Correspondent Banking.
The Correspondent Banking is dead meme suits the global banks. It is inconvenient for them to deal with regional banks and much simpler to have a global network that is totally under their control. The technologists will deliver that for them. Voila – a handful of global banks control global trade.
Technically this is simple – really simple. Blockchain will be like Internet – we will use it invisibly every day. TCP/IP is not rocket science (but might have been perceived that way in 1996).
If you step outside the innovation echo chamber and talk to the regional banks you can sense the discomfort. They are being forced to consider a future without themselves in that future. Yet in the real world, these regional banks are prized by their customers.
Correspondent Banking will go real time. The 9,000+ member banks of SWIFT will keep the human relationships and just switch over to a new system.
One thing preventing small banks from competing is lack of equity capital. It is much easier today to buy one mega global bank that grew by “rolling up” lots of smaller banks. That is really the only option today for investors. The gamechanger is new equity, whether from Security Tokens or traditional Equity Exchanges. That is why an unknown Community Bank filing for an IPO – Silvergate Bank – is so exciting.
Silvergate is traditional regulated bank offering services to the Blockchain Economy. It presages the future and its S-1 is data treasure trove for those seeking to understand that future.
I wrote at the start that “Banks are vertically integrated, tightly coupled, politically dependent entities”
I now want to focus on that last part about “politically dependent entities”. Banks are licensed by sovereign governments and Blockchain is inherently a stateless global network. We shall soon witness the loud bang that happens when an irresistible force meets an immovable object. Which brings us to the R word – Regulation.
Regulators typically arrive about the time that technology is doing the job for them
When 2008 happened, the regulators in America threw a complex rule book called Dodd Frank at the banks. For 10 years, the lawyers and regulators have worked through the details and now some elements seem to be up for negotiation. It has become a political football, just when technology may be making it irrelevant.
This has happened before. Regulators typically arrive about the time that technology is doing the job for them. Look at what happened in two earlier waves of technological disruption:
- IBM was being regulated just when the world was moving from mainframes to PCs.
- Microsoft was being regulated just when the world was moving from PCs to Internet.
- Today Google and Facebook are being regulated just when the world was moving against all our data being used as a tool to control us. Note: this is happening right now, which makes it a bit harder to see than the two previous waves.
The problem is that in 2008, the technological disruption was still in the mind(s) of Satoshi Nakamoto. So the regulators resorted to the only thing they knew – a complex legal document.
When the next financial crisis hits, the discussion around bailouts and regulation will be quite different.
Why Bailouts will not be possible next time.
- Populism has a political voice. The rise of extremism of both right and left is all over the globe will make it harder to bail out banks again.
- Governments are running out of firepower to pump in more liquidity. For every loan there has to be a lender and at some point lenders worry about inflation from money printing. Lack of funds will make it harder to bail out banks again.
- The disruptive alternative (Bitcoin) is now more mature and tested. People now have the tools take control over their own financial resources, regardless of what politicians say.
How Analog Scale is fundamentally different from Network Scale
Analog Scale, what most Big Banks have, is all about vertical integration, management hierarchy, secrecy and control. In short, hierarchy.
Network Scale is all about networked partnerships through APIs, online networking, knowledge networks and verifiable transparency. In short, wirearchy.
The thesis of this post is that wirearchy beats hierarchy.
Cryptoeconomics takes this wirearchy to a new level.
In October 2014, I was privileged to be at an Ethereum MeetUp in London to hear Vitalik Buterin talk about:
“Cryptoeconomic Protocols In the Context of Wider Society”
That is right. This was about as interesting to 99.999% of the population as the discussions at the Homebrew Computer Club in the 1970s when the PC revolution was starting. At the time I was more conscious of witnessing history in the making (as I recorded here) than really understanding cryptoeconomics. Today I see cryptoeconomics as an updated version of what one the greatest investor of the 20th century (Charles Munger) talked about, which is the power of aligning incentives. I knew this to be true from my years leading enterprise sales teams. What is different about cryptoeconomics is that it takes these incentives out of the closed world of the enterprise and makes them available to 7 billion people in a permissionless network.
We can already see Network Scale in the big winners in the Centralised Internet. What Vitalik Buterin was talking about in 2014 and is now making happen is Network Scale in the big winners in the decentralised Internet. As Trace Mayer puts it, this will be a once in a species level transfer of wealth.
Trading Takeaway – how to profit from this insight
Investors will start to sell/short banks & buy Bitcoin, Blockchain & Cryptocurrency. The banks will resist change and have a lot of clout, so shorting at first will only be for those banks who face traditional balance sheet problems (such as Deutsche Bank). Problems with consumer trust and regulators at banks such as Wells Fargo don’t seem to translate into stock price weakness.
That is because there is a difference between inevitable and imminent. The changes I am writing about maybe inevitable but it is really tough to figure out timing. That is why the simpler strategy is to go long Bitcoin, Blockchain & Cryptocurrency; you can hold for as long as it takes for this to play out. The Bitcoin, Blockchain & Cryptocurrency tsunami is likely to follow the usual rule of disruptive change which is is that a) it takes longer than people think and b) the change when it happens is bigger than people think.
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People who geek out on code is law and law is code (I plead “guilty as charged your honour”), will love this. Busy entrepreneurs and executives may want to jump to the practical takeaway about international arbitration clauses.
The problem today is summed in the old schoolyard dialogue:
“I am right and you are wrong”
“Yea, who says?”
“Yea, you and whose army?”
Law has to be backed up by credible force. Which is an issue when there are 195 countries, each claiming national sovereignty.
The Blockchain borderless alternative is not yet working, as we explore in the chapter of the Blockchain Economy book entitled why non state governance for bitcoin, ethereum and other cryptocurrencies is so hard. Irony aficionados enjoy the fact that about a year later after raising what at the time was record amount for an ICO to solve governance by code, Tezos collapsed into ye olde courtroom battles.
TL:DR. the legacy system is broken and the replacement system is not ready. Fortunately there is a practical hack which is international arbitration.
Treaty of Westphalia.
For historians and international jurisdiction lawyers, the Treaty of Westphalia in 1648 is the seminal event that led to the rise of the Nation State with the principle of Westphalian sovereignty. This is the principle in international law, enshrined in the United Nations Charter, that each nation state has exclusive sovereignty over its territory.
When I used to run an enterprise software company I recall the sometimes heated negotiation about which jurisdiction was used in the contract. This was not an academic debate. In a dispute, you want to be on your home turf in a language and legal system that you are familiar with. That is a tough enough conversation between two parties. What on earth do you do when the participants in a Blockchain contract maybe from hundreds of countries and the issuer maybe from an offshore jurisdiction (where there are simply not enough lawyers and judges to cope)?
Our Advisory Services are known for their combination of big picture thinking with pragmatic execution. So, enough of the big picture thinking, lets move onto the pragmatic execution. If the legacy system is broken and the replacement system is not ready, what is the practical hack? The answer is a Binding Arbitration clause.
Binding Arbitration is is a clause in a contract that requires the parties to resolve their disputes through an arbitration process, outside the courts.
It must be binding. All parties must accept the conclusion of the abitrators. If not, lawyers for one side will find a way to drive the dispute to the courts, making arbitration useless.
That means that the location for arbitration is critical.
Location for Arbitration
The location for Arbitration must meet these criteria:
- Big enough economy to have enough lawyers and expert witnesses. The disputes will be at the intersection of Blockchain technology and law and how many people understand enough of both to be part of a credible arbitration process? Offshore jurisdictions usually fail on this score. The issuer jurisdiction does NOT need to be the same as the Arbitration Location.
- A rule of law that is globally respected.
- Good airports and plenty of flights (usually goes with 1).
- English language. It is the closest we have to a global language of business (much as we may not like the cultural erosion from less use of local languages).
- A time zone that works well globally.
Switzerland, where Tezos was adjudicated, met 1,2 & 3 bit not not 4 (although, as a Brit living in Switzerland, I can attest to the fact that English is widely used for global business done within Swiss borders). The Swiss brand around neutrality does help build confidence.
5 is where UK is better than USA, Canada or Australia, but it is a less critical criterium. I am seeing more arbitration clauses set in UK, which will be a boon for UK lawyers and expert witnesses (a smidgeon of good news among all the Brexit turmoil).
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The Theme last week was Artificial Intelligence trends.
The Theme this week is China opening up its insurance market. This is actually a gradual process and now we are witnessing an upgrade from joint ventures to the approval of fully independent foreign insurers in China.
For more about the Front Page Weekly CXO Briefing, please click here.
Editors Note: Insurtech is normally Thursday. We changed to Wednesday this week because this news is big.
For this week we bring you three stories illustrating the theme of China opening up its insurance market.
Extract, read more on AXA press release:
“AXA announced today that it had entered into an agreement with the current domestic shareholders of AXA Tianping Property & Casualty Insurance Company Ltd (“AXA Tianping”) to acquire the remaining 50% stake* of the company.
Total consideration for the acquisition of the 50% stake would amount to RMB 4.6 billion (or Euro 584 million*), representing an implied 2.4x FY17 BV* multiple, of which, subject to regulatory approvals, RMB 1.5 billion (or Euro 190 million*) should be financed through a capital reduction of AXA Tianping to buy back shares from the current domestic shareholders.”
AXA Tianping was jointly founded in 2004 by AXA’s subsidiary in China and Tianping Auto Insurance. After 14 years, it has become the biggest foreign property insurance company in China. This purchase, if approved by Chinese regulators, will make AXA Tianping a fully-owned subsidiary of AXA group and help AXA move further in Chinese market.
Extract, read more on Reinsurance News:
“Insurance giant Allianz has received approval from the China Banking and Insurance Regulatory Commission for the preparatory establishment of an insurance holding company in China.
Based in Shanghai, Allianz (China) Insurance Holding Company Limited will be the country’s first ever insurance company wholly owned by a foreign insurer.”
This happened a day before the AXA news. But Allianz’s plan was approved by the regulator already. The approach is different, since AXA is achieving it through equity acquisition while Allianz is starting from scratch. But the goal is same, to make presence in Chinese market.
Extract, read more on Reuters:
“China will accept applications early next year from foreign insurers seeking to take control of their local joint ventures and is even weighing giving them full ownership earlier than flagged, people with direct knowledge of the matter said.
The regulator is expected to publish its final guidelines as soon as the first quarter of 2019 and would begin taking applications from interested foreign insurers soon after that, they said”
This article was released last Monday, and certainly it’s a signal. Our first two news proved that things are moving much faster in China.
China has already drawn its roadmap of opening up for the financial sector. Insurance industry is obviously executing the plans with efficiency and determination. I believe there are still huge potentials in Chinese insurance market and the future of insurance market in China will be shaped by Chinese and foreign insurers together.
Zarc Gin is an analyst for Warp Speed Fintech, a Fintech, especially InsurTech-focused Venture Capital based in China.
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Editors note: the question of jurisdiction is in many entrepreneurs’ minds as we read headlines such as “SEC Charges EtherDelta Founder Over ‘Unregistered Securities Exchange”. Entrepreneurs (and the incumbents thinking about how to disrupt before being disrupted) know that timing matters and that Security Tokens are coming. They also know that flying the Security Tokens plane while the plane is still being built is scary and dangerous.
A security token is issued digitally on the blockchain, backed by tangible assets such as shares in a company, real estate or rights to cash flows. Security tokens are digital assets subject to securities regulation, with compliance required in the issuer jurisdictions as well as in investor jurisdictions – from initial offering by the issuer to all secondary trades among investors. The path to issuing a security token is a long, uncertain, innovative process with advisors, lawyers, exchanges, platforms and regulators, as issuers are breaking into new regulatory territory, applying conventional securities laws to revolutionary security tokens. The regulatory situation currently is confusing because the incipient security token ecosystem is evolving. Regulators who are trying to find their way lack experience, with no model example to look to.
Editors note: in law, precedence is everything. It is very tough to be guided by precedence when everything is changing as something totally new and disruptive such as Blockchain appears.
The task of securities regulators is well known to facilitate the orderly, productive functioning of securities markets and to protect investors with fairness practices, disclosure and qualification thresholds. However, with the advent of electronic financial systems, global finance has become comprehensively regulated by laws and procedures pertaining to anti-money laundering, sanctions and anti-terrorist funding.
Editors note: some might see regulation as designed to protect consumers/retail investors. That is what it says on the tin. Some might cynically say regulators have been captured by incumbents who seek protection from disruptive new entrants (i.e. that regulation is designed to prevent innovation). Sheldon points to the concern of regulators – anti-money laundering, sanctions and anti-terrorist funding.
To appreciate the sheer comprehensiveness of this regulation, one need only remember one example – the experience of banking organization HBSC, which this writer represented as counsel. Originally known in 1865 as “The Hongkong and Shanghai Bank”, HSBC Holdings plc is today the largest bank in Europe, a global roll-up of banks headquartered in London. Operating out of 3,900 offices in 67 countries, HBSC is the world’s 17th-largest public company, with the Americas, Asia Pacific and Europe each representing approximately one-third of its business. HSBC is the largest bank in Hong Kong and prints most of Hong Kong’s local currency in its own name. HSBC has frequently been named the world’s most valuable banking brand by industry rankers.
In the early 2000’s, as HBSC and other major institutions embarked on sprees of acquisitions of valuable global banking businesses, compliance with the relatively new anti-money laundering laws was not primarily on the minds of acquirers, who were in fact acquiring regulatory liabilities with businesses they were acquiring. In 2012 HSBC was the subject of anti-money laundering enforcement hearings in the United States Senate Permanent Subcommittee on Investigations. HBSC was investigated for deficiencies in its anti-money laundering practices, which gave HBSC a permanent hangover from years of acquisition partying. The Senate subcommittee found HSBC had transferred $7 billion in drug crime-related funds from its Mexican to its US subsidiary, was disregarding terrorist financing links and was circumventing U.S. safeguards to block transactions involving terrorists, drug lords and rogue regimes. In one instance, “two HSBC affiliates sent nearly 25,000 transactions involving $19.4 billion through HBSC’s U.S. affiliate accounts without disclosing the transactions’ links to Iran. The Justice Department charged, “HBSC officials repeatedly ignored internal warnings that its monitoring systems were inadequate”, exposing the U.S. financial system to “a wide array of money laundering, drug trafficking, and terrorist financing.”
The Senate subcommittee also found HBSC provided financing and services to banks in Saudi Arabia and Bangladesh that were tied to terrorist organizations, while also clearing $290 million in “obviously suspicious travelers cheques” that benefitted Russians “who claimed to be in the used car business.”
Furthermore, the investigation showed how the bank’s regulator, the Office of the Comptroller of the Currency (OCC) failed to take a single enforcement action against HSBC despite numerous violations by the international bank. Among them, failing to monitor $60 trillion in wire transfer and account activity, a backlog of 17,000 unreviewed account alerts regarding potentially suspicious activity, and a failure to conduct anti-money laundering due diligence before opening accounts for HSBC affiliates.
Editor’s note: incumbents, thinking about how to disrupt before being disrupted, are even more nervous than entrepreneurs about falling foul of regulators. Banks are licensed by governments. Having that license taken away is an existential threat.
Dozens of countries now adhere to their own anti-money laundering directives, and are additionally obligated by muscular international instruments and standards deploying sophisticated IT systems for anti-money laundering data collection and analysis, such as United Nations conventions against narcotic drug trafficking, organized crime and corruption, and FATF (the Financial Action Task Force on Money Laundering) formed by the G7 countries.
Editors note: in an era of increasing protectionism and nationalism, expect these regulators to get tougher. I will carbon date myself by saying I have an old passport, pre-Thatcher era, which has a stamp in it saying that I was approved by the Bank of England to take GBP50 out of the country. That story won’t sound so strange to our subscribers in China or India or other countries with exchange controls.
Security tokens and blockchain technology, with their opaque digital representations, high speed of transacting and decentralized record-keeping, present fierce challenges to anti-money laundering, anti-terrorist financing and economic sanctions efforts, demanding even higher standards of regulation than conventional securities.
Due to the stigma that has attached to a stampede of low quality ICOs to date (most ICOs have been cryptocurrencies), there is an apparent emerging convention to term the issuance of security tokens “STOs” to distinguish issuances of security tokens from issuances of cryptocurrencies and utility tokens.
Jurisdictions regulate STOs under their existing securities regimes, which are not sufficiently comprehensive or evolved to provide clarity to issuers, investors and regulators. Innovation and improvisation are now the domain of intrepid issuers aiming to fashion a regulatory path with regulators, or to stealthily rely on existing exemptions. Prof. Bhaskar Krishnamachari of the University of Southern California observes: “We are flying an airplane while we are still building it”.
Editors note: entrepreneurs seeking to seize the day with early-mover advantage want to know whether the plane lacks seat-back entertainment (boring but safe) or lacks hydraulics (will crash unless pilot is really good and a bit lucky). The short answer is a) all startups have risk b) get good navigators to minimise that risk.
The US Securities and Exchange Commission (SEC), recognized global leader in securities regulation, has not offered anything regarding security tokens. Security token issuers are attempting to effect conventional registrations with the SEC or to rely on Reg D exemptions and new crowdfunding provisions. It is not surprising the SEC has been slow to act. A large organization with six independent divisions and 25 offices, sharing financial regulation with several other US agencies (CFTC, FINCEN, IRS, state regulators, etc), the SEC simply has not yet addressed security token offering regulation. However, the SEC recently announced on October 18 the establishment of The FinHub, the SEC’s Strategic Hub for Innovation and Financial Technology tasked to address new distributed ledger-enabled securities. The FinHub replaces and builds on the work of several internal SEC working groups and is intended to serve as a resource for public engagement on the SEC’s FinTech-related issues and initiatives, including STOs.
The FinHub will be staffed by top industry experts, led by Valerie A. Szczepanik, Senior Advisor for Digital Assets and Innovation and Associate Director in the SEC’s Division of Corporation Finance.
The current situation is confusing and the ecosystem itself is evolving. Jurisdictions are trying to find their way, while there is no example to look to.
A small number of STOs are taking place in USA, such as:
- Indiegogo – shares in Colorado resort (Aspen Coin)
- Spin – electric scooter offering 125 million for investors to share in revenue
- Blackmoon Financial Group -security token which tracks its lending fund
In the EU, similar to USA, STO issuers are seeking registrations and relying on conventional exemptions. In the EU, exemption may be available for offerings of less than 1mm Euro per year, offerings to less than 150 people per member state, and to qualified sophisticated investors.
A UK example of a current STO is The Elephant (tokenized private equity platform).
A small number of STO’s are taking place in light-touch regulatory jurisdictions, such as Switzerland and Singapore, but these are smaller markets and their rules are not widely accepted by major countries. Examples of STOs being carried out in Switzerland:
- SwissRealCoin – Switzerland’s first real estate coin
- Nexo – fiat loans
- Lykke – offering security tokens representing equity in Lykke (which is building a financial asset marketplace)
An STO example in Germany is Brille 24 (eyewear).
An STO example in Lithuania is security tokens representing equity in Desico (which is building a financial asset marketplace)
Surprisingly absent in security tokens is South Korea. Despite being innovators in so many areas of blockchain, South Korean regulators currently seem more focused cracking down on bad ICOs than enabling compliant STOs.
Editor’s note: the Etherum ICO in 2014 was the Napster moment for the Securities business. Napster was free and illegal. Then in 2017, entrepreneurs went for the ICO gold rush, using the Ethereum platform. Like with Napster, the regulators cracked down. But market demand finds a way to leverage disruptive technology. The STO market awaits something like iTunes or Spotify – cheap (not free) and legal. It hears the music and wants to buy it.
Bernard Lunn is a Fintech deal-maker, investor, entrepreneur and advisor. He is the author of The Blockchain Economy and CEO of Daily Fintech.
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It was my name day on September 20th – a significant day for a Greek Orthodox – but I was by no means going to miss the “Blockchain: Building Trust in Society” event with Dimitrios Psarrakis, a Greek leading specialist in European regulatory policy. This was the first event in PwC Switzerland’s joint thought leadership series with the blockchain hub Trust Square. I was not disappointed; on the contrary, both the speech, the panel discussion with Daniel Gasteiger, Founder, Trust Square & Founder, Procivis, Doris Fiala, Chairwoman, Swiss Control/Parliamentary Oversight Committee & President, Swiss FDP Liberals Women, Guenther Dobrauz, Dimitrios Psarrakis; and the party; were unique.
Greeks built the principles of Democracy. Eva Kaili, is the Greek EU parliamentarian that is leading a team with a mission to raise awareness in the European Parliament on the revolutionary potential of Blockchain and how to grab the opportunity to lead in the 4th industrial revolution with relevant and powerful policies.
At the opening of his speech, Dimitrios Psarrakis, spoke about their team work in the EU parliament to educate, raise awareness and understanding about blockchain. They slowly but surely managed to obtain nearly 750 votes in the parliament for the Blockchain Resolution, a long and detailed policy for the EU which is based on the principle that Blockchain holds the potential to build Trust in our society in a different and better way, at many levels.
Driven by the fact that the internet has been a technological development that has undoubtedly created more convenience and connectivity, but has fallen short in creating more fairness and trust; Blockchain presents an opportunity to build trust and fairness in a very different way.
Driven by the belief that Blockchain will restructure several sectors: energy, healthcare, capital markets, Intellectual property etc.; the EU wants to mobilize capital to fund this revolution – the 4th industrial revolution.
The Blockchain Resolution includes several articles and aims to be fully in place in 2019. It has no intention to regulate any instruments – like coins, tokens etc-. It will only regulate the use of them on the newly created platforms. The Blockchain Resolution sees these new digital assets as legitimate instruments and does not attempt to categorize them as securities or commodities. The Blockchain Resolution sees them as alternative investments or contractual arrangements. Therefore, applying the Regulation in the EU for alternative investments, which is fairly flexible, is appropriate. The due diligence process on the platforms should be similar to the due diligence process in crowdfunding.
In Europe there is no consensus on the definition of a Security. Europe has MIFID, without a standard definition of a Security.
The Blockchain Resolution sees digital assets as alternative investments and the regulatory framework that applies is fairly flexible. Europe, through the Blockchain Resolution, wants to create policies that will mobilize capital to fund the next wave of restructuring the way several markets / sectors function.
The view of the EU is to present regulatory principles that are Technology neutral, Business-model neutral, and pro-Innovation.
The main principle is to allow for Disintermediation Economics that build Trust. Such economics promise to (a) reduce transaction costs and create new efficiencies, (b) reduce operational frictions by increasing liquidity, (c) automate monitoring processes with limited informational asymmetries (e.g. agency frictions, moral hazard, adverse selection).
The Blockchain Resolution is brave enough to look into the promise of Blockchain for Public infrastructure. The view is to restructure (a) traditional public services like land registries, licenses, certificates etc. (b) ways to reduce tax evasion and fraud, (c) cross-border transactions, regulatory reporting, data transactions between European citizens via smart contracts.
The Blockchain Resolution just got support from the Strasbourg Plenary.
“Blockchain has united this House, as all the parties in the Committee on Industry, Research and Energy (ITRE) voted in favor of the resolution under the principle of being technology neutral and innovation-friendly in Europe.” “One of the core messages of our text was to signify that the European Union aspires to become the global leader in the fourth industrial revolution,” said Eva Kaili.
The European Commission will be next in November at the European Parliament Blockchain event. This will be followed by the Blockchain and international Trade Report. In December, the Crowdfunding Regulation will be updated.
Some of the recommendations that the resolution makes are:
- For member States to establish non-profit “innovation hubs” to promote research, education and training among their citizens
- For the Commission and ECB to identify dangers for the public and incorporate cryptocurrencies into the European payment system.
- To develop technical standards for Distributed Ledger Technologies
- Conduct a clear analysis of legal enforceability of smart contracts among EU member States
- Decentralize the storage of EU citizens’ data in preventing the misuse of data
- Decentralize infrastructure to ensure no monopolies are held, for instance the storage of nodes and servers
- Use blockchain for tracking EU funding to achieve greater accountability
- Evaluate blockchain-based e-voting systems as a use case for the EU
- The creation of funding opportunities from the EIB, EIF and EFSI 2.0
- The creation of an Observatory for the Monitoring of ICOs and clarification of utility tokens and security tokens as unique asset classes
- For any regulations on blockchain to remove barriers and founded on principles of technology neutral and business model-neutral
In Q1 2019, the Blockchain Resolution will be seen and hopefully adopted by ESMA. Europe is leading the way.
We live a world in which Trust is lacking, Trust is being re-defined, Trust has to be re-built.