Make no mistake, Bitcoin, its forks, and Altcoin cousins are very volatile assets. I reluctantly call them assets because traditional currencies rarely fluctuate 40% in either direction on a daily basis. However, these wild swings also provide an opportunity for great capital appreciation – and losses. The lure is that just about anyone can make money in this market if they are aware of the risks involved, know to trade in volatile asset classes (straddle or strangle anyone?), and don't mind being prepared to lose all capital at risk.
Over the past year, cryptocurrency has come out of the shadows and into the limelight. It is now more accessible, with market makers, such as Coinbase, allowing people to trade in “satoshis” or fractions of crypto assets thereby making buying them accessible to anyone willing to invest $100.00.
ICOs – or Initial Coin Offerings – are another innovation born out of the increasing popularity of cryptocurrencies and the utility of the underlying blockchain technology that makes it all happen. ICOs are very similar to IPOs except for the utility and cryptocurrency that is sold. This factor makes ICOs more versatile than traditional stock offerings. In 2018, ICOs will continue to grow and we are bound to see some never-before-seen business models and use cases for smart contracts in what some predict could disrupt the traditional business model.
I recently had the opportunity to interview via email Jeff Bandman, the former acting Director for the Clearing & Risk Division at the Commodity Futures Trading Commission (CFTC) to provide some insights into the crypto market.
Q: Tell us a little bit about your background and your company.
A: I am Founder and Principal of Bandman Advisors, a strategic advisory practice focused on helping financial services clients, ranging from start-ups to global firms, meet innovation and regulatory strategy challenges. I am the FinTech regulation mentor for the Techstars Barclays FinTech Accelerator in New York. I’m also a member of the Blockchain for Algorithmic Regulation and Compliance (BARAC) initiative at University College London's Centre for Blockchain Technologies. I’m doing a lot of work on crypto, FinTech and RegTech with a focus on the US, UK and EU. I’ve been spending a lot of time lately looking into custody of digital assets.
Q: Tell us your thoughts on the current regulatory environment for cryptocurrencies and ICOs. Was this something you had direct oversight of while at the CFTC?
A: I think the current regulatory environment is on an arc toward greater legal certainty. Initial Coin Offerings are quite a new phenomenon – and to put it in context, it is the third in a series of enormous interconnected innovations in a few short years First, the rise of Bitcoin and other cryptocurrencies; Second, the emergence of blockchain and distributed ledger technology; And most recently ICOs and token sales, with huge implications for investment and capital formation, for democratizing access of retail investors to new and innovative businesses, and opportunities to incentivize and monetize ideas at an early stage of development, through funding of so-called “utility tokens”. In 2017, as of mid-October, there have been over 250 of these ICOs, raising over $2.25 billion. These numbers are also continuing to rise.
I believe the SEC is taking effective measures to balance its responsibilities to protect investors while allowing new technologies to develop. The SEC’s 21A Report of Investigation, issued in July 2017, provided a crystal-clear analysis of the issuance of the so-called DAO tokens in 2016. It made clear that the Howey test applied, looking at substance rather than form. I view that report as a “Digital Marbury versus Madison”. By that I mean it is a true landmark in its sphere, in clarifying the SEC’s jurisdiction in this space, just as that early U.S. Supreme Court case was a landmark in establishing the Court’s jurisdictional power of judicial review. And like Marbury versus Madison, it neatly established the principle without the cloudiness of further litigation or enforcement action in the particular case. It put the market on notice that these tokens can be securities, but did so without a blanket or extreme approach that some jurisdictions have applied in banning all ICOs. The SEC has taken a balanced approach, providing a clear line of demarcation while recognizing that one size does not fit all. A one size fits all approach would stifle innovation. The July DAO Report was extremely well-received by the market as setting forth a clear dividing line and promoting greater legal certainty. And the SEC has taken further steps, with the creation of a cyber task force and the announcement of its first enforcement actions against ICO fraudsters and investor warnings. I believe the markets are welcoming and adapting to greater legal certainty accompanied by robust enforcement.
Q: Any other trends of note in the marketplace? Lawsuits you think will serve as precedents in the space?
A: What's happening with Ripple and R3 and with Tezos are both pretty interesting.
I also see really interesting trends regarding VCs and ICOs, particularly around my recent trip to the West Coast to lead a regulatory workshop for blockchain innovators who are considering launching an ICO at the EtherealSF Summit organized by ConsenSys. These VCs have been preaching disruption for years in the context of their startups - but now THEY are getting disrupted due to ICOs, and many of them do not seem to like it. While some have adapted, and you see VCs as lead investors or participating in and getting large allotments in token pre-sales, others seem disturbed that they are no longer the exclusive gateway to funding and then rationing funds to these entrepreneurs. But ICOs enable entrepreneurs and innovators to bypass traditional channels of funding.
Q: Anything you'd like to say to crypto skeptics including central banks outlawing participation in ICOs? Are their voices falling on legacy ears?
A: I am seeing enormous open mindedness from central bankers. Leaders like Bank of England and Bank of Canada have studied feasibility of using blockchain for next generation real time gross settlement systems. From my work on international regulator working groups and chairing the work stream I mentioned earlier, I know they are seeking to better understand implications of digital currency, and issues like finality of settlement and how to achieve delivery versus payment for digital assets. There is also work underway regarding a potential “utility settlement coin” driven by private banks but which would involve accounts are central banks.
Q: People question Bitcoin’s (BTC) ability to be a currency given its volatility. Blankfein recently stated that currencies don't swing more than 20% on any given day. Would you agree with this assessment?
A: I think the jury is still out on whether BTC or others will be able to function like a currency. Right now, transaction fees on the BTC network are too high for many types of use. I do not think BTC will stay this volatile forever. Other cryptocurrencies may emerge - and may not have even been established yet - that could function more effectively.
Q: Do you see BTC and its cousins as assets more than currency?
A: BTC appears to be viewed more as an asset or store of value. I think there is room as the digital economy evolves for a small number of widely adopted currencies with different functions - for example, one as a store of value, and another as a currency or medium of exchange to be used on digital network. For example, Ethereum calls this gas in the tank.
Q: Were you expecting more short selling of the bitcoin future, or greater usage of the bitcoin futures from CME and CBOE?
I think two factors prevented that.
First, the mechanics of the market - the cost of accessing the market and funding a short position, including Initial margin and variation margin charges arising from the exchange clearing houses plus potential additional add-ons from the FCMs.
Second, I think a lot of players are watching to see if the first settlement cycle in January can operate smoothly, or will be disrupted in some way.
Q: A great deal of volume on BTC (up to December 2017) has come from Japan and South Korea. Do you expect this to change and, if so, when?
A: I think more US investors will come in. Many are going through an education process now, both as a result of all the attention to the run up in BTC price and the launch of a regulated futures market. This is still a retail-driven market. It is also possible that other regulated products like ETFs and ETNs will become available to investors in the US, and they may prefer these types of channels to direct ownership.
Sara Corcoran is publisher of the National Courts Monitor website, “Your Daily Ration of Civil Justice Rationing,” and a frequent commentator on national legal policy and civil courts issues.