BLOCKCHAIN HIGHLIGHTS FROM 2ND HALF OF 2020: CRYPTO BANKS, SAND DOLLARS AND DEFI

Writer: Kirk Phillips, CPA, CMA, CFE, CBP

The lightning fast pace of innovation is the one constant in the blockchain and crypto asset space. Developer talent is in short supply and blockchain career demand is jumping to the front of the pack. There is no global stakeholder left who is not aware of and considering blockchain tech in some capacity. Regulators, central banks, financial institutions, big fintech and a host of others are weighing in and getting into the game. This has been the theme in 2019 and 2020, but the pace is accelerating, and competition is heating up. We are still in the early days and enterprises should focus on taking advantage of this once in a lifetime opportunity. There have been 4 major story lines in the latter half of 2020 which frame the global trajectory heading into 2021.

Banks and Crypto Assets

In July 2020, the US Office of the Comptroller of the Currency (OCC), an independent bureau of the US Treasury Department, stated federal banks can provide custody services to their cryptocurrency customers. The OCC stated, “In the letter published today, the OCC concludes that providing cryptocurrency custody services, including holding unique cryptographic keys associated with cryptocurrency, is a modern form of traditional bank activities related to custody services.” This was big news in the blockchain space considering banks continue to be risk averse towards opening bank accounts for crypto related businesses. The OCC news could be the first nudge helping to dissolve some of the risk aversion. US banks already offer financial services, so it is only a matter of time before crypto assets are woven into the wider service offering.

The Kraken Bank

Kraken is the first crypto exchange to become a US bank in September 2020. This milestone marks the moment where the new and old financial paradigms come together in a single platform. The seemingly soft-spoken yet highly progressive and innovative US state of Wyoming made this possible. It is not a surprise to those already familiar with Wyoming who invented the widely used Limited Liability Company (LLC) in 1977. Wyoming is the smallest populated state in the US with less than a million residents. This equates to a nimble legislature which is capable of creating blockchain friendly laws ultimately bringing in more revenue to the state.

The Special Purpose Depository Institution (SPDI) statute was one of the blockchain bills passed into law allowing Kraken to become a US bank, but not just any bank. CoinDesk reported, “SPDI banks can hold digital assets but will never have legal ownership over those assets. This means that even if a SPDI bank goes bankrupt, those assets have to be returned to customers, whereas a trust company can have its assets claimed by a judge during bankruptcy.” Caitlin Long, an expert in bitcoin and blockchain technology, also helped pioneer this groundbreaking legislation.

The Sand Dollar

The Central Bank of The Bahamas launched the Sand Dollar in October 2020, the world’s first central bank digital currency (CBDC). Several central banks have been working on and eventually expect to launch a CBDC in the near future. Sand Dollar payments are made by eWallet apps on mobile phones which a majority of Bahamian residents already have. Cointelegraph reported, “Each Sand Dollar is pegged to the Bahamian dollar, which is in turn pegged to the US dollar. The Sand Dollar is intended to drive greater financial inclusion within the archipelago nation of more than 700 islands, about 30 of which are inhabited.” The Bahamas’ small nation status combined with a compelling need to create a better financial infrastructure was the right recipe for being first to market. The Sand Dollar is now a catalyst for accelerating other CBDC projects as the milestone has been crossed and other central banks do not want to get left behind.

The Yield Farming Craze

Meanwhile, on the other end of the blockchain and crypto asset spectrum, decentralized finance projects (DeFi) attracted staggering amounts of capital from June to September of 2020, highlighting the greed and exuberance of human nature. Many DeFi platforms reward liquidity providers in the form of a native token and/or interest-like payments in other crypto assets by using smart contracts to “program the money”. Those native tokens were traded up to sky high values, thus reinforcing the greed. This is known as “yield farming” and savvy farmers could make unsustainable triple digit returns in some cases. Aggregator platforms emerged allowing users to maximize returns across various DeFi projects further exacerbating the craze. Open source copycats, like Swerve Finance, surfaced overnight collecting $600 million of assets in one week. Profit seeking yield farmers would simply bounce around from DeFi platform to the next draining assets just as fast as they added them. Even though DeFi has since settled down, it will no doubt replace a large chunk of centralized traditional finance while using stablecoins and CBDCs alongside other crypto assets.

Crypto platforms are morphing into banks and banks are morphing into crypto platforms. The examples above happened in the US, but the narrative will continue around the globe. Whether these services look the same at the end of the metamorphosis is an open question. The more CBDCs get rolled out by central banks the faster the overall adoption of blockchain and crypto assets. All asset types will eventually be tokenized among hundreds of blockchains including real estate and securities. Even a CBDC is simply a tokenized version of central bank fiat currency. Remember, not all blockchains are the same and the age of DeFi has forced the term CeFi to distinguish the difference between decentralized finance and centralized finance. The benefit is a potential unlimited range of financial products coupled with a new realm of risk that did not previously exist. Both businesses and consumers get to choose which model they prefer rather than the more limited choices of legacy finance.