One of the main criticisms of cryptocurrencies is their volatility, which makes them difficult to use in everyday life. However, fiat currencies such as the Swiss franc suffer from a long-term problem that harms the national economies in various ways and would make the currency non-viable in a free market. This article takes a closer look at the behavior of the Swiss central bank in recent decades in regard to this topic.
Historically, the Swiss franc was a safe haven currency, but not anymore. Now, they are barely better than euros and U.S. dollars. Central banks, including the SNB, are mandated by the laws of their countries to keep the value of their currency “stable”. This is because currencies that are volatile are not good units of account. Countries that rely on unstable currencies have lower economic growth, and eventually, companies and individuals switch to other currencies, because people lose trust in the currency.
A financial crisis of trust or confidence occurs when people lose trust in a currency’s purchasing power. When people stop demanding a currency and switch to another currency, the currency’s purchasing power depreciates. If central banks continue to print during this time, a hyperinflation can occur.
As Philipp Bagus and David Howden pointed out in the paper, “Central Bank Balance Sheet Analysis”, the two main factors that contribute to people’s perceptions of a currency’s purchasing power are the quantity and quality of the reserves backing the asset. Like any bank, the SNB has a balance sheet. The SNB balance sheet has two sides: assets and liabilities.
Assets are what the SNB buys including foreign currency and gold for its reserves, and the debt of commercial and state-owned banks.
Liabilities are what the SNB uses to pay for the assets including notes and coins in circulation that it can “issue” or “print”, money that commercial and state-owned banks are required to keep on deposits at the central bank, money that government entities hold at the central bank, money that international organizations like the IMF hold there, debt obligations like certificates of deposits and so forth.
The stability of the currency is measured by domestic price inflation. A national currency is considered stable when there is less than 2% inflation per year. However, real stability is when and the real price (not nominal) of goods and services is stable over time. A national currency is considered unstable when the real price of goods and services is always changing. Another indicator of currency stability is its exchange rate against a major currency, for example, the US dollar or Euro. However, this indicator is not trustworthy when there is not a free market in central banking. Central banks around the world have been heavily devaluing their currencies in unison for the past fifty years. Therefore, exchange rates have been substantially more stable than they would have been otherwise despite enormous increases in the costs of goods and services in real terms. In 2000, the high of the USD and CHF exchange rate was at 1.8 CHF per USD. The dollar lost almost half of its value against the Swiss Franc in the past twenty years.
If the central bank buys securities from UBS, they create money out of thin air and credit UBS account that is held at the central bank. The newly created money shows up as a liability on the SNB’s balance sheet and it is offset with the securities they purchased from UBS.
If the central bank deposits low quality assets as backing for the newly issued money, then traders expect that currency’s exchange rate will decrease. This means that that the currency will depreciate or trade at a discount to other currencies with better quality reserves.
Every year, the SNB publishes its annual report in which it discloses its assets and liabilities. The SNB balance sheet for the last 13 years – compiled from its annual reports and scaled by the country’s nominal GDP as calculated by the Swiss Federal Statistical Office – is summarized in the chart below. For illustrative purposes, assets are presented as positive numbers (a “purchase”) and liabilities as negative numbers (a “payment”).
Figure 1: SNB Assets and Liabilities as a Percentage of Swiss GDP (2007 – 2019)
From the chart, we can see that the assets and liabilities of the SNB expanded in response to the crisis beyond Switzerland’s annual GDP. Prior to the crisis, the SNB’s balance sheet was the same size as 20% of Switzerland’s annual production. The balance sheet has swelled by a multiple of six and is now greater that Switzerland’s total annual production. Although the balance sheet’s assets have increased, looks can be deceiving. The quality of the assets on the balance sheet have decreased. Instead of relying on AAA-rated bonds, the central bank has increasingly purchased risky AA-rated bonds, A-rated bonds, and overpriced equities.
Figure 2: SNB Assets and Liabilities as a Percentage of Swiss GDP (2007 – 2019)
Source: SNB, CryptoResearch.Report
Although a central bank is mandated to keep inflation low and steady, the central bank is also supposed to support economic growth. Although, central banks are supposedly independent from politicians, they often succumb to political pressure to inject money into the economy in order to keep people optimistic and happy with the politicians in office. As Former Chief Economist of the U.S. Commodities Futures Trading Commission so succinctly puts it, central banks are tasked with squaring a circle,
“On the one hand, a central bank needs to create more money, channel it to the commercial banks, and “encourage” the banks to lend it to companies. But companies need to earn enough to pay interest and taxes, so they have to raise prices at least somewhat, which will show up as inflation and make the central bank reduce the amount of money that goes to the banks and so on.”1
Figure 3: Growth of SNB Foreign Currency Investments 2010 through 2019
Source: SNB, RealUnit AG Schweiz
The SNB’s balance sheet consists of currencies that are issued by highly indebted countries that are systematically losing value each year due to inflation, and the SNB has been heavily printing money since the 2008 banking crisis in order to keep the economy humming along. However, this is not sustainable. The stock, debt, and housing markets have absorbed large portions of the newly printed cash increasing the inequality gap between capital holders and non-capital laborers.
The problems that the Swiss franc is facing are not a peculiarity of the franc, but something that can be observed with all other major national currencies. It can therefore be said that although the Swiss franc would probably not survive in a free market, he wouldn’t be alone in this.
On June 23th, the newest edition of the quarterly “Crypto Research Report” was published. Endorsed by Bitpanda and Coinfinity, the tenth report includes an in-depth analysis of Irving Fisher’s Equation of Exchange model, Tether’s risk to Bitcoin’s price, and an Exclusive interview with the team behind MimbleWimbleCoin. Since the last edition of the Crypto Research Report published on February 10th, Gold is up 10.6% and Bitcoin is down 5.91%.
The Crypto Research Report can be downloaded from the following links:
In three chapters and more than 60 pages, the authors provide a critical and academic perspective on the legal, technical, and economic aspects of cryptoassets. Key topics covered in the report:
• Modeling Bitcoin’s Price with the Equation of Exchange. The target addressable market for crypto assets is approximately $212 trillion. The largest use cases include medium of exchange, which includes all global fiat currencies worth $126 trillion, and consumer loans with a global value of $42 trillion. If Bitcoin penetrated 10% of this market over the next ten years, each Bitcoin would be worth $397,000 by the end of 2030. • Is Tether a Catastrophic Risk for Bitcoin? This guest article by Schlossberg&Co’s Pascal Hügli investigates if Tether is really being used to manipulate the price of Bitcoin or not. Since the beginning of this year, $5 billion worth of Tether USDT has been issued. If the new Tether is not fully backed, and if Tether eventually collapses, this will most likely bring down at least one exchange and wreak havoc on the price of Bitcoin. • Exclusive Interview with the Team behind MimbleWimbleCoin. MimbleWimbleCoin is a new privacy-based coin that was airdropped to Bitcoin holders for free in December. Since December, the price has soared 6000%, and the authors argue that their token economics are superior to the privacy coin Grin, and that they are more scalable than Monero.
Figure 1: Federal Reserve Assets Almost Double and Dollar Index Stays Flat
Source: St. Louis Federal Reserve FRED, Yahoo Finance, CryptoResearch.Report
For the first time in Bitcoin’s young life, the global economy briefly plunged into recession. Covid-19 resulted in 40 million Americans unemployed representing an unemployment rate of 15%. In Austria, there are 571,477 unemployed (12%). In Germany, 2.639 million (5.8%).
Despite having an entire quarter’s GDP erased from 2020, hedge fund managers are all singing the slogan, “All Time High by the Fourth of July”. What this slogan means is that the S&P 500 is expected to hit a new all-time high by July. Although, this sounds unbelievable, central banks around the world have the power to make this happen, and so far, they seem to be doing everything they can to weaken their currencies and artificially prop up asset prices.
Despite unprecedented quantitative easing, trillions of short-term credits to the repurchase agreement market, and lowering interest rates to zero, the US dollar index (DXY) barely moved. This means that the dollar can take a lot more abuse from the printing machines before it starts to devalue against other fiat currencies. Also, the 5-year forward inflation expectation for the US dollar is sitting at a low 1.43%.
Traditional markets are no longer reflecting the state of the economy. Instead, they are reflecting the central bank’s effort to keep the pension system alive and to get Trump reelected. Unfortunately, there is no turning back now. Every hiccup in the economy needs to be met with even greater inflation, leading to an even wider gap between reality and finance.
And where was Bitcoin during all of this? From $3,600 in March to $10,000 in May and then back down again to $9K, the ride on the Bitcoin rollercoaster has made some nauseous and some rich. Many cryptocurrency companies are in dire shape due to the shut-down and lack of customers, but Bitcoin hodlers just keep holding on in hopes of a post-halvening bull market. So far, the halvening has been a non-event. Bitcoiners around the world joined in on Zoom webinars to celebrate Bitcoin’s special day, but the Bitcoin price hardly budged. The uncertainty surrounding the economy has definitely put a damper on the crypto market. However, there is still hope yet. As governments around the world wage currency wars to protect their export markets and inflate away their burdensome debt, some households may turn to Plan B.
We are happy to announce that the Crypto Research Report has struck a strategic partnership with CoinTelegraph, the largest crypto news company in the world. The September edition of the Crypto Research Report will be distributed by CoinTelegraph on their website, which gets 6 million views a month. The goal of the joint effort is to publish the results of a landmark study on institutional demand for crypto assets in the German-speaking countries. This study is being conducted by Professor Dr. Philipp Sandner from the Frankfurt School of Finance and Management, Professor Dr. Alfred Taudes from the Vienna University of Economics and Business (WU), and the editor of the Crypto Research Report, Demelza Hays.
This edition of the Crypto Research Report is especially thankful to the Crypto Research Report’s Premium Partners, Coinfinity in Graz and Bitpanda Pro. Coinfinity is a broker in Austria that is famous for creating an easy to use Bitcoin cold wallet called The Card Wallet. Coinfinity also enabled Bitcoin purchases at 4.000 retail outlets across Austria via the Bitcoinbon program. In addition to Coinfinity, we are exuberant that Bitpanda has joined as a Premium Partner of the Crypto Research Report! Bitpanda is a fully licensed exchange based in Austria. They have recently added Bitpanda Pro, which offers more liquidity and lower fees. We are personally excited about Bitpanda Metals, which allows investors to diversify their portfolio with physically backed and 100% insured precious metals.
Bitcoin, the most valuable and widely-used cryptocurrency, has catalyzed an explosion of innovation, disrupting a broad spectrum of markets across hundreds of different industries around the world. The king of crypto, however is not without flaws — issues that many alternative cryptocurrencies attempt to address, the most visible of which is Bitcoin Cash.
What is the difference between Bitcoin and Bitcoin Cash, though, and why does it matter?
In this post, We’ll break down the fundamental differences between BTC and BCH.
How Bitcoin Works
In order to understand the difference between Bitcoin and Bitcoin Cash, it’s necessary to first develop an understanding of Bitcoin and how it works.
The release of the Bitcoin white paper on 31 October 2008 by Satoshi Nakamoto was a game-changer for the world of digital currency. The idea of digital currencies can be traced back to as early as David Chaum’s ideation of “eCash” in 1983, which was first implemented in 1995 as “Digicash.” Several other digital currencies were launched before the release of Nakamoto’s white paper, but all of them suffered from the same problem — double spending.
The Double Spend Problem
The “double spend problem” relates to the digital nature of digital currencies — at a fundamental level, these currencies are just digital files. In order to ensure a digital currency has value, the system upon which it operates must ensure that the files that the currencies consist of cannot be copied in the same way a regular file on any given computer can be copied.
The solution to the double spend problem was first published by Nakamoto in the “Bitcoin: A Peer-to-Peer Electronic Cash System” white paper. The Bitcoin system uses a distributed encrypted ledger spread across all network participants, leveraging a Proof of Work system first ideated in 1999 by Markus Jakobsson and Ari Juels.
Nakamoto’s’ solution to the double spend problem draws from previous digital currency research much in the same way that Albert Einstein drew upon the works of Lorentz and Poincaré in the composition of his theories of special relativity and general relativity, but is the first solution to wholly solve the double spend problem.
The Importance of Blocks
A key feature of Satoshi Nakamoto’s Bitcoin solution is the implementation of the blockchain — the Bitcoin network uses Proof of Work to keep network participants honest, and writes transactions to an ongoing chain of encrypted blocks. These blocks ensure that the ledger which keeps track of all balances cannot be changed retroactively — transactions from a given period are encoded into an immutable block, with the encryption process incorporating the output of the previous block in order to make retroactive artificial block creation functionally impossible.
This architecture solves the double spending problem, but presents an important question, one that catalyzed the creation of Bitcoin Cash — how big should blocks be?
The Block Size Debate
Each transaction that occurs on the Bitcoin network takes up a specific amount of size. Depending on the complexity of the transaction, the size of an individual Bitcoin transaction can typically range between 250 and 600 bytes of data.
In the early days before the launch of the Bitcoin network, there was no limit to the size of a block. In 2010, however, Nakamoto — who was still actively interacting with the Bitcoin community and publicly contributing to Bitcoin code — implemented a 1 MB block size restriction, hardcoding it into the architecture of the Bitcoin network.
This hardcoded limit was implemented for a number of reasons. Early Bitcoin developers cited the unforeseen development of pool mining, the creation of dedicated mining hardware, and an evolving fee market as reasons for the implementation. Satoshi, apparently realizing that there would need to be a maximum block size in order to prevent the creation of blocks larger than miners would accept, implemented the 1 MB Bitcoin block size limit in late 2010.
The Impact of Block Size Limits
The Bitcoin network collects transactions into batches that are encrypted into blocks every ten minutes. Limiting block size therefore limits the total amount of transactions that can be processed in that time period — at an average of roughly 500 bytes per transaction, the Bitcoin network can process a little over 2,000 transactions per block.
This restriction limits the Bitcoin network to a transaction throughput speed of around 7 transactions per second, which is not sufficient for large scale payment networks — the VISA network, for example, is capable of processing 24,000 transactions per second.
With Bitcoin increasing in popularity and value, the impact of block size restrictions on transaction throughput sparked a debate in the cryptocurrency community, with many community members calling for an increase in block size limits in order to expand the transaction throughput capacity of the network.
The core problem with block size expansion highlighted by opponents of the size increase is the inflation of block size — the larger the block, the more complex the process of encryption is, eliminating smaller network participants with access to fewer resources from participation. A Bitcoin network with a larger block size could potentially lead to the centralization of computing power directed at maintaining the Bitcoin network, which is antithetical to the core decentralization ethos of the Bitcoin project.
The Origin of Bitcoin Cash
Bitcoin Cash was created as a direct solution to the issues created by block size restrictions. Removing the block size limit, however, required a “fork” in the Bitcoin blockchain — creating a new, altered implementation of the Bitcoin code that would create a new blockchain.
On August 1st, 2017, block size increase proponents forked the Bitcoin blockchain to create Bitcoin Cash, a new implementation of Bitcoin code that increased the block size limit to 8 MB. This new block size allowed for far more efficient transaction throughput, and created a new chain that provided everybody with Bitcoin in their Bitcoin wallets at block 478558 with an equivalent amount of Bitcoin Cash on the new Bitcoin Cash blockchain — free money!
Bitcoin & Bitcoin Cash Compared
Bitcoin and Bitcoin Cash have divided the cryptocurrency community, with proponents of each arguing for the supremacy of their chosen side. Here are the basic differences between the two:
Transaction Speed:
Bitcoin: As of Q3 2018, the speed at which the Bitcoin network is able to process transactions ranges between 10 and 20 minutes, with occasional spikes in network traffic causing transaction confirmation times to surge beyond one hour.
While second-layer scaling solutions such as the Lightning Network promise to reduce transaction confirmation times to less than one minute, Bitcoin transactions are still not fast enough to facilitate instant purchases.
Bitcoin Cash: The relatively small load on the Bitcoin Cash network compared to the Bitcoin Network, roughly 10% in size, currently allows the Bitcoin Cash network to confirm transactions at a far higher rate. Bitcoin Cash transactions are typically confirmed within ten minutes, but are often almost instantaneous.
Centralization
Centralization is a key issue in the BTC vs BCH debate. The development of dedicated mining hardware and the forming of mining pools, in which miners rent hardware located on massive server farms, has led to the centralization of both Bitcoin and Bitcoin cash.
Bitcoin: Mining pool juggernaut Bitmain currently operates a large portion of the hardware dedicated toward Bitcoin hash power. Data from Blockchain.com demonstrates that BTC.com and Antpool, both operated by Bitmain, contribute roughly 32% of all Bitcoin hashpower.
Bitcoin Cash: Data published in July 2018 demonstrates that almost 50% of all Bitcoin Cash hashpower is located on server farms operated by Alibaba and Amazon. More recent data shows a split between CoinGeek at 25%, BTC.top at 14%, and BMG Pool at 14% as the largest players in the Bitcoin Cash mining industry.
While both networks are actively mined by different mining pools, the hardware that is performing the mining is largely centralized in server farms, presenting centralization concerns for both Bitcoin Cash and Bitcoin.
Bitcoin Vs Bitcoin Cash
Bitcoin Cash and Bitcoin are fundamentally similar, with the only difference consisting of block size. While the Bitcoin Cash block size increase does solve the transaction throughput issue for the short and medium term, it’s entirely possible that block size would need to be increased again, further reinforcing network centralization.
Bitcoin’s centralization solutions such as the Lightning Network, however, have also demonstrated their own centralization concerns.
Ultimately, there is plenty of room for both cryptocurrencies, and both have something unique to bring to the cryptocurrency ecosystem.
About the Author
This is a guest post submission written by Kieran Smith. Kieran Smith provides content strategy and copywriting services for cryptocurrency companies at Bitcopy.
The market sentiment in the crypto markets since the halving can be described as cautiouslyoptimistic. So far the event itself has had little impact on the price but this impact is still anticipatedby many. In this situation it is worth considering the question of when and in what form we can expect to see these effects taking place. A look at the history of Bitcoin is certainly important.
Every four years, Bitcoin’s number of coins released to the network every ten minutes drops in half. There are currently 6.25 Bitcoins released every 10 minutes. This number has dropped from 12.5 with the halving event a few weeks ago. Holding demand constant as we say in economics, and cutting the supply in half, should theoretically increase the price of Bitcoin. But the question is, by how much will the Bitcoin price increase, and have investors already priced this into the market?
A similar reduction in supply applies to Dash. Every 383 days, the amount of new Dash released to the market decreases by 7.14%.
Historically, the price of Bitcoin went up substantially in the year following the halving. For example, Bitcoin had a 5,569% return in 2013 after the 2012 halving. Bitcoin had a 1,334% in 2017 following the 2016 halving. Dash also had its best year in 2017, the year after the second Bitcoin halving. Dash went up + 9,186%.
We are specifically interested in how many weeks it took for Bitcoin to reach its new all-time high after the halving. In recent research by Binance, they show that Bitcoin took over a year to reach its next all time high after the 2012 (52 weeks) and 2016 (75 weeks) halvings.
Overall, we are not convinced that the halving has been priced in yet for Bitcoin. Bitcoin’s return for the year is 25% while Dash is up 75%.
Answering the question of how long this process could take this time is particularly difficult. It is also not clear, how much altcoins will follow the lead of Bitcoin but if the future is anything like the past, we could be looking at over one year before the reduction in supply is fully priced into Bitcoin’s price.
Several weeks have passed since the Bitcoin Halvening. Weeks in which large parts of the market have been relatively quiet. Hardly any major cryptocurrency today differs from its position on May 9th, two days before the halving. Compared to mid-February and mid-March, however, a clear difference can be seen in the performance of individual projects during the Corona crisis. This article attempts to get to the bottom of this phenomenon and to draw parallels to the halving of 2016.
In an economic expansion, small firms tend to have better returns than large firms. In an economic recession, the reverse tends to be true: large firms tend to outperform small firms. This is because in an expansion, fiat inflation pushes investors into increasingly risky investments, but during a downturn, investors seek conservative safe havens to store their wealth.
For example, the small-cap Russell 2000 index dropped 38.6% between February 19th and March 17th, when the S&P 500 large-cap index was only down 29.5%.
A similar pattern may exist with cryptocurrencies.
When the global economy is in an expansionary period caused by easy credit lending policies, diversification into alt-coins tends to outperform Bitcoin. However, when the global economy is hit hard, Bitcoin tends to outperform a diversified portfolio of alt-coins. For example, trading volumes of the altcoins in the Top 10 on Coinmarketcap.com decreased by 30% between March 6th and April 1st, while Bitcoin’s trading volume didn’t decrease at all.
The market capitalization of the altcoins in the Top 10 on Coinmarketcap.com decreased by 37% between March 6th and April 1st, while Bitcoin’s market capitulation decreased 27%. Unlike Bitcoin’s trading volume, Bitcoin’s market capitalization did drop significantly in response to the Corona Virus. This is because the majority of crypto asset investors only have exposure to Bitcoin and not to altcoins. When an economic recession occurs, altcoin investors may see Bitcoin as a safe haven, but the overall market sees government bonds as a safe haven. Therefore, an economic shock puts selling pressure on Bitcoin as investors go into bonds and large-cap stocks like Facebook, Apple, Netflix, and Google. The buying pressure that altcoin investors have as they flee altcoins and go into Bitcoin dampens the selling pressure that Bitcoin experiences during an economic crisis.
Figure 2: Market Capitalization of Bitcoin vs. Altcoins
Source: Calculation of Top 10 market cap excludes Bitcoin and Tether, Coinmarketcap.com, CryptoResearch.Report
Figure 3: Return of Bitcoin vs. Altcoins During Corona Virus
During the same time, Bitcoin’s price lost 28% while altcoins in the Top 10 lost 38% on average with Tezos and Ethereum being hit the hardest, and XRP being the most stable.
So the big takeaway: During an economic crisis, Bitcoin is expected to out perform altcoins.
Another time when Bitcoin is expected to outperform altcoins is during the Bitcoin Halvening. During the last Bitcoin Halvening on July 9, 2016, Bitcoin’s dominance was 83%. Bitcoin’s dominance did not begin to drop until March of 2017, over half a year later. By January of 2018, Bitcoin’s dominance had reached an all-time low of 32%.
Currently, Bitcoin’s dominance is 65% and shows no signs of weakness. In light of a Bitcoin halvening, many cryptocurrency investors are exchanging altcoins for Bitcoin.
Between the economic shock that caused a flight to safety for altcoin investors and the reduction in Bitcoin’s supply, which will take months to impact the market, there is strong evidence that Bitcoin’s dominance will grow compared to altcoins in the Top 10. The altcoin season is not expected to begin until the global economy has reopened, investor sentiment has increased, and economic uncertainty has decreased.
This can be clearly seen from the fact that, apart from Bitcoin and Ethereum, hardly any cryptocurrency was able to restore its price level of mid-February. Economic uncertainty offers no fertile ground for high-risk speculation. In general, the risk tends to rise with falling market capitalization. Only general economic stability will help the altcoin sector to stabilize.
A recent analysis of PAX Gold (PAXG) and Tether Gold (XAUt), specifically with regards to reporting and transparency on the underlying gold backing their tokens, raised multiple questions due to inconsistencies in the data provided. In both cases there were inconsistencies between the number of tokens issued and the amount of gold backing the tokens in aggregate as well as inconsistencies in allocations to multiple specific addresses according to the data provided by PAX Gold and Tether Gold themselves.
Findings Regarding Tether Gold’s Backing as of Approximately ~14:00 UTC April 19, 2020
1) There were six addresses that did not have the same amount of gold allocated to them on the blockchain as indicated by Tether’s “Gold Allocation Lookup” tool.
2) One address was over-allocated by the same amount another address was under-allocated by, netting each other out. However, the discrepancy on each address was still significant (2.264 troy ounces).
3) Two of the six addresses with discrepancies had no gold allocated to them at all but indicated 1/10th of an ounce (~$170) on the blockchain. This can not be explained by a minimum precision in the system as there were other addresses with lower total XAUt balances with the correct amount of gold allocated both on the blockchain and according to Tether’s “Gold Allocation Lookup” tool (see also Tether’s assertion about precision on their transparency page that physical gold is tracked to 1/1000th of a troy ounce and XAUt tokens are tracked to six decimal points of precision).
4) These discrepancies cannot be explained due to transactions that occurred while completing the analysis because the most recent transaction was almost 24 hours prior. The analysis was performed between ~11:00-14:00 on April 19, 2020 UTC.
6) Tether had 100 bars listed as backing assets ranging in weight between 373.762 to 415.408 troy ounces which is well within the expected weight range for LMBA 400 oz good delivery bars according to LBMA specifications. However, Tether’s “Gold Allocation Lookup” tool does not provide the fineness, gross weight or fine weight of the bars so it was impossible to determine if any given individual bar was over-allocated with respect to its actual weight.
7) The data suggested that Tether Gold does not partially tokenize any individual bar as evidenced by the fact that the allocation of every bar fell well within the expected weight range for LBMA 400 oz good delivery bars although this is impossible to verify without additional information.
8) Tether’s transparency page did not shed any light on any of the discrepancies at the time of the analysis.
9) Tether’s transparency report showed more physical gold backing Tether Gold than could be verified with their “Gold Allocation Lookup” tool. The transparency report and blockchain both indicated 40,128.674 ounces vs. 40,094.657 ounces reported by the lookup tool.
10) The data presented above raises the question as to whether or not Tether Gold is in fact tracking the underlying gold to 1/1000th of an ounce precision as stated on their transparency page.
11) Tether’s “Gold Allocation Lookup” tool fails to provide bar photos, bar gross weight, bar fine weight, bar purity, bar refiner/brand or bar location (see the difference as compared PAX Gold below). PAX Gold also provides a time stamp on their allocation reports while Tether Gold does not.
While there could be any number of potential explanations for the discrepancies, such as the “amount is not statistically significant” (0.085% of the total), there should be no discrepancy greater than the three decimal points of precision Tether Gold itself says their underlying gold is tracked to and this was not the case.
Findings Regarding PAX Gold’s Backing as of Approximately 15:30 UTC April 30, 2020
1) PAX Gold’s single largest holder is 0x5195427ca88df768c298721da791b93ad11eca65 which at the time of analysis on held just under 63% of the total PAX Gold supply (16,051.0676 tokens, over $27 million USD) but PAX Gold’s “Gold Allocation Lookup”toolindicates 0 ounces of physical gold backing the tokens stored on this address. This discrepancy has appeared consistently for more than two weeks.
2) As of the time of analysis, PAX Gold had issued 25,497.096 PAXG tokens, but only reported holding 9,616.175 troy ounces of gold bars (gross weight) through their “Gold Allocation Lookup” tool and only 9,446.024 troy ounces of those bars were allocated to Ethereum addresses holding PAX Gold tokens.
3) The data suggested six bars may have been over-allocated as compared to both their gross and fine weights.
4) The data suggested that five bars may have had allocations that exceeded the maximum weight of the LBMA good delivery bar specification which is 350 – 430 troy ounces in gross weight. The five over-allocated bars ranged from 463.88 to 652.65 troy ounces in allocation.
5) These discrepancies are far too big to be considered rounding errors and are significantly greater than the discrepancies found in Tether Gold despite the fact that PAX Gold is licensed and regulated.
7) Any potential claim that 0x5195427ca88df768c298721da791b93ad11eca65 is an “unbacked treasury address” (or similar) is not consistent with data reported on CoinMarketCap.com which indicates that PAX Gold has a supply of 25,497 tokens in circulation with a market cap of over $43 million USD.
Conclusion
The “Gold Allocation Lookup” tools provided by both PAX Gold and Tether Gold fail to provide critical details regarding the underlying gold and both show less underlying gold than tokens issued.
Caveat to these findings: Due to the fact that PAX Gold has far more frequent on-chain transaction activity and there are far more addresses holding PAX Gold than Tether Gold, some of the discrepancies outlined above may be due to timing. This data has not yet been analyzed with a full archive Ethereum node to mitigate any potential timing discrepancies. However, the discrepancies are too large and too frequent to be explained entirely by timing alone. Timing also could not explain the lack of any physical gold allocation to 0x5195427ca88df768c298721da791b93ad11eca65.
Disclaimer: The findings above are based solely upon the publicly available data provided by Tether Gold and PAX Gold and the Ethereum blockchain and do not necessarily correspond to the actual physical gold holdings of either entity.
Author Bio: Brian Hankey is an entrepreneur and Co-founder of CACHE. CACHE is a provider of transparent, regulated, redeemable gold-backed tokens with GramChain physical asset tracking.
Listen Now to our exclusive interview with Jonas Gross and Manuel Klein who recently co-authored an article discussing what central banks are going to issue new digital currencies, and which ones actually use blockchain technology.
In this podcast, we discuss how most of the countries that are issuing central bank digital currencies (CBDCs) are actually NOT using distributed ledger technology (DLT) or blockchain. The only country that is confirmed to be using DLT for their CBDC is the Marshall Islands, and they are using Algorand, which is a permissioned database structure. There is NO country that is using a public and permissionless to issue a CBDC currently. Not really surprising.
We discuss the history of money and the difference between retail and wholesale central bank digital currencies. We also discuss potential risks of this newly issued currency.
Jonas is the author of the World Economic Forum’s recent paper on Central Bank Digital Currencies that was published in Davos in January. He is working at the Frankfurt School of Finance and Management in Germany, and he is doing his doctoral degree in Bayreuth. Manuel is working for Factset, and is involved in many monetary reform groups. They can both be found on LinkedIn if researchers would like to further discuss the results of their paper.
Our weekly newsletter this week discusses how Bitcoin outperformed altcoins in the Top 10 during the economic crisis. To read about the two main reasons that Bitcoin is forecasted to outperform a broad index of altcoins over the next few weeks, subscribe now!
Perth Mint’s Gold Token (PMGT), Paxos Global’s PAX Gold (PAXG) token, DIGIX Dao (DGX) vs. buying physical gold with crypto via Vaultoro or Bitpanda
Dear Crypto Asset Investors,
As the investment consultant of the Cayman-based Dash Investment Foundation, I designed a Dash and Gold rebalancing strategy that suggests for the Foundation to buy gold on a regular basis. I had to do extensive research on the fees, stability, liquidity, and risks of several gold-backed tokens.
In the end, the Supervisors and Directors of the foundation, decided not to buy a gold-backed token but rather to directly buy gold from a company that stores the gold on the Foundation’s behalf in vaults in the Alps (Liechtenstein and Switzerland).
However, the Foundation may make a position in one gold-backed token, and the questions that matter the most for us are:
Do we as the token holder or buyer legally own the gold that backs the token?
If the company goes bankrupt, do we lose our investment or is our investment ring-fenced on their balance sheet?
How liquid is the gold-backed token? If the foundation invests in Paxos Global’s PAX Gold (PAXG) token, will we be able to sell our gold-token and close our position?
How correlated is the gold token with the price of gold? Does it trade at a premium or a discount?
What are the fees?
This article briefly compares three gold-backed tokens including the Perth Mint’s Gold Token (PMGT), Paxos Global’s PAX Gold (PAXG) token, and DIGIX Dao (DGX). As you can see from Figure 1 below, the blue dots show that DIGIX Gold Token traded at a discount to the gold price while the gray dots, PAX, traded at a premium until mid-March of 2020, when all gold tokens began primarily trading at a premium. Out of the three coins, Digix Gold Token is the most volatile and Perth Mint Gold Token is the most stable when comparing the price of the coin on the market and the spot price of gold.
Figure 1: Stability of Gold-backed Tokens 12/01/2019 – 04/24/2020
Figure 2 below shows that PAX gold token has the highest liquidity or daily trading volume. However, even PAX’s daily trading volume liquidity is quite low, averaging a little over $ 1 million per day during 2020.
Figure 2: Trading Volume of Gold-backed Tokens 01/01/2019 – 04/24/2020
The Perth Mint’s Gold Token (PMGT) is the world’s first digital asset backed by government-guaranteed gold stored at the Perth Mint. PMGT is issued by a company called InfiniGold and trades on the KuCoin Exchange. The Perth Mint is the world’s largest refiner of newly mined gold and has AUD 4.5 billion worth of gold under custody for clients. Each token is backed 1:1 by Perth Mint digital GoldPass certificates which represent one ounce of physical gold held in storage at The Perth Mint. The weight and purity of every ounce of gold backing PMGT is assured by the Mint’s sovereign owner, the Government of Western Australia. Regarding fees, PMGT on their website proudly states that they have apparently no fees for custody, storage, insurance or management. However, if you read the small print in their terms and conditions, you can find they charge a fee called the “certificate fee”. This is basically when you buy or sell gold using their phone application, the company creates a digital certificate that involves creating or destroying an ERC-20 token.
If you trade PMGT on secondary markets like the cryptocurrency exchange KuCoin, then the certificate fee does not apply. The certificate fee only applies when buying or selling directly to InfiniGold. But be careful what price they charge for buying gold or selling gold, because they may put a spread on top of the spot in order to extract profits. If you have bought Perth Mint Gold Token directly from the issuer before, please comment or email us below about your experience and the spread on gold’s spot that you paid.
Paxos Global’s PAX Gold (PAXG)
Each token represents one fine troy ounce of a 400 oz London Good Delivery gold bar, stored in Brink’s gold vaults. Anyone who owns PAXG owns the underlying physical gold, held in custody by Paxos Trust Company. Regarding fees, PAX has similar fees to Perth Mint’s Gold Token. For example, whenever you buy or sell PAXG from your Paxos account (on either the wallet or PAX Gold pages), Paxos charges small fees to process both the creation and destruction of PAXG tokens (see fee schedule below). This includes all sales or conversions of PAX Gold to or from USD, PAX, gold bars or unallocated gold. These fees do not apply on the itBit exchange or anywhere else outside the Paxos wallet.
However, in addition to Perth Mint’s certification or creation/destruction fees, PAX also has fees for transferring. Whenever PAXG tokens are sent via Ethereum, Paxos charges a small (0.02%) transaction fee, and the Ethereum network charges nominal gas fees (in Ethereum). This paragraph is included on their website:
“Sending a PAX Gold (PAXG) token from one ERC-20 address to another, such as when moving funds from a wallet to an exchange, is an on-chain transaction; possession of the token is transferred and recorded on the Ethereum blockchain.
There are two kinds of fees that occur when you send PAXG on the blockchain:
Standard ‘gas’ fee: Sending digital assets on Ethereum, requires computing power, or ‘gas.’ Just like any other Ethereum token, PAXG requires standard gas fees paid in ETH to compute the transaction.
PAXG on-chain transaction fee: PAXG charges an additional fee. That fee is set to 0.02% of the amount of PAXG sent on the blockchain.
For example, if you want to send 10 PAXG from one Ethereum address to another, and you want to ensure that the receiver gets at least 10 PAX after fees, you should send at least 10.0020004001 PAXG total to cover the cost of the on-chain transaction fee. If you initiated a transfer of 10 PAXG, the receiver would get 9.998 PAXG after fees.”
Digix Dao (DGX)
There are two tokens associated with this company: DGD and DGX. The one that matters for the gold market is DGX, which equals one gram of standard gold.[1] The company reportedly procures its gold from LBMA-approved refiners. The tokens are issued by Pte. Ltd. in Singapore, and the gold is stored at The Safe House in Singapore.
DGX does not have a creation/destruction fee or certification fee like PAX and Perth, but DGX does have a storage fee, and they also have a transfer fee similar to PAX. Every time a DGX transaction takes place on the Ethereum Blockchain, a 0.13% transfer fee is charged. There is also a 0.60% per annum storage fee that is charged on account balances.
Conclusion
To summarize the three gold-backed tokens, we find the Perth Mint’s custodial risks and fees to be the lowest, however, PAX has the highest liquidity, which matters. DGX has the highest fees.
In the cryptocurrency world they say, “Not your keys, not your crypto.” Well, the parallel for gold would be something like, “Not your vault, not your gold.” All of these gold-backed stablecoins have counterparty risk. Perth’s vaults could be seized by the government or Perth Mint could freeze just one person’s gold account if instructed to do so by the government. Therefore, diversification in custodians is a good rule of thumb, and even owning some physical gold privately to eliminate counterparty risk is an option as well.
In addition to the Paxos Gold-backed token’s daily liquidity and market capitalization, the coin pays an annual interest rate of 4% on cryptocurrency lending platforms like Crypto.com. The Crypto Research Report portfolio has 15% allocated to PAX Gold, and is staking that gold on Crypto.com.
Perth Mint’s Gold Token would almost be the best gold-backed token on the market, except, you can only trade the token on KuCoin Exchange currently. In contrast, PAX is traded on reputable exchanges like Kraken.
As an alternative to buying a gold-backed token, companies like Bitpanda and Vaultoro allow users to directly buy gold with cryptocurrencies. Vaultoro’s solution for example allows investors to own the underlying physical gold and the gold is held in custody by Vaultoro at Philoro Vaults in the Alps. Vaultoro’s solution has a 1.9% fee for buy or sell limit orders and and a 2.5% fee for boy or sell spot orders. Vaultoro also has a spread between spot and bid-ask, therefore, the amount of premium that you pay can be quite high. Liquidity is also an issue since the Vaultoro orderbooks do not have that many trades.
Winners and Losers
What comes up, must go down. Last week, Hive pumped 525%. This week, down 55%. The week’s biggest losers also include Dash with -5% and Atom with -5%. Dash’s correction may be because their annual reduction in supply by 7% just occurred last week, and the price pumped prior to the reduction in supply. The CRR Portfolio contains two of the coins that are in this week’s biggest loser list.
On the biggest winners list, we have Ethereum and Bitcoin both up 13%, and Stellar up 12%. The CRR portfolio is holding one of the coins that are in this week’s biggest winner list.
Figure 1: Largest 7-Day Returns for Top 50 Market Capitalization Coins
Almost two weeks ago, we added MimbleWimble Coin (MWC) to the portfolio and we have gained 78.87% so far. We bought in at $13.49, and the price is currently $24. We added the coin after having a very deep and close talk with one of the founders of the coin, who remains anonymous, but is open to discussing the technical concepts of privacy. He or she is truly an expert on Internet privacy.
This week, we closed our position in Zcash after speaking with the CTO of Ledger, Charles Guillemet, about Zcash’s inflation bug that means we are unable to prove the total supply of the coin. There could be an infinite amount of Zcash, and we would not know.
Our second trigger of five triggers to sell Crypto.com’s CRO at 0.064 was briefly breached this week (please see newsletter from March 29), So, we are planning to sell the second tranche of our CRO once CRO’s price hits 0.064 again. We bought into CRO on March 26th for 0.044. We are up 27% on this trade over the last five weeks.
The CRR Portfolio is up 19.62% for the year.
Source: Price Data from Coinmarketcap.com, CryptoResearch.Report
The Crypto Research Portfolio is staking Dash on the Celsius network and earning 6.71% per annum. The portfolio is also earning 8.32% on USDC and 2.53% annual interest on Bitcoin on the Celsius network. We are also earning 12% APR on our CRO coins and 4% on our Pax Gold coins on Crypto.com.
Beware! The popular crypto lending company, Celsius, has changed all of their Bitcoin and Dash addresses for all clients. This means that all Celsius users should create new Bitcoin and Dash addresses. Any Bitcoin or Dash sent to old Celsius addresses after May 1st may result in permanent loss.
That’s all for this week folks! If you would like to read our free 50-page quarterly report supported by Coinfinity AG and Falcon Private Bank please visit www.CryptoResearch.Report. The report is available in English and German.
A small change to the Dollar Cost Average strategy increased Bitcoin’s return by 20% over the last decade.
Dear Crypto Asset Investors,
Everyone talks about Dollar-Cost Average (DCA) but no one ever talks about Value Averaging (VA). The article discusses how VA beat DCA for the past 10 years for Bitcoin investors.
Figure 1: Value Averaging Beat Dollar-Cost Averaging for Bitcoin (2010-2019)
If you want to invest in Bitcoin and other cryptocurrencies, you have to decide if you want to dump all of your money into Bitcoin at once or spread out your investment over a certain period of time, normally a year.
People tell you to do the latter and spread out your investment over a period of time. The famous Crypto YouTube personality Ivan on Tech tells his listeners to Dollar-Cost Average in almost every episode.
But does Dollar-Cost Averaging really work with Bitcoin?The answer is that DCA works, but Value Averaging works even better as the backtest shows. In our research, Value Averaging beat Dollar Cost Averaging every year of Bitcoin’s existence.
In this article, we compare Buy and Hold, Dollar-Cost Averaging, and a little known strategy that only seasoned stock traders use, called Value Averaging. We also provide the dataset for any analysts that would like to play with the raw data.
When prices are going down in the cryptocurrency market, some sellers panic and sell. Investors that are convinced of the blockchain technology, do not sell, but whether ask, “Should I buy the dip?”
Value Average (VA) investing helps investors to buy more when the price of Bitcoin and other crypto assets are going down during a dip and to buy less when the price of Bitcoin and other crypto assets are going up during a rally.
When an investor wants to invest in an asset, there are two common strategies. The most common approach is just to go all in at once called Buying and Holding.The second approach is to spread out their investment over a period of time, normally a year called Dollar-Cost Averaging (DCA). For example, an investor that wants to buy Bitcoin today and has $10,000 to invest can buy Bitcoin at the current spot price of $8,750, or they could invest $1,000 a month for the next ten months.
Many investment advisors would recommend do the latter approach, because DCA smooths the portfolio’s volatility and maximum drawdown. DCA especially makes sense in a bear market, when the price of the asset is going down. Imagine investors that went all in during the December 2017 rally to $20,000 a Bitcoin. These investors suffered enormously. If they had dollar-cost averaged in, they would have faired better.
However, there is a simple change to the DCA strategy that has been found to provide even higher results in traditional asset markets like the stock market. This strategy is called Value Averaging (VA).
Here is how value averaging works: Suppose you determine that you want to invest $1,000 in cryptocurrencies. If you dollar-cost-average, this means that you would invest $1,000/12 = $83.33 each month. With value averaging, you take the $83.33 as the goal amount to invest, but some months you invest more (when the price of BTC is going down) and other months you invest less (when the price of BTC is going up).
This is how VA looked in 2019:
On January 1, 2019, you would have invested $83.33 at $3,843.52 per Bitcoin and received 0.021681514 Bitcoin.
On February 1, 2019, you should normally have to invest $83.33, so that means that your total investment at this point should be $83.33 (from January) + $83.33 (from February) equal to $166.66.
Since the price on February 1, 2019 was $3,487.95 per Bitcoin, your original investment from January is now worth $75.62 (0.021681514 times $3,487.95).
Since the price of Bitcoin went down, you need to invest more this month than the normal $83.33 goal. Specifically, you need to invest $166.66 (how much you should have in your portfolio by now) minus $75.62 (the value of your portfolio).
This is equal to $91.04. So you should have invested $91.04 at the beginning of February 2019 instead of $83.33.
Repeat this calculation every month to determine how much you need to invest.
As you can see in this example, you have invested more because the price of Bitcoin rose, and the opposite would be true if the price had risen.
Figure 2: Value Averaging Increased Return Every Year for an Investor that Invested $1000 a Year
As you can see, some months the strategy says not to buy any cryptocurrencies at all. This is because the portfolio grew enough in value to reach the target invested amount. This is one benefit of the Dollar Cost Averaging strategy compared to Value Averaging. With Dollar Cost Averaging, you at least buy a little amount every month, which means more satoshis in the end or “stacking sats” as they say online, even if you paid more for them than you would have with Value Averaging.
This article was originally published in March to the subscribers of the Crypto Research Report weekly newsletter. If you would like to receive professional financial analysis without waiting, subscribe.
Charles Guillemet discusses how to securely store cryptocurrencies using Ledger’s security suite of products including the Nano S/X and the Ledger Vault. We also discuss several of Ledger’s recent updates including their recent integration with Crypto.com. Crypto.com users can now use their Ledger wallet to access Crypto.com’s services without giving up their private keys.
Charles discusses the difference between multi-party computation (MPC) and multi-signature wallets, and why Ledger Does NOT use Multi-party Computation (MPC). He also discusses why MPC is too risky to adopt without further research. We discuss how over 1.5 million Ledger wallets have been sold already, and we cover how professional investors can use the Ledger Vault to securely store crypto assets.
We discuss Ledger’s early beginnings in 2014 in Paris as Le Maison du Bitcoin, which was founded by Éric Larchevêque. Le Maison du Bitcoin was a place where people could go and discuss Bitcoin, and they had a Bitcoin ATM. Today, they are called Coinhouse, and they are still there.
Pascal Gauthier, the CEO of Ledger, asked Charles Guillemet to become the CTO a few months ago, and now Charles is responsible for overseeing that Ledger’s products are secure. He can be found on LinkedIn if researchers would like to further discuss multi-party computation, secure enclaves, quorums, and hardware security modules.
Our weekly newsletter this week discusses long and short opportunities for publicly listed cryptocurrency mining companies. To read our in-depth analysis of Bitfarms, Hive, Hut 8 Mining, DMG Blockchain, SBI Group, NVIDIA, AMD, and Taiwan Semiconductor Manufacturing Company (TSMC) subscribe now! Our favorite publicly listed mining company is Bitfarms, but they recently lost their CEO. Read more about the reasons we are not that excited about the other publicly listed mining companies: https://cryptoresearchnewsletter.substack.com/
A subscriber messaged me on Twitter and asked if I could analyze publicly listed cryptocurrency mining companies. This article tries to find long and short opportunities on mining companies by comparing Current Megawatt capacity, Future Megawatt capacity, Annual Ehash / Petahash Output, Annual Number of Coins Mined, and Average Electricity Cost. We also feature a new metric designed specifically for analyzing mining companies referred to as the “Efficiency Ratio”. The Efficiency Ratio measures how likely it is that a mining company will go bankrupt after the Bitcoin-halving. The efficiency ratio is based on the efficiency of mining rigs that are often quoted as Joules per Terahash when buying a mining machine. We calculated the efficiency of the whole company’s mining operation by taking their total megawatts capacity and dividing it by their hash output, which gives us an estimate of what type of equipment the firm is running. Firms running S9s have a high chance of not surviving the halving.
This is part one of a four part series, because there is so much to cover. We will be publishing our analysis of mining companies including Bitfarms, Hive, Hut 8 Mining and DMG Blockchain in parts one and two and then our analysis of chip and hardware manufacturers including SBI Group, NVIDIA, AMD, and Taiwan Semiconductor Manufacturing Company (TSMC) in parts three and four. We thank Patrick Scoffin of Gamma Capital for his helpful feedback on this article.
Also, thank you for the topic request! If any of you ever have a topic request, please just reach out on Twitter to @cryptomanagers or @cryptophd, and we will get to work!
Sincerely, Demelza
This article is a sneak peek of the Crypto Research Newsletter published every week to our subscribers. We do not often publish these posts publicly, so if you would like to receive professional financial analysis of crypto assets on a weekly subscribe here: https://cryptoresearchnewsletter.substack.com/
How to Value Publicly Listed Cryptocurrency Mining Companies
In parts one and two of this report, we analyze 4 companies listed on the Toronto Stock Exchange Venture Exchange (TSXV) including Bitfarms, HIVE, Hut 8 Mining, and DMG Blockchain.
Figure 1: Price of TSXV Cryptocurrency Mining Companies
Figure 2: Price of TSXV Cryptocurrency Mining Companies
Source: Yahoo Finance, CryptoResearch.Report
According to Matt D’Souza’s and Blockware Solutions recent research report on mining, mining companies that are running S9s with electricity prices above US$0.055/kWh are operating at a loss currently. Even more concerning is that the report finds that after Bitcoin’s halving, many S9s will be completely shut-off unless the price of their energy stays at US$0.025/kWh or lower.
To summarize our results, we found that HIVE is running 30 MWs in the form of S9s at an electricity price of $ US$0.04/kWh, which means the price of Bitcoin needs to stay above $5,136 in order for them to stay profitable before the halving. After the halving, the price of Bitcoin needs to stay above $8,346 in order for HIVE to remain profitable. However, they are also running 20 MWs in Sweden that they have not published any numbers on. We hope that HIVE publishes complete figures on their Petahash output and average electricity cost for all of their operations so that we can reanalyze them.
Hive Blockchain Technologies Ltd. has mining facilities in Iceland, Sweden and Canada. Up until November of 2019, they were using Genesis Mining to operate their Swedish mining facility. However, in November, they switched to Blockbase Mining Group, which was founded by an old acquaintance of mine, Vlado Stanic. We covered Blockbase in the April edition of the Crypto Research Report last year.
HIVE mostly mines Ethereum. Their stock is extremely correlated with the price of Ethereum, and has traded at a premium to Ethereum in the past. During 2019, Ethereum’s price went up, Ethereum’s daily block reward increased, and yet Ethereum’s hash rate remained relatively constant. The Ethereum network is expected to implement Programmatic Proof of Work this year, which will remove ASICs from the network. Therefore, inefficient miners like HIVE will have a better chance of surviving by mining altcoins like Ethereum. Fidelity owns 7.5% of their company, and this investment may have been seen as a way to diversify into Ethereum since most of Fidelity’s mining investments are in Bitcoin. However, HIVE only mines Bitcoin, Ethereum, Ethereum Classic, and Zcash, so Ethereum’s transition to proof-of-stake may negatively impact HIVE’s mining income. This could explain why Hive bought Cryptologic’s 30-megawatt (MW) mining operation in Quebec that has 14,000 Bitmain S9s in place.
HIVE had 20 MWs in Sweden and Iceland prior to their acquisition of Cryptologic’s facilities in Canada. They now have 50 MWs in total. Cryptologic’s 30 MWs cost $95,000 per MW, and they pay US$0.04/kWh. This is considered relatively low priced. The 30 MW produces about 173 Petahashes of SHA 256 Bitcoin mining computing power. They have not published numbers on what their 20 MWs in Sweden are producing in terms of Petahashes or what they energy cost is. We can only assume, the numbers are not as attractive as Cryptologic’s. Their efficiency ratio is 30,000,000 Joules / 173,000 Terahash = 173, which is much higher than it should be. It should be approximately 100, because they are running S9s. Companies running S17s should have an efficiency ratio of roughly 40. This means that either Cryptologic was not using their entire 30 MW facility, or they were extremely inefficient.
Overall, we are bearish on HIVE, because they have been consistently unprofitable over the years and they just bought a facility running outdated S9s. Also, many of their financial statements and their corporate presentation erroneously reference Q2 and Q3 financial figures from 2020, when they meant to write 2019. The only take away is that they did not spend sufficient time preparing their reports. They also have basically no Twitter presence or social media presence at all.
Figure 4: HIVE’s Poor Proofreading Skills
Source: MD&A from March 2, 2020 available on SEDAR, which is Canada’s version of the USA’s EDGAR. SEDAR (System for Electronic Document Analysis and Retrieval) is a mandatory document filing and retrieval system for Canadian public companies.
Figure 5: HIVE’s Poor Proofreading Skills Version Two
Source: Corporate Presentation from March 3, 2020 available on official HIVE website.
In addition to HIVE’s minimal effort proofreading, there is a weird podcast that HIVE posted on their official Twitter last year that is supposed to be the CEO of HIVE, Frank Holmes, discussing HIVE, but the podcast has nothing to do with Frank Holmes.
Stay tuned for part two on Bitfarms, Hut 8 Mining and DMG Blockchain. We will save SBI Group, NVIDIA, AMD, and Taiwan Semiconductor Manufacturing Company (TSMC) for a parts three and four that focus on chip and hardware manufacturers, but we are bullish on SBI Group’s cryptocurrency hardware subsidiary that uses chips from TSMC. They are expected to compete head to head with Bitmain.
Our Pax Gold (PAXG) is our big winner so far this year. We are lending Pax Gold on Crypto.com for 6% interest per annum. We are also earning 12% APR on our CRO coins on Crypto.com. The portfolio is earning 8.32% on USDC and 2.53% annual interest on Bitcoin on the Celsius network.
That’s all for this week folks! If you would like to read our free 50-page quarterly report supported by Falcon Private Bank please visit www.CryptoResearch.Report. The report is available in English and German.
“This shows once again how the traditional Swiss approach of having principle-based laws that give a lot of discretion to citizens and regulatory agencies are much more innovation-friendly than overly detailed European-style laws.”
Luzius Meisser
Key Takeaways
Traditional banks require $10 million in
equity. Crypto banks can apply for FinTech Bank License as of January 1, 2020.
This license only requires $300,000 in equity. Startups that want to be
licensed to trade security tokens require $1.5 million in equity.
Switzerland has already introduced the
standards on Virtual Asset Service Providers (VASP), and it has done it more
restrictively than the recommendations set forth.
We want to sincerely thank Dr. Martin Liebi and Silvan Thoma from PwC Switzerland for contributing this chapter. Dr. Martin Liebi: Martin is director and the head of capital markets at PwC Legal Switzerland. Contact Martin for any further information and guidance: [email protected] Silvan Thoma: Silvan Thoma is manager in the Regulatory & Compliance Team of PwC Legal Switzerland. Contact Silvan for any further information and guidance: [email protected]
Cryptocurrencies, which are based on distributed ledger technology, have gained importance in financial services in the recent past. This primer seeks to give an overview of the key obligations under Swiss regulatory laws related to:
Trading in cryptocurrencies is increasingly subject to regulation on multiple levels, namely:
Trading
ICOs
Entities
trading in cryptocurrencies
Asset
management related to cryptocurrencies
Table 1: Requirements for Swiss Licenses
Source: Martin Liebi, PwC
Payment tokens, exchange of cryptocurrencies
into fiat money, custody wallets, banks, securities dealers, and asset managers
are generally subject to anti-money laundering requirements, such as
registration, supervision, and identification of counterparty requirements.
Anti-money laundering obligations are the basic regulatory requirements that
apply to most entities trading in cryptocurrency markets. Depending on their
additional activities, they might require a license as a bank, securities
dealer (Swiss version of an investment firm), bilateral organized trading
facility (OTF) or asset manager, or a combination of these licenses.
Switzerland is also planning to introduce a new license category in the near
future, called fintech bank. Licenses are required in the cases listed below.
“FINMA – supervised institutions are thus not permitted to receive tokens from customers of other institutions or to send tokens to such customers.”
FINMA
Accepting client deposits, in particular when issuing OTC derivatives which are not securities, generally requires a banking license. The banking license is the highest regulated category of financial market participation. Cryptocurrencies and their associated private keys may be deposits under the Swiss Banking Act.
Critical Point: A bilateral systematic internalization is when brokers take clients’ trades on their own book. Brokers that engage in this type of activity are subject to higher regulation regarding transparency including the need to show the clients the quote prior to the trade. More information on the regulation of BSI can be found on FINMA website.
Trading in cryptocurrencies which are securities, either on behalf of clients or on one’s own account (if certain turnover thresholds are being exceeded), generally requires a securities dealer license. The licensing requirements also apply to the entity’s public issuing of derivatives. Bilateral systematic internalization of cryptocurrencies and related derivatives or financial instruments is subject to additional regulatory requirements under the Swiss Financial Market Infrastructure Act (FMIA).
Critical Point: When a manager has the power of attorney to manage a client’s account at a bank, they do not need a license currently. This changes in the beginning of 2020. The new regulatory regime is called the Swiss Financial Services Act and Swiss Financial Institutions Act. The acts come into force on January 1, 2020; however, existing asset managers have up to three years to comply.
Asset management activities related to Swiss and foreign collective investment schemes regarding cryptocurrencies and related financial instruments generally require a license. The distribution of collective investment schemes and the representation of foreign collective investment schemes also require a license. Individual portfolio management and advisory activities are, under the current regulatory regime, not subject to a licensing requirement (except for AML registration). However, this is likely to change under the new regulatory regime planned to enter into force soon.
Critical Point: If a broker, such as Bitcoin Suisse, or a Crypto Fund, such as Incrementum’s Crypto Fund, wants to trade a Bitcoin call or put an option with a counterparty through an over-the-counter trade, they would agree on a price for the option, and then they would need to report this to FINMA and also show their collateral that they can use over time to prove their ability to sell or buy the coins, depending on what side of the option they are on. Natural persons do not need to report options trading positions.
Trading in derivatives based on cryptocurrencies that can be
considered derivatives may be subject to multiple obligations depending
upon the status of the counterparties involved, such as reporting and risk
mitigation. For example, GenTwo’s structured products based on cryptocurrencies
or Lykke’s platform that has coins that are linked to a colored coin, which is
a small fraction of the underlying coin.
There is a rich variety of cryptocurrencies available. There
is no generally recognized classification of ICOs and the tokens that result
from them, neither in Switzerland or internationally. Switzerland does not yet
have an established legal doctrine or case law on cryptocurrencies.
“In Switzerland, according to FINMA’s characteristic, an asset token represents assets such as participation in real physical underlings, companies, or earnings streams, or an entitlement to dividends or interest payments. In terms of their economic function, these tokens are analogous to equities, bonds, or derivatives.”
Marcel Hostettler, Partner at MME Legal AG
As we discussed in the January
2019 Edition of the Crypto Research Report, the Swiss Financial Market
Supervisory Authority (FINMA) differentiates between three types of tokens.
These are utility tokens, payment tokens, and asset tokens. This classification
uses an economic approach, applying the concept of “substance over form,”
meaning it is all about what the real purpose of the token is, after you
scratch on its surface. That is why a token may have characteristics of multiple
types of tokens and the classifications of tokens is not mutually exclusive.
Asset and utility tokens could also be classified as payment tokens, which will
then be referred to as hybrid tokens. In such cases, the requirements are
cumulative and therefore more complex.
Utility tokens are tokens which are intended to provide
digital access to an application or service by means of a blockchain-based
infrastructure. For example, Timicoin is a utility token which enables access
to a shared database for the exchange of health information. Utility tokens are
currently not treated as securities by FINMA if their sole purpose is to
confer digital access rights to an application or service when issued. There is
no connection with capital markets, which is a typical feature of
securities. Utility tokens will, however, also be treated as asset tokens if
they also have an investment purpose when issued.
Critical Point: Some scholars argue that asset-backed stablecoins are securities similar to ETFs; however, other scholars argue that asset-backed coins, like the metal-backed Tiberius Coin, are not securities. Similar to physical ownership of a precious metal, a token is a representation of physical ownership that gives the owners the right to the underlying.
Payment tokens, commonly known as cryptocurrencies
are tokens which are intended to be used, now or in the future, as a means
of payment for acquiring goods or services or as a means of money or
value transfer. Cryptocurrencies give rise to no claims on their issuer.
Payment tokens are most similar to currencies. Given that payment tokens are
designed to act as a means of payment and are not analogous in their function
to traditional securities, FINMA currently does not treat payment tokens as
securities.
Asset tokens represent assets such as a debt or equity
claim on the issuer. Asset tokens promise, for example, a share in future
company earnings or future capital flows. In terms of their economic function,
therefore, these tokens are analogous to equities, bonds, or derivatives. FINMA
generally treats asset tokens as securities. Tokens which enable
physical assets to be traded on the blockchain also fall into this category,
meaning that, for example, real estate companies which use tokens on a
blockchain would have to deal with asset token regulations.
Table 2: FINMA Token Categorization System
Source: Martin Liebi, PwC, * Hybrids consist of at least two
categories of token-categories.
Asset tokens constitute
securities if:
they represent an uncertificated security
(meaning that the security has no physical representation, either in the form
of being printed on paper or being stored on a memory stick),
they represent a derivative (i. e. the value of the conferred claim depends on an underlying asset), there was a pre-financing or pre-sale phase of an ICO which confers claims to acquire tokens in the future.
Critical Point: The Lykke model and structured products from Vontobel, Leontec, GenTwo, and Amun represent derivatives on cryptocurrencies.
“It’s crucial for an ICO issuer to write a formal request to FINMA including the information required according to the ICO Guidelines and await the ‘no-action letter’ from FINMA before proceeding with the ICO.”
Pascal Sprenger, KPMG
All of the above require the token
to be standardized and suitable for mass standardized trading. Being
suitable for standardized trading means they are publicly offered for sale in
the same structure and denomination or are placed with more than 20 clients
insofar as they have not been created especially for individual counterparties.
In addition to regulatory
requirements and obligations (see below), securities are subject to prospectus
requirements under the Swiss Code of Obligations if they are analogous to
equities or bonds.
Trading in asset tokens that are derivatives is generally subject to the regulatory obligations applicable to conventional derivatives. These are the reporting obligation, risk mitigation obligations, and, at least in theory, the clearing obligation and the platform trading obligation under the Swiss Financial Market Infrastructure Act (FMIA). All of these obligations under the FMIA have been developed tailored to a bilateral relationship between two counterparties trading in derivatives.
Critical Point: It is, however, difficult to clearly identify the counterparties to tokens that are derivatives due to the decentralized nature of blockchain-based tokens and the anonymity of the holders of the tokens. Fulfilment of regulatory obligations applicable to derivatives can, thus, be cumbersome.
There are currently no specific financial market regulations in Switzerland that cover initial coin offerings (ICOs) explicitly. ICOs are, hence, currently treated in accordance with the generic categorization of tokens into payment, utility, and asset tokens. Thus, only asset tokens qualifying as securities are subject to treatment under financial market regulationsand are, in particular, subject to the prospectus requirement if they are economically equivalent to a share or bond. The placement of securities and the issuance of securities in the form of derivatives, along with trading in securities, may be subject to licensing requirements (see below). Securities are also tokens that are put into circulation at the point of fundraising. Pre-financing is a situation in which the investors have the prospect of receiving tokens at some point in the future, while the tokens or the underlying blockchain remain to be developed. Tokens that are issued pre-ICO and which entitle investors to acquire different tokens at a later date are called pre-sales.
1.) Registration with Self-Regulatory
Organization
Payment tokens and utility tokens can be traded on a
bilateral and multilateral basis just on the basis of a registration for
AML (anti-money laundering) purposes with a self-regulatory organization. As
long as the operator of such activities will be fully compliant with the
applicable AML obligations, no other obligations will apply to such trading
activities. The registration with a self-regulatory organization for AML purposes
is for many operators the first step in the build-up process of their trading
activities and can be done with little effort and costs.
The professional acceptance of
public deposits generally requires a banking license, unless an exemption
applies. Generally, all liabilities qualify as deposits. This is also true for
derivatives that do not qualify as securities, for example, because they are
tailor-made and not appropriate for mass trading. Professional acceptance of
public deposits generally means more than 20 depositors or public promotion of
the willingness to accept deposits.
Critical Point: Unlike most other regulatory sandboxes globally, Switzerland has a static sandbox where companies can try and test new business ideas without triggering a licensing requirement. However, you cannot pay interest or invest these assets on the deposit of under 1 million CHF.
Critical Point: If there is an investor deposit with a crypto broker and the money is only there for 60 days, then this does not trigger a licensing requirement for the crypto broker. This exemption also applies to brokers that take public deposits for security transactions, such as buying or selling stocks.
There are currently different scholarly opinions on whether cryptocurrencies and the transfer of the private key qualify as a deposit. Even if considered a deposit, there might be multiple exemptions applicable, and thus no banking license would be necessary. Typical exemptions are:
Not qualifying as professional activity: Swiss sandboxes accepting
deposits of up to 1 million CHF is not considered to be professional activity
if these are not invested and not subject to interest payments and if the
clients are pre-informed about the lack of FINMA supervision and deposit
insurance.
Deposits with precious metals dealers, asset managers, or similar enterprises that are not subject to interest payments and made for the sole intention of settling transactions, as long as the settlement occurs within 60 days. Securities dealers benefit from a longer settlement period determined on a case-by-case basis.
Critical Point: If you are a very wealthy person with a family office, you do not need a license to invest in cryptocurrencies because there is no third-party counterparty risk. The bank or family office is investing in cryptocurrencies with their own skin and not the skin of someone else.
Non-qualifying deposits: Deposits are not public if deposited
by banks or qualified shareholders having at least 10 % of the votes or the
capital and related third parties and institutional investors having at least
one person dealing full time with asset management matters (professional
treasury).
FINMA treats cryptocurrency client
dealers that engage in similar activities to client FX (foreign exchange)
dealers as such. Client cryptocurrency dealers that accept fiat money for
cryptocurrencies from clients on accounts and are themselves party to
cryptocurrency transactions with their clients generally do require a banking
license. This is not the case if an asset manager has sole power of
attorney, allowing the management of cryptocurrency positions.
Critical Point: A Swiss FinTech license is similar to a Liechtenstein e-money license. A privileged deposit in Switzerland is a deposit of at least 100,000 CHF. In Liechtenstein, a privileged deposit is only 30,000 CHF.
(2)
FinTech Banking License
On January 1, 2020, Switzerland will introduce a new
licensing category called FinTech license that should put FinTechs, and in
particular entities trading in cryptocurrencies, under more adequate
supervision. The FinTech license will allow holding public deposits, e. g., in
the form of payment tokens or utility tokens or fiat similar to a bank up to an
amount of 100 million CHF. It will, however, not be possible to do business
with these deposited assets, e. g., by lending them to third parties, and no
interest can be paid on these public deposits. The deposited assets are, unlike
a bank, not subject to the legal privilege of privileged deposits. On the positive
side, the regulatory capital required is much lower than that required by banks
(300,000 CHF as a minimum or 3 % of the public deposits).
“The Fintech license allows institutions to accept public deposits of up to CHF 100 million, provided that these are not invested and no interest is paid on them. A further requirement is that an institution with a FinTech license must have its registered office and conduct its business activities in Switzerland.”
The Federal Council of Switzerland
The FinTech license allows also for additional
alleviations, such as accounting rules according to the Swiss Code of
Obligations. An entity wishing to receive a FinTech license will have to
undergo a licensing process with FINMA.
Assume you are the new CEO of a bank and you have the idea
of entering the crypto market. These are the requirements you have to fulfill
to trade tokens which are not securities.
Requesting
a License
Dealers in cryptocurrencies that require a banking license have to file an application to get a banking license with the Swiss Financial Market Supervisory Authority, FINMA.
Organizational
Requirements
Any bank needs to have a board
of directors with at least three members and a separate management team.
A bank also needs a compliance and risk management function as well as an
internal audit function, along with the business function. The bank must
implement an effective separation between the trading desk, credit business,
settlement, and the control functions (risk and compliance). The outsourcing of
internal audit, compliance, and risk management is generally possible. Any bank
must also have an effective internal control system in place.
(3) Capital Requirements
Any bank must have equity of at
least 10 million CHF and is subject to additional capital requirements
depending upon its business activity and risk profile. Banks are also subject
to special regulatory accounting rules.
(4) Notification Requirements
Banks have to inform FINMA about
the fact that they are initiating operations in a foreign jurisdiction. Furthermore,
the acquisition or divestment of subsidiaries, representations or branches in a
foreign jurisdiction must be reported to and pre-approved by FINMA. FINMA must
also be informed about qualified holders of shares in the bank and about any
decrease, increase, or reaching of the related qualified holdings of 10 %, but
also 20 %, 33 %, or 50 % of the capital and the votes.
(5) Pre-approval Requirements
Any foreign shareholders of a bank
need pre-approval from FINMA. Any change to the organizational documents of a
bank must also be pre-approved by FINMA.
Privileged deposits of depositors are subject to special protection. Deposits in the name of the depositor up to an amount of 100,000 CHF are privileged claims subject to privileged treatment in bankruptcy. Banks must cover 125 % of their privileged deposits with Swiss and covered claims.
Critical
Outlook: Securities are also subject to privileged treatment in the event of
bankruptcy. Therefore, the question is how cryptocurrencies will be treated in
the future in this regard.
Trading in Cryptocurrencies Which Are Securities
Great, your crypto bank worked out well and you met all
the requirements. But that is not enough for you. As CEO of crypto bank, you
are now eager to enter the market for cryptos which are tokenized
securities.
Trading in cryptocurrencies that are securities
requires the trading entity to be licensed as a securities dealer.
Securities are standardized, certificated (existing in physical form), and
uncertificated (not existing in physical form) financial instruments suitable
for mass trading. They are, thus, either offered publicly in a similar
structure and denomination or placed with more than 20 clients, unless they are
being created specifically for individual counterparties.Don’t
worry, you don’t need such a license for trading in utility and payment tokens!
A security can trigger multiple legal consequences when
being traded. These consequences are:
Persons
professionally trading in securities will potentially have to apply for a
license as a securities dealer (the Swiss equivalent of an investment firm
or broker/dealer).
Facilities
allowing for the multilateral trading of securities require a license as a
stock exchange or multilateral trading facility (MTF) or must be reported
as an organized trading facility (OTF).
Facilities
allowing for the bilateral trading of securities must be operated by a duly
licensed operator (the Swiss bilateral version of an OTF, which replaces
the systematic internalizer in the EU).
Organized Trading Facilities (OTFs) Regulated by the Swiss Financial Market Infrastructure Act
Your friend Daniel is a securities dealer and you chose him
as a cooperation partner for your bank. But dealing cryptos that are securities
means you have to meet several requirements:
(1) Swiss-based Securities Dealers
Professional trading in
securities typically requires a license as a securities dealer granted by
the Swiss Financial Market Supervisory Authority, FINMA. The detailed
requirements and licensing process depend heavily upon the place of domicile of
the securities dealer and the business activity pursued. A Swiss domiciled
securities dealer is any legal entity or partnership that professionally sells
or buys securities either:
on
its own account on the secondary market with the intent of reselling them
within a short period of time (own-account dealers and market makers)
on
behalf of third parties (client dealers)
by
publicly offering securities to the public on the primary market (issuing
houses)
by
professionally creating derivatives and offering them publicly on the primary
market (derivative house)
Table 3: Which Security Tokens Dealers Need and Additional License
Source: Martin Liebi, PwC,
“The true game changer is to get an OTF license from FINMA here in Switzerland.”
Richard Olsen, Founder of Lykke
“Own account dealers” (see below) and “issuing houses” (see below) have to be primarily active in the financial sector at an individual and group consolidated level. This means that the main business activity of a group must be in the financial sector. Even sizeable securities trading activities of treasury companies within a group that is pursuing a primary business purpose other than a financial activity are, thus, not subject to the licensing requirements of a securities dealer if the securities trading is closely related to the group’s business activity (e. g., treasury departments of industrial companies). This does not, however, apply to market makers and client dealers, who will have to apply for a license even if the group’s main business activity is not a financial activity.
FINMA Licensing Categorization System
Trading on One’s Own Account (Proprietary Trading)
Securities dealers trading on
their own account will only become subject to a licensing requirement if they
pose a systematic risk to the financial system. That is why their gross
annual turnover in securities must be at least 5 billion CHF. They
typically do not have any clients. Securities dealers trading on their own
account generally act in a professional capacity and on a short-term basis. Key
aspects of trading on one’s own account include trading without instructions
from third parties and taking on risk, which is primarily market
risk. In the context of a clearing situation it can, however, lead to a
counterparty risk if clients do not advance money to settle the securities.
Trading on a short-term basis
means the active management of securities to achieve gains from short-term
fluctuations in prices or interest rates within a short period of time.
Long-term investments in securities and, in particular, the holding of
securities until maturity are not deemed to be trading on one’s own account.
Trading on One’s Own Account (Market Makers)
Market makers trade publicly in
a professional capacity in securities, on their own account and on a
short-term basis. They trade publicly because they offer the securities to
anybody. They set a firm bid and ask for prices on an ongoing basis or on
request (request for quote).
Trading on Behalf of Third Parties (Client Trading)
“August 27, 2019. Sygnum and SEBA have both been granted a banking and securities dealer license from the Swiss Financial Market Supervisory Authority (FINMA). This is the first time this license has been awarded to digital asset specialists.”
Greater Zürich Area Magazine
Client dealers handle securities in their own name,
but on behalf of clients, in their professional capacity. A professional
capacity is assumed if the securities dealer maintains accounts directly or
indirectly or acts as a custodian for more than 20 clients.
Whether the securities dealer is dealing on account
for the client or on his/her own account is determined based on economic
considerations, namely who is bearing the risk of the transaction. If the
client is bearing the economic risk, trading activities over the nostro
accounts of the securities dealer are deemed transactions on behalf of the
client. Client dealers maintain accounts for the settlement of the transactions
for these clients or with third parties or keep these securities for themselves
or for third parties in their own name.
There are exemptions when no
licensing requirement is triggered, such as if all clients are Swiss. Asset
managers and investment advisors are not deemed to be securities dealers if
they are acting based on a power of attorney, unless they purchase or sell
securities to their clients using their own account or securities deposits.
Placing Cryptocurrencies as Securities (Issuing Houses)
Securities dealers in the form
of issuing houses place cryptocurrencies as securities issued by third
parties on a professional basis at a fixed price or for commission and offer
them to the public on the primary market. A key criterion for whether the
placement of cryptocurrencies as securities on the primary market is an
activity of a securities dealer is thus whether it is “public.”
An offering is public if it is
addressed to an unlimited number of people, in particular by via advertisements
in the media, prospectuses, or other electronic means. Offers of securities are
made exclusively to qualified investors such as domestic and foreign banks and
securities dealers or other enterprises under government supervision, shareholders
and partners with a significant equity interest in the borrower and parties
affiliated and related to them, and institutional investors with professional
treasury departments, meaning the employment of one person on a full-time basis
managing the company’s assets, are not considered. An offering is deemed to be
“public” even if securities have been placed with fewer than 20 people, but the
offering has been addressed to an unlimited number of people who do not have to
be exclusively qualified investors.
Creating Cryptocurrencies as Derivatives (Derivative Houses)
Derivatives houses create
cryptocurrencies in the form of derivatives, meaning financial instruments
whose value is derived from an underlying. They handle this professionally
themselves and offer them on the primary market on their own account or on
account of a third party. A placement of derivatives with less than 20 clients
after a public offer still qualifies as public offer. A placement of derivatives
with less than 20 clients does not trigger the requirements of a securities
dealer.
Security Token Derivatives? Many investors erroneously believe that exchange-traded funds in traditional markets like stocks and bonds are derivatives. They actually are not considered derivatives. Rather, they are a separate category of securities similar to mutual funds. Unless they use leverage to enhance the performance over the underlying asset such as the ProShares Ultra S&P 500 ETF seeks to provide investors with returns that equal twice the performance of the S&P 500 index. That is an example of an ETF that is a classified as a derivative. Also, there are investment contracts that qualify as a derivative but not as a security – at least in Switzerland. For example, a tailor-made over-the-counter call option is a derivative but not a security. In the European Union, this is normally still considered a security.
(2) Foreign securities dealers
Foreign securities dealers are entities that either:
possess
an equivalent license abroad, or
apply
the expression “securities dealer” or an expression of similar meaning in their
corporate name, business purpose, or documents, or
conduct
trading in securities.
Foreign securities dealers, meaning entities that are
not domiciled in Switzerland, are generally subject to the same requirements
as Swiss-domiciled securities dealers, unless the law sets forth different
obligations. Securities dealers that are actually managed in Switzerland and
execute their transactions mainly out of Switzerland must incorporate in
Switzerland and be organized according to Swiss regulations. They will be
subject to the regulatory requirements of a Swiss securities dealer. Securities
dealers organized under Swiss law are deemed to be under foreign control if a
foreign person indirectly or directly holds more than 50 % of the votes or has
a material influence on the securities dealer in any other way.
(3) Obligations of a Securities Dealer
Daniel, the security dealer, now clearly knows what forms
there are and he is certain about how his firm’s work is seen from a
legislative point of view. But still he needs to know what exactly he must do
to build up a fully compliant service. Here are the steps he must follow:
(1) Applying for a License
Anyone falling within one of the categories
of a securities dealer mentioned above has to apply for a license with
the Swiss Financial Market Supervisory Authority, FINMA.
(2) Organizational Requirements
The securities dealer must have a board
of directors and a management team. There must be an adequate separation
between trading, asset management, and administration. The securities dealer
must also establish an internal control system consisting of compliance, risk
management, and internal audit. An external regulatory audit firm must also be
appointed. It is possible to unify some of the control functions with a
specific person.
(3) Capital Requirements
Any securities dealer must have fully paid-in minimal capital of at least 1.5 million CHF. Any shareholder indirectly or directly holding more than 10 % of the capital or the voting rights of a securities dealer or that may in any other way influence the business activities of the securities dealer must meet FINMA’s fit and proper criteria. The provisions applicable to banks regarding their own capital and accounting generally also apply to a securities dealer. Privileged deposits of clients are subject to enhanced protection.
(4) Reporting, Information, and Approval Obligations
Any securities dealer will have to comply with
multiple reporting, information, and approval obligations on an ongoing
basis. Any change to the preconditions for granting the license, but in
particular the articles of association, regulations, material change of
business activity, management, board of directors, and external audit firm, as
well as build-ups, investments, and divestments of foreign operations, must be
pre-approved by FINMA.
Any indirect or direct
acquisition or sale of a stake in a securities dealer reaching, exceeding, or
falling below the thresholds of 20 %, 33 %, or 50 % of the capital or the votes
must be reported to FINMA.
(5) Exception: Algorithmic and High Frequency Trading
Participants in Swiss trading
venues that are engaging in algorithmic or high frequency trading activities
are subject to enhanced recording requirements and their systems
must ensure adequate functioning even in stress situations.
Trading arrangements in derivatives or financial instruments
related to cryptocurrencies can be an organized trading facility (OTF)
that is subject to special regulation. An OTF is, in Switzerland, the catch-all
facility for many other trading setups encompassing bilateral and multilateral
as well as discretionary and non-discretionary trading activities in both
securities and financial instruments, meaning any other financial instruments
used for investment purposes while not constituting securities. The Swiss OTF
offers a lot of flexibility, which makes it a highly suitable platform
for cryptocurrency trading.
An OTF is any trading facility
that:
is governed by a set of rules that is standardized and binding to participants,
allows for the conclusion of contracts within the scope of application of these rules,
enables the initiative to trade to come from the participants.
An OTF can only be operated by a bank,
securities dealer, trading venue, facility recognized as a trading venue or a
legal entity within a financial group that is controlled directly by a financial
market infrastructure and is subject to consolidated FINMA supervision. Unlike
under MiFID II/MiFIR, a systematic internalizer is not a special category of
investment firm/securities dealer but is either a bilateral OTF or a securities
dealer if the related requirements are met.
Critical Point: Credit Suisse and UBS are examples of entities that have OTF licenses. Pre-trade transparency means that the bid and ask spread must be disclosed to the client prior to the trade. Many cryptocurrency brokers are trying to get an OTF license.
The operation of an OTF is also subject to requirements that ensure orderly trading, transparency and investor protection, such as best execution requirements in the case of discretionary trading. Any operator of an OTF must issue rules and regulations and appoint an independent control function that monitors compliance with these regulations. Pre-trade transparency is required in the case of bilateral and multilateral liquid trading, meaning at least 100 trades on average per day over the last year. Post-trade transparency is only required in the case of multilateral trading. Anyone operating an OTF or intending to do so in the future must report this fact or intent to the Swiss regulator FINMA.
After having reviewed bilateral trading systems, in
the following part different multilateral systems will be described.
“Unlike under European law, the Swiss law OTF category serves as a rather wide catch-all category.”
CapLaw.com
Cryptocurrencies can be traded on a multilateral basis
based on multiple organizational setups depending upon the legal nature of the
cryptocurrencies traded and the trading mechanism.
Payment tokens and utility tokens can be traded on a
multilateral basis, meaning the simultaneous exchange of bids between several
participants and the conclusion of contracts based on non-discretionary or
discretionary rules, simply based on a registration with a self-regulatory
organization (SRO) for AML purposes.
The highest regulated entity for trading in
cryptocurrencies on a multilateral basis is the stock exchange. A stock
exchange means an institution for multilateral securities trading where securities
are listed, whose purpose is the simultaneous exchange of bids between several
participants and the conclusion of contracts based on non-discretionary rules.
A stock exchange can admit to trading payment token and utility token.
Stock exchanges are regulated according to the
principle of self-regulation in Switzerland. This means that the law gives
certain guidelines and determines certain obligations that must be complied
with on a mandatory basis. The operator of a multilateral trading operation has,
however, the discretion to determine the organization and the rules applicable
to the trading activities of the stock exchange as a default.
A stock exchange must have multiple bodies, such as the
admission board, the reporting office, the disclosure office, a trade
surveillance office, the regulatory board, the sanctions commission, and the
appeals board. It must also have a board of directors, a management, a
compliance function, a risk function, and an internal audit function. The
organization must be appropriate in terms of staffing and organization to
operate a multilateral trading operation. In particular, there are also certain
obligations regarding the features and the resilience of the trading system and
the IT system, such as pre- and post-trade transparency, algorithmic trading,
and guarantees for the orderly trading.
(2) Multilateral Trading Facility
A multilateral trading facility (MTF) means an institution
for multilateral securities trading whose purpose is the simultaneous exchange
of bids between several participants and the conclusion of contracts based on
non-discretionary rules without listing securities. An MTF differs thus from
a stock exchange only in so far that securities are not listed on an MTF.
Payment token and utility token can, next to securities, also be traded on an
MTF.
The organizational requirements and the required
staff are almost identical to the ones required for a stock exchange. The only
real difference results from the fact that securities are not listed on an MTF
but admitted to trading.
(3) Organized Trading Facility
An organized trading facility (OTF) is an establishment that
allows, next to the bilateral trading in securities or financial
instruments for the exchange of bids, also for the multilateral trading in
securities or other financial instruments whose purpose is the exchange of
bids and the conclusion of contracts based on discretionary rules or the
multilateral trading in financial instruments other than securities whose
purpose is the exchange of bids and the conclusion of contracts based on
non-discretionary rules.
An OTF must either be operated by a licensed bank, securities
dealer or the authorization or recognition as a trading venue. The law requires
some obligations regarding conflict of interests, transparency, and orderly
trading. Within these guidelines, the operator of an OTF has, however, a vast
discretion to self-regulate the OTF.
(4) DLT Trading System
“The Swiss proposal can be seen as confirmation of the positive attitude of the Swiss government towards DLT and strikes a good balance between self-regulation, supervision, and alleviations for smaller marketplaces.”
Martin Liebi, PwC
The Swiss lawmaker is planning to introduce soon a new
category of multilateral trading facility specifically made for DLT-securities
amongst many other key legal changes addressing pressing needs (such as, but
not limited to the bankruptcy treatment of crypto assets and a new category of
securities called DLT securities etc.). The key differentiating features
of this license category will be that one license covers the entire trading
and post-trading (settlement and custody). Although a similar setup like a
stock exchange is required, FINMA can on a case-by-case basis relieve the
license holder from certain requirements depending upon the risk profile and
the scope of activity. Participants can be either natural persons or licensed
entities.
The issuing of payment tokens
constitutes the issuing of a means of payment subject to this regulation as
long as the tokens can be transferred technically on a blockchain
infrastructure. This may be the case at the time of the ICO or only at a later
date.
In the case of utility tokens,
anti-money laundering regulation is not applicable as long as the main reason
for issuing the tokens is to provide access rights to a non-financial
application of blockchain technology.
The offering of services to
transfer tokens if the service provider maintains the private key is a
financial intermediary activity subject to AML requirements.
Securities dealers and banks duly
licensed by FINMA are financial intermediaries. They are subject to the
requirements of Swiss anti-money laundering provisions. Any other trading
activities not subject to a license as a securities dealer are not subject to
the Swiss anti-money laundering regulations (unless they concern a payment
token). Asset managers of individual portfolios are also subject to anti-money
laundering supervision but are not subject to FINMA authorization.
Financial intermediaries not
supervised by FINMA must register with an AML self-regulation organization
or directly with FINMA. They will then become subject to the client and
beneficial owner identification and transaction surveillance requirements set
forth in the applicable directives of the self-regulation organization.
“Swiss Federal Council continues to monitor developments around blockchain/DLT.”
Financefeeds.com
Banks and securities dealers
have to comply with the verification of the identification requirements of
contractual parties and the establishment of the identity of the controlling
person and the beneficial owner according to the Agreement on the Swiss Banks’
Code of Conduct with regard to the exercise of due diligence (CDB16).
Compliance with these requirements is audited by the external auditor on an
annual basis.
Financial intermediaries undertake
to verify the identity of the contracting partner when establishing business
relationships. The execution of transactions involving trading in securities
must exceed 25,000 CHF in the case of an account opening.
(2) Establishment of the Identity of Controlling Persons and Beneficial Owners
Critical Point: Form A is used to disclose the beneficial owner or if you go to a bank counter at LGT and you try to exchange a certain amount of euros and Swiss francs above a certain threshold, then you need Form K.
If an operating legal entity or partnership has one or more controlling persons with voting rights or capital shares of 25 % or more, these are to be identified in writing. Controlling persons are those natural persons who effectively have ultimate control over the company. Whether these persons exercise control directly or indirectly via intermediate companies is irrelevant. A controlling person must generally be a natural person. The contracting partner must confirm the name, first names and actual domiciliary address of the controlling person in writing or by using Form K.
The financial intermediary
requires from its contracting partner a statement concerning the beneficial
ownership of the assets. Generally, the beneficial owners of the assets are
natural persons. If the contracting partner declares that the beneficial owner
is a third party, then the contracting partner has to document the latter’s
last name, first name, date of birth, and nationality, along with his/her
actual domiciliary address, or the company name, address of registered office,
and country of registered office using Form A.
(3) Business Relationships and Transactions with Increased Risk
Financial intermediaries have to
determine business relationships and transactions that are subject to increased
risk. The initiation of such business relationships and the execution of such
transactions are subject to enhanced due diligence requirements. Such business
relationships must be approved by the management.
(4) Organization
Financial intermediaries must establish an organization
that allows for efficient compliance with the applicable anti-money
laundering regulations and, in particular, has to designate a dedicated
anti-money laundering function. New products must be checked by the securities
dealer for their compliance with the applicable regulations. Securities dealers
must establish an effective mechanism for the surveillance of transactions and
business relationships based on an IT system.
4.) Regulatory Requirements Regarding Payments on the Blockchain
Switzerland has already implemented the FATF
standards on virtual asset services providers (VASP). These apply to
crypto exchangers, wallet providers, and trading platforms. FINMA has made it
clear that information regarding the person giving the payment instruction and
the beneficiary must be submitted in case of a payment made on the blockchain
like in any other payment made between banks (e. g., SWIFT). Any such payment
must also be made between two entities registered for AML purposes (unlike the
FATF recommendations that allow also for payments between non-AML-registered
entities). Payments are only possible between two clients of the same
AML-registered entity or between wallets of the same client held with the
AML-registered entity. Payments to third parties outside of the scope of
influence of the AML-registered entity making the transaction must be
identified like an own client (identity, beneficial ownership, and actual
transaction power) by means of adequate technical measures. In case of
exchanges fiat-vs-payment tokens and the involvement of an external wallet must
the exchanging entity check who has the power to transact about the wallet by
means of adequate technical measures.
This more restrictive implementation of the
FATF-VASP standardswill force wallet providers to become registered for
AML-purposes to allow for the execution of payments. Such registration can
be done on a voluntary basis with an SRO for AML purposes in Switzerland. It
will also require an exchange of information between the two entities executing
the payment because there is yet no system available that can transmit the data
required for the identification of the contractual party and the beneficial
owner.
