Transcript: Series 2 Episode 6: Cryptoassets - regulating the future of money

Andrew Strange: Hi everyone and welcome to our first Risk & Regulation Rundown podcast episode of 2021. I’m Andrew Strange, your regular host, and as usual, we are recording this remotely, so please note this might impact the sound quality.

We wanted to focus our first episode of the year on a topic that speaks to some of the innovation and forward looking developments that we're seeing in the financial services sector, and I hope you'll agree that our topic of cryptoassets fits that bill perfectly.

I've got two fantastic guests here today, who are going to bring some really interesting and different perspectives on the subject, Henri Arslanian, PwC’s Global Crypto Leader, who's based in Hong Kong; and Sharon-Marie Fernando, a Senior Manager from our Legal Practice here in the UK. Welcome both of you to the podcast.

Sharon-Marie Fernando: Hi Andrew.

Henri Arslanian: Hi Andrew, thanks for having me.

Andrew:: Henri, as our Global Crypto Leader for PwC, why should firms be thinking about this issue today, when clearly there’s so many other things to contend with on their agendas?

Henri:: Well absolutely Andrew, first of all, thanks for having me and thanks to your listeners. I know you have a choice of what to listen to, so thanks for tuning in on the podcast and allowing us to share our passion for the future of money. As you mentioned, Andrew, this is obviously a big topic, everybody now is talking about Bitcoin and cryptocurrencies, and the reason is this is actually probably the most exciting time in the recent history of money. When you look at the evolution of Bitcoin and cryptocurrencies, Bitcoin was created 12 years ago, and really has evolved significantly over the last couple of years. We're seeing some big trends right now. The first, that is very relevant to our listeners, is the entry of institutional players. A couple of years ago, really the crypto industry was led by a lot of start-ups, guys with T-shirt in a basement, in a garage. Right now, the really big drivers in the crypto industry are the large financial institutions, and some of the large asset managers as well. Over the last couple of months, we saw some of the large hedge funds enter the space, embrace Bitcoin, and this is a trend we expect to see in 2021 as well. It is being driven by increased regulatory clarity, increased presence of regulated counterparties, and just a broader awareness about the asset class as well. One thing as well for a lot of our financial institution clients that are listening, there is also a lot of demand from retail customers as well.

For example, right now, just to put things in perspective, only five years ago you only had 5 million clients with an account at a crypto exchange. Last month, according to Cambridge University, you have over 100 million people with accounts on a crypto exchange. We're really seeing more and more adoption and interest from retail customers. A good example of this is even, before the holidays, we had PayPal make it basically available to all its US customers, 280 million customers now can buy Bitcoin out of their PayPal app, and in 2021, this will be rolled out globally as well to over 250 million clients. It really is becoming easier for anybody to access it. So the large entry of institutional players, for those in the financial institutions and servicing the broader institutional market, and there's a lot of interest and activity on the retail side as well. So really, the future of money may be closer than we think.

Andrew:: Fascinating, thank you, Henri. The image of people coding in their garages takes me back to the origins of something like Facebook, where actually, we can't believe that Facebook started out also with a few people working in a back office doing some coding. There’s some really big developments here clearly. But Sharon, with my kind of parochial UK view, this sounds like a bit of a regulatory minefield or perhaps an opportunity. Where are we in terms of regulation in the UK market?

Sharon: Thanks Andrew. Well at this point in time, it's a bit of both. There are huge opportunities in relation to cryptoassets, but there are also some concerns as well. At this moment, cryptoassets as an asset class in their own right are unregulated. They are regulated in the sense that where they fall within the scope of a security, e-money, or within the scope of a MiFID II financial investment, where a reference is made to cryptoassets, say in a derivative, or where a collect investment scheme is created, then there would be an issue in terms of cryptoassets being within the scope of the UK regulatory perimeter. But there is a lack of clarity around how cryptoassets are treated. There's been some moves towards creating some clarity in this space. That's been driven by increased regulatory focus, and there’s been a number of UK developments in the legal space in terms of what's been going on from the regulatory point of view, and also from a consumer protection and financial crime point of view.

Just to mention a couple of items, there was the recent creation of the Cryptoasset Task Force, that happened in 2018. A report was released from the Cryptoasset Task Force, which sets out a review of the UK market and the threats and opportunities that cryptoassets provide. We've also had very welcome perimeter guidance from the FCA by way of a consultation paper and policy statement on the regulatory treatment of cryptoassets. In terms of developments from a consumer protection and financial crime point of view, there has been the banning of derivative sales to retail clients. The FCA has taken action to prevent the marketing of cryptoassets to retail customers as well due to their volatility. Also, there have been warnings from the regulator as well due to the nature of the investment because they promise high returns, and obviously there's a volatility element to them as well.

Andrew:: That sounds like there's an awful lot of changes there potentially to the regulatory perimeter, and certainly I know we’ve had to deal with that in terms of onshoring legislation, and Treasury, PRA and FCA all proposing different rules and approaches to certain regulatory topics. But there has been another significant development from Treasury this month, where they've called for evidence on the regulatory approach to cryptoassets and stablecoins, which includes the introduction of a regulatory regime for stable tokens.

Sharon, do you want to just take us through the key implications of the paper for stable tokens first?

Sharon: Yes, of course, that's right. The UK Treasury has released a consultation on the treatment of cryptoassets, but they are taking a phased approach to that. As part of the first phase, they've been focusing on stablecoins. The intention is to create a new category of token, which would be regulated effectively, and that will be called a stable token. Any activities that are to be performed with stable tokens will be UK regulated activities. That could comprise issuing stable tokens, executing transactions in them, and as Treasury has noted, that could even include actively marketing them in the UK. That's a really interesting development. Systemic stable token payment systems are also likely to become subject to payment services regulation according to the consultation paper that was released.

Andrew:: It's that hodgepodge of different regulatory approaches tackling different tokens or different approaches, that's quite a challenge. Beyond stable tokens, Treasury proposes that other types of cryptoassets such as Bitcoin and other exchange tokens will be outside the regulatory perimeter, at least in the short term. The Government plans to consider the case for bringing more cryptoasset market actors within the regulatory perimeter at a later stage. Can you tell us a bit more about that, and what the impact could be?

Sharon: Yes, of course. As I mentioned, Treasury is taking a phased approach to looking at the regulatory position of various cryptoassets. Obviously, as I mentioned, stablecoins, stable tokens are within the first phase, but the Treasury will be considering the regulatory status of other cryptoassets in due course as part of that phased approach. It's really interesting, because decentralised finance and distributed ledger technology have been noted to remain outside the scope of UK regulation. My view is that eventually the UK regime will be likely to mirror that of the EU’s proposed markets and cryptoassets regulation, which basically seeks to apply common standards and authorisation requirements for cryptoasset issuers and service providers, so there is some direction of travel there. First of all, stablecoins will be in focus, but there is that ongoing review of cryptoassets, and whether or not they need to be brought into the regulatory perimeter in the UK.

Andrew:: Thanks Sharon, that was a really helpful overview of the UK Government’s and UK regulatory thinking on this.

Turning to Henri, what are your reflections on the regulatory architecture that we are seeing and hearing from the UK, and how does it sit in that wider context of approaches you are seeing from other countries or even at a global level? Is the UK leading the way here or is there something the UK needs to be able to learn from?

Henri:: Absolutely Andrew, there is a lot of action going on right now globally, right. Let me just give you an example on the regulatory perspective. Today, again according to Cambridge University, only 5% of regulators do not have somebody working on crypto. Again, and I would say that overwhelmingly the vast majority of financial centres have now reasonable crypto regulations in place. Also, by the way, one area I will be focusing on next is actually tax clarity. While we have regulatory clarity, we also need tax clarity as well if you want institutional investors to come in, but some of these elements are very important.

We just mentioned stablecoins, just to give an example, in 2020, a year ago, there was only $5bn in stable coins assets, in December, it was $25bn. Actually, if I look in the crystal ball for 2021, I expect to see a really big rise in the usage of stablecoins. You may say what is the goal there, what is the point of a stablecoin? Maybe, for our listeners, they know a Bitcoin is digital currency, its price is determined by offering demand. When you look at stablecoins, it is a digital currency that is backed one to one by fiat currency, US dollar, GBP, or Japanese yen, or whatever. That allows you actually to commit cross-border payments, 24/7, instantaneously, and at no fees. That has a big impact for not only the retail public, but also institutional players as well.

Today, the average fee, Andrew, of a global cross-border payment is 7%. The average. In many emerging markets, it's double digit, just to send money from one part to the other. This is why we are seeing stable coins be a big focus, especially since the announcement of Libra in June 2019, that was now renamed to Diem. This is actually going to be one of the big areas to watch in 2021 as stablecoins become a big area of focus. I really hope that's going to help us when it comes to cross-border payments and really helping people. When it comes to the UK’s position on that, I have to say that globally right now, there is a regulatory race. Two years ago a lot of smaller jurisdictions came up with regulatory clarity, and now what we're seeing in 2020 and 2021 is some of the established jurisdictions are coming up with pretty good regulatory clarity on digital assets. Not only Bitcoin, not only stablecoins, but the entire ecosystem, places like Hong Kong, Singapore, Switzerland, and even the United States.

I have to say in the last couple months, we've seen, towards the end of 2020, really pretty interesting regulatory clarity coming up from the US. From a UK perspective, it is very important for the FCA, for the brother authorities to provide regulatory clarity. I always say half-jokingly that the crypto industry is probably the only industry in financial services that actively lobbies for more regulations. Because everybody wants just the clarity, and then the ecosystem can build on top of it. Again, I am very bullish on 2021 on the crypto industry. One of the reasons is because there is more regulatory clarity, and unlike other traditional industries, countries need to come up with proper clarity on it. If not, we are seeing a lot of movement that can happen in the ecosystem in search of clarity on this area.

Andrew:: Thank you, Henri, I’ve got loads of reflections on that. You’re right, anything with a 7% fee strikes me as an industry that is ripe for disruption from the outside. You are quite right, particularly, when I think about some of the slightly more conservative approaches we've taken in the UK to things, sometimes that regulatory clarity is great for firms, but also it can offer legitimacy to services and products too, which is really helpful from a consumer perspective.

It was great to hear about where policymakers are at overall, but let's turn now slightly more to actual financial services firms, perhaps even some of the incumbent firms that we are all used to dealing with as our clients on a daily basis. What do we perceive the risks and the challenges are, as well as the opportunities? Henri, perhaps I could start with you and you can give a view on FinTechs and firms from outside the UK, and then Sharon I will come to you for a perspective on perhaps more established UK-based firms. Henri?

Henri:: Sure, of course, let me talk about the broader, some of the native firms, and then I can talk about financial institutions. When you look about the crypto industry, unlike a couple of years ago, now there are numerous regulated FinTech or crypto firms, many of them making hundreds and millions of dollars of revenue a year, and that are regulated, they have all the certifications, the SOC 1, the SOC 2s, the big four audits that actually a lot of the regulated counterparties would need to deal with. So that's already happening right now out there, there is a big market. The big area that I am watching right now is really what's going to happen with financial institutions. In 2020, we saw numerous large financial institutions, from Standard Chartered, to JP Morgan, to the DBS in Asia, who had made their plans public, their crypto plans public, on how they want to service this industry. I expect in 2021, we are going to see many other financial institutions enter the space. Frankly, they are not doing this out of pure love and because they have nothing else to do, but because it's a revenue opportunity.

This is a new industry, there's a lot of opportunity, it brings a new top line growth in an area that is expected to generate a lot of growth over the next couple of years. Strategically, we are seeing many financial institutions enter this space. The drivers behind that is very clear, it’s because there's more and more regulatory clarity today and there is a lot of regulated institutions, and to be fair there is a lot of demand from the end clients. Over the last couple of months, we saw some of the large hedge funds, who made their plans public in crypto. Obviously, all these firms are clients of the traditional financial institutions.

Obviously, as a financial institution, you need to service to your clients, and this is why I expect to see a lot more activity from the large big banks in this space. One way they may do this is actually by M&A. For any financial institutions, you buy, or you build a typical management consulting approach, many financial institutions right now we are seeing are making some of their plans public on how they want to build these solutions. We've seen it with DBS, and we’ve seen it with some of the partnerships with Standard Chartered, but one thing you'll see in 2021 and 2022, over the next 24 months, is an increasing amount of M&A in the sector. 2020 was a record year, when it comes to crypto M&A. Just to give you an example, only in the first six months of the year, we surpassed the records of 2019, and the average deal size went from less than $20m to over $45m. I really expect in 2021, we are going to see a wave of M&A, many of them driven by large financial institutions, who are trying to enter this space by way of acquisitions, or minority or majority investments in existing crypto firms.

Andrew:: Thanks Henri. Sharon, aside from M&A, from a UK perspective, what do you think we are going to be seeing?

Sharon: It's great that Henri has mentioned a lot of the opportunities that would obviously apply to UK firms as well. But, as Henri also mentioned, where there is the opportunity that's driven by regulatory certainty, we don't yet fully have that in the UK. As you know, the Treasury is consulting on the development of the regulatory regime for cryptoassets, so that's one thing to bear in mind. Another point is that, as cryptoassets aren't a huge asset class at the moment in the UK, a lot of financial services firms don't really have that level of systemic risk that they would have, because obviously they are less exposed to cryptoassets, and due to their volatility that could obviously then cause some issues in terms of financial stability. We don't have that as an issue at the moment, but that's something to keep an eye on as the asset class continues to grow and interest in cryptoassets continues to grow.

Obviously, there are market integrity and financial crime risks, which are well discussed, and which regulators are keeping an eye on. That’s also something that's potentially something for firms to worry about, but as Henri has mentioned there are some amazing opportunities as well for UK firms. One of the things that I particularly picked out was in relation to transactions. They could be made much faster and cheaper, there's a whole lot of new business models that can be driven off the back of cryptoassets, and also the ability to just tokenise anything of value and create a whole asset class based on that, so the possibilities are basically endless.

Andrew:: Thanks Sharon, so beyond 2021, clearly this market is going to continue to develop, what do we see longer term as the biggest issues that regulators will need to be mindful of as this market continues to grow? Henri, what's your view on that, please?

Henri:: Well this area moves very fast, right. I always tell half-jokingly that anybody that tells you they’re a crypto expert, you’ve got to run away. I spend 24/7 of my time in this space, and I have absolutely no idea what's going to happen one month from now, because things move very fast. Just to give an example, crypto markets don't sleep, it's a 24/7 market. So, if on Thursday night, on Friday night, you want to go to the pub, have a good time, spend your weekend with your kids, relaxing, you should not be getting into crypto. This market is genuinely 24/7 and it is genuinely global.

There is a lot of realities of this market that are actually quite fast paced. However, there’s a lot of exciting things coming up over the next couple of months and years. One thing, as regulators we are seeing an increasing level of clarity, we are also seeing more enforcement in this space, which is very welcome. Again the crypto industry is one of the few industries that actively encourages regulators to crack down on the bad apples that tend to give the industry a bad name. But there are a couple of things that I am really watching for the months ahead, part of that is stablecoins, part of that is the entry of institutional players. One area I am very bullish on right now is central bank digital currencies. Again, so Bitcoin is fully centralised, nobody can stop it, nobody can control it, stablecoins are often issued by private enterprises, whether they are large technology firms or other regulated institutions.

The big area I am watching right now is central bank digital currencies - crypto digital assets issued by a central bank. Today, there's really - as your listeners may know - two kinds of central bank money. One of them is a bank note, like a five-pound note that you hold in your wallet, that is a liability on the Bank of England; and the second type of central bank money are the reserves that your lovely bank holds at the central bank. The money that you hold in your bank account is not central bank money. Our generation, everybody listening to this podcast, we are probably going to be the lucky generation, who's going to see a third form of central bank money - central bank digital currency. That is kind of a digital banknote, and that's super exciting. There is a lot of work going on right now. The FCA in the first quarter of 2020 issued its consultation. As was mentioned before, there's a lot of work going on in this space, but really when you look at this, this is a space that's moving extremely fast. COVID, one of the good things of COVID is that it really catalysed the change going on, on the future of money, with central bank digital currencies.

On this topic, all eyes are on China. China is, without any doubt, years ahead of any other country. The People's Bank of China has been researching this topic since 2014, and right now, just to put things in perspective, there is over 2 billion Renminbi, that's $300m of transactions in the new digital currency have taken place. There are over 12,000 use cases that have been done. Even in mid-January, there was a lottery done by the Shenzhen, which is the Silicon Valley of China, giving digital currency to the public to experiment with. When it comes to the future of money, this is taking place as we speak. Therefore, for any financial institution, you need to keep an eye on this, because, while there is a lot of opportunity, especially for the public that's going to get access to a third form of central bank money, there are also risks.

One risk, for example, is the risk of a bank run. If today I do not trust banks anymore, I don't trust the banking system anymore, I can go to an ATM or cash machine and withdraw all my bank notes as much as I can. This, of course, has physical limitations, how much cash I can withdraw, and how I can store it safely. With a digital currency, basically I'm able to actually withdraw as much money as I want in my digital wallet in a matter of seconds. So, this obviously brings a lot of risk on acceleration of a bank run, it also puts risks on the profitability of traditional banks.

Today, when I deposit money at my lovely bank, that bank is able to literally create money. They are able to actually lend that out and what happens behind the scenes is money creation, which is something if more and more people are holding their money in digital currencies, in their digital wallets, that actually increases the funding risk of banks, it may reduce their profitability, and may reduce their revenue. There are all of these big considerations, and this is why you are seeing now the Bank for International Settlements, the club of central banks, if you want, in many central banks, including the FCA look at this topic very closely. Because yes there's a lot of benefits for the public, but there are potentially a lot of downsides for the traditional financial institutions, and this is something that central banks are very conscious of and are trying to look at the holistic impact on the ecosystem.

Andrew:: Amazing Henri, thank you. So aside from not having children, and central bank digital currencies, and potential runs on banks, Sharon, is there anything you want to add from a UK perspective to that?

Sharon: Yeah sure, there is obviously a balancing act in terms of risks versus opportunities, and that is obviously a consideration from a UK regulatory point of view. Obviously, there are concerns about investor protection and investor understanding of cryptoassets, the level of volatility that they present, and whether or not they are suitable for the average investor in the UK. But that's not to go without mentioning the opportunities that cryptoassets bring, Henri and I have both talked about that a little earlier on in this podcast. Just the speed and efficiency of being able to deal in transactions with cryptoassets, it really pushes traditional financial services firms to up their game as well, because of the increased competition that cryptoassets bring into the regulatory perimeter and the service providers for those cryptoassets will bring into the regulatory perimeter. Also, there is a huge pool of investment opportunities that's created as well, so much greater than any of the other investment types that we've traditionally seen in the past, and that's a really exciting prospect.

Henri:: Yeah, if I may add actually, Sharon, to what you mentioned, especially for the listeners of this podcast (I understand many are in the regulatory space) this presents lot of opportunities. The advice I give, I wear many hats, one of them is a professor at the University of Hong Kong where I teach this topic, and I tell a lot of the young folks, or young people listening to this podcast, the ones that are just an analyst at a bank, they are doing their training contract at a law firm or just as a junior person in a financial institution, that crypto gives you a lot of opportunities personally from a career perspective. This space will happen, this space will grow, it gives you a lot of opportunities to be that key person within your organisation.

For those with regulatory backgrounds, for example, this is a space that has tremendous opportunities right now, it's new, but again, as long as you're happy to step outside your comfort zone, you're happy to address new legal and regulatory considerations and issues, it provides a lot of opportunities in that space. Also personally, what I tell everybody is that, you may like Bitcoin, you may hate it, you may love digital assets, you may hate it, but I think we all have this intellectual duty to at least try to understand it. Especially in a lockdown environment, the one piece of advice I give to everybody is, instead of watching Netflix, instead of watching Amazon, I love the Queen it's a great show, but instead of wasting time on watching these things, if you spend an hour a week, just on watching some of the educational content on the future money. Today there's tons of videos, there’s tons of free content that is available on the future of money, and just think about what is the impact this can have on you personally, but also on your career. The next decade, we're going to see, I call it the roaring 20s again will come for people involved in regulation, people involved in finance, in this particular area, it will provide a lot of opportunities.

For those who are ready, it will be great, but unfortunately there will be some winners and losers. I hope for some of your listeners, who have listened to this podcast, this may be a tilt to spending some time, maybe 10 minutes or 15 minutes just reading about it and trying to understand this space a bit more.

Andrew:: Brilliant Henri, thank you so much. Sharon, thank you too. On the roaring 20s note I will end it there. It's been a really fascinating discussion. It's been great to hear about innovation, the speed of change in the market, and just the breadth of issues that firms are having to face. To our listeners, I hope you’ve also found this episode really helpful, please do share this podcast and subscribe to future episodes, and I'll be back with our next episode next month. Thank you.