Motus Capital Management
Motus Missives – Vol. 10 | Based
In this edition of Motus Missives, we will highlight product, technology, and regulatory updates that we believe will lead to increased adoption and further value accruing to this ecosystem. As a reminder, all previous editions of Motus Missives may be found here.
This past week we spoke with the team at Coinbase to discuss the roadmap for the Layer 2 blockchain they are building on the Ethereum network, named Base. Layer 2 blockchains (“L2s”) are meant to offer scale and reduced transaction costs, and eventually settle transactions down to the “Layer 1” ledger benefitting from greater security (think batch processing). This offers users faster transactions at lower cost, without sacrificing the benefits of decentralized security. It is our view that Base (and similar offerings) will open pathways to onboard 10s of millions of additional users to decentralized finance in a way that is simple and secure, promote financial inclusion, and drive meaningful usage and value to the protocols and applications for which we invest in. Base is expected to be live this summer, arriving shortly after Ethereum’s upgrade earlier this month which further enhanced security of the Ethereum network. Sparing the technical details, this upgrade further reinforced our long-standing thesis of Ethereum being the primary foundation of crypto activity for the foreseeable future.
Taking a step back, one of the main criticisms lobbied against crypto is that not many people use it. The primary reason for this is that it is somewhat clunky and takes technical know-how to interact directly with decentralized applications…for now. The experience moving value or data via blockchain today is akin to having to interact directly with SWIFT to send a wire, or having to understand TCP protocol to send an e-mail. Instead, to send money or an e-mail we all interact with a frontend interface provided by a company (your bank or gmail), and we do not have to understand or care too much about what is happening underneath. These companies also build in guard rails aiming to prevent us from doing things that could lose our funds or compromise our data, with ways to recover those if an error occurs. Back to Base, their intent is to provide a similar experience for users, providing a frontend gateway to interact directly with blockchains and crypto equipped with:
Username and password
Customer Service for issues or errors
Guardrails to prevent loss of funds or data
Curated services (decentralized applications)
And they already have a 110mm+ userbase and $80B+ of assets to offer it to, most of which do not interact directly with blockchain today. From a regulatory perspective (more on this below), these users will be KYC’d, in addition to blockchain already being more transparent than existing financial systems. Initial “curated” products/services will likely be focused on payments and yield, available to anyone anywhere with a smart phone. For those already comfortable interacting with decentralized applications, Base will still allow developers to create novel and innovative applications outside of what Coinbase may market directly. With Coinbase abstracting away many of the initial education hurdles, we find it inevitable that many of these users will continue down the “rabbit hole” to discover what the broader ecosystem has to offer.
In short, we find it likely that the path to broad crypto adoption involves centralized user interfaces as a gateway to decentralized applications. Ultimately this will drive the most value to the blockchains and applications used, as well as the companies providing the interface to them. Base may be the first, but certainly will not the last. We view this as extremely positive for crypto broadly, Ethereum specifically, and will be actively searching for investment opportunities that are positioned to benefit the most.
Disclosure: We are customers of Coinbase Prime, but do not have any direct financial interest in the success of Base. We just believe it to be incredibly positive for the ecosystem broadly.
Regulatory Updates: US is Playing from Behind
“Please note that access is restricted for IP addresses from the following countries: Afghanistan, Crimes, Cuba, DRPK (North Korea), Iran, Libya, Sudan, Syria, and the United States of America.”
This statement above, both shocking and disheartening, is copied and pasted from an application built on the Ethereum network, and is becoming a standard pop-up when attempting to access different applications in this emerging ecosystem.
Much of the news in the US regarding regulation of crypto has been, to put it nicely, negative. There appears to be both a misunderstanding of this industry by many US elected officials and regulatory bodies, and an apparent fear that blockchain, crypto, and stablecoins specifically could disrupt the status quo. Reminder to all that this is a global market, and what is very clear is that developed countries outside the US are far ahead in terms of providing both clarity and guidelines to allow this industry to flourish. Perhaps these countries appreciate the possibilities that blockchain and digital assets offer, or they see that welcoming this industry provides a potential advantage over the US in terms of Finance and Technology (jobs and influence). Either way the US continues to fall behind. Historically, efforts to protect the status quo vs. embrace new technology has been a losing strategy, and we hope the US changes course sooner than later as we already have seen significant developer talent, successful businesses, and overall activity move offshore.
This past week the House Financial Services Committee held two hearings. The first was with SEC chair Gary Gensler who has taken the stance that century old rules apply to a new asset class, regulation by enforcement is the only path forward, and that ambiguity provides the power to change the rules whenever it suits. For example, when pressed on if the Ethereum native token ETH is a security or commodity, no answer was given, despite there being years of debate, regulated futures on the token, and multiple financial services companies allowed to facilitate trading of it that are regulated by both the SEC and CFTC. This is the complete opposite approach that the EU, Hong Kong, Singapore, Japan, and others have taken (more on this below).
The second hearing was to discuss regulation for fiat-back stablecoins (1 token is backed by $1 of cash and equivalents). The size of this market is not trivial, as last year stablecoins settled more activity than Visa. Amongst others the panel included Adrienne Harris, Superintendent of the NY DFS, Dante Disparte, Head of Global Policy at Circle, and our former Citi colleague and friend Austin Campbell, Columbia Business School Professor and former head of the Paxos stablecoin (USDP and BUSD). In our view, this hearing was far more productive. The NY DFS has already issued guidelines for stablecoin issuers (Circle and Paxos) to operate in a compliant way with built in consumer protections. These guidelines have worked, and it is worth noting that failed companies such as Celsius and Blockfi were not able to operate in NY given they did not meet these guidelines. The high-level message delivered was this: stablecoins are not a new innovation, the blockchain is. Stablecoins just utilize public blockchains to provide a cheap and efficient means of transferring money around the world, promotes financial inclusion, and if done correctly would bolster the US Dollar as the dominant global currency. We are already seeing this around the world where for the first time people can access US Dollars as a haven from their local currencies. On the risk side, countries such as Russia are trying to promote their own stablecoin for international trade as an explicit attempt to reduce the influence of the US Dollar. Importantly for the committee, regulated stablecoins can also be issued in a way that limits their use by illicit actors and enforces required KYC/AML regimes. We were very impressed with this group, and certain committee members gaslighting aside, the conversation showed some promise in terms of educating members of the possibilities that provide benefits to consumers in a safe and compliant way, and the risks of failing to act.
Below are recent regulatory frameworks issued by developed countries worth noting and following:
European Union: Markets in Crypto-Asset Regulation (MiCA): MiCA is the result of 2.5 years of negotiations and political agreement that was officially voted on and adopted in European Parliament on April 20. The policy is the most comprehensive framework for crypto assets globally to date, and provides clear guidelines for token offerings, stablecoin issuance, crypto services such as exchanges and custodians, and new rules to prevent abuses for the entire industry. Importantly, it clarifies that protocols that operate in a fully decentralized manner without an intermediary (Decentralized Finance) are outside of the scope of the regulation. The key here will be the definition of “fully decentralized manner”, but this is consistent with what market participants have been asking for – centralized companies should be regulated based on the service they provide, but decentralized applications are self-regulating given they simply execute code. Prior to MiCA, companies that wanted to operate in the EU had to comply with each country’s regulator, constraining the growth of EU dominance in this space vs. their US or Asian counterparts. With the passing of MiCA, it is likely this will change, and puts pressure on the UK to adopt similar policies to keep pace.
Hong Kong: HK has recently ramped up efforts to become a global crypto hub with the explicit support of China’s state-owned banks. In late March at its government-backed fintech week, HK announced its intention to legalize crypto retail trading and introduce a licensing regime for digital asset providers. Rumors of this first started in February, and since then their department for foreign direct investment has received interest from over 80 digital asset related companies from China and abroad to establish a presence in Hong Kong. Following the US takedown of crypto-related banking in March, Hong Kong pushed to onboard impacted customers to their banks, and have been successful thus far.
Societe Generale rolls out euro-backed stablecoin on Ethereum. On April 20th the French bank announced it would launch EUR CoinVertible (EURCV), the first institutional euro-backed stablecoin deployed on a public blockchain in response to requests from their clients to improve services such as cash management, cash pooling, and corporate treasury activities. Whether the EURCV will gain adoption is to be determined, with the main point being their use of a public blockchain vs. a private blockchain. Private blockchains became all the rage in 2020-2021 with existing financial services companies without any notable success. Private blockchains are effectively a less efficient database, and do not provide the same security, transparency, and alignment of incentives that public blockchains (namely Ethereum) offer. Good on Societe Generale for acknowledging this.
Others. Singapore has been a leader on the regulatory front issuing guidelines since 2020. Japan has proven to have effective consumer protections in place as evidenced by FTX Japan customers having no losses from the broader collapse of FTX. Dubai is also actively seeking to attract crypto related entrepreneurs and market participants.
There have been a number of developments recently from a technology and regulatory perspective that we believe are extreme positives for the crypto ecosystem. Streamlined interfaces and clear guidelines that promote responsible innovation without overreach are key pieces to that end. There is still much work to be done, but progress on these fronts plus an improving technology stack have us extremely excited about the ability for this ecosystem to attract new users and accrue value to the novel protocols for which we invest in.
Thank you for your continued trust in us to navigate these types of events, and we remain steadfast in our commitment to find attractive opportunities across the crypto ecosystem with risk at the forefront of our decision making.
Please do not hesitate to reach out with questions, comments, or feedback!
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