2018 February 12 - Volume.2 Issue.6

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2018 February 12 - Volume.2 Issue.6

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Grayscale Diversifies Products With Cryptocurrency Basket Fund

Barry Silbert, CEO of Digital Currency Group (DCG) announced last week at the Yahoo Finance All Markets Summit that its asset management business arm, Grayscale, has launched its 4th cryptocurrency investment product, the Digital Large Cap Fund, compromised of a basket of 5 cryptocurrencies – Bitcoin, Ethereum, Ripple, Bitcoin Cash and Litecoin. 


The Digital Large Cap Fund (DLC) started off on 1 February with $4Mn in Assets under Management (AuM). In comparison, Grayscale launched its Ethereum Classic Investment Trust, and the ZCash Investment Trust with $10Mn and $15Mn respectively last year. Both of which have made dream returns for accredited and institutional investor who have used Grayscale as a conduit to the cryptocurrency markets.

The name of the fund implies that the underlying cryptocurrencies will aim to represent 70% of all digital assets traded on the market (see chart 1). And Grayscale will remove or add assets every quarter to meet this target level. The current chosen cryptocurrencies, Bitcoin, Ethereum, Ripple, Bitcoin Cash and Litecoin, have maintained their status in the Top 10 for the better part of 2017 and have consistently been at this target for the last few months.

|| BETTING ON BITCOIN

On 1 February 2018, the total AuM across all of Grayscales investment funds totalled an impressive $1.763Bn. And over 93% of that was in Bitcoin alone. The four new cryptocurrencies added to the Digital Large Cap however, represent only 0.12% of the total AuM across all of the firms’ funds (see chart 2).

The basket of cryptocurrencies will be heavily weighted with Bitcoin and Ethereum – a total of 79.1% of the total AuM of the fund while Ripple, Bitcoin Cash and Litecoin will only account for 20.9% (see chart 3).

|| SIZE DOESN'T MATTER

But regardless of size, the fund could very well perform in grand fashion. Diar number crunching of historical prices shows that had the DLC Fund started alongside the ZCash fund, only a few months ago towards the end of October 2017, the basket Fund would have actually outperformed all of Grayscale products. A 3-Month hypothetical return at the start of February would have been a whopping 163% return, albeit a downturn in the cryptocurrency markets since Mid-January. And the funds AuM would be close to 3 times its inception value.

While Grayscale views Bitcoin as digital gold, Ethereum Classic as the platform that could drive the Internet of Things (IoT) and ZCash as a privacy coin that could potentially be the next offshore wealth haven, the DLC seems to address a growing demand in the cryptocurrency markets. Michael Sonnenshein, Managing Director of Grayscale tells Diar that “the goal with DLC is to provide investors with a singular investment that gives them broad market exposure."

1: Grayscale Digital Large Cap Fund Targeting 70% Market Cap (%)


2: Grayscale AuM Across All Funds on 1 Feb 2018 (USD)


3: Grayscale Digital Large Cap Fund Composition ($4Mn)

Note: BCH – 6.8%, LTC – 2.5%


4: *DLC Fund Hypothetical 3-Month Return (1-Nov-17 – 1-Feb-18) (%)

GBTC ETC Trust ZEC Trust DLC Fund*
41 142 63 163


Note: *Assuming DLC Fund Started Same Date As ZEC Trust. 
Sources
: Grayscale, Diar, CoinMarketCap

Cryptocurrency Exchange Thefts Pass $1Bn Mark

Italian based exchange, BitGrail, announced last week the theft of 17Mn Nano coins. The estimated value at the time of theft is between an eye-tearing $175-200Mn, making it the third largest hack in crypto history. But concerns are being voiced by the Nano team that not all is as it seems calling possible foul play by the exchange operators. The developers are awaiting the wallet addresses from BitGrail in order to facilitate a freeze of stolen funds on exchanges. Only 9 exchanges trade Nano at present, but the cryptocurrency has been gaining traction following a rebrand (formerly RaiBlocks) and free transactions.

The BitGrail hack brings the total cryptocurrency exchange thefts well past the $1Bn mark – 60% of which has taken place in the last 15 days alone (see table).

Select Major Heists Take Lions Share of Exchange Thefts

Period Exchange Cryptocurrency USD Value
Jan-18 Coincheck NEM 496.850.000
Feb-14 Mt. Gox BTC 357.500.000
Feb-18 BitGrail XRB 175.000.000
Aug-16 Bitfinex BTC 67.662.140
Other* BTC 31.336.884
Total 1.128.349.024

* See All Exchange Thefts Here: Diar, 29 January 2018

Bitcoin Price Proves Resilient Against Centralized Hacks

Hacks on centralized exchanges have had limited effect on Bitcoin’s short term and long-term price Diar number crunching shows. With the possibility of stolen coins being blacklisted and blocked from being deposited by exchanges who wish to remain compliant with Anti-Money Laundering and Know-Your-Client (KYC) regulations, fiat off-boarding mass sums, while not impossible, becomes tricky.


Diar found that at least 1.43Mn BTC have been previously involved in theft, which account for approximately 12% of all bitcoins in circulation (Diar, 18 December 2017).

The majority of cryptocurrencies, including Bitcoin, are pseudo-anonymous and therefore, the coins can be tracked with Blockchain analysis. The stolen cryptocurrencies are actively monitored and the exchanges are instructed not to accept any deposits in stolen coins. Since all of the exchanges with enough liquidity are KYC compliant, the stolen coins are essentially rendered useless and the supply is effectively decreased.

Diar looked at ten of the largest Bitcoin hacks from exchanges and analyzed the effect that the hacks had on the price (see table). Even though the hacks introduced increased volatility on the markets, the price developments showed that Bitcoin is actually quite resilient against exchange hacks – even in short term. The effect of exchange hacks on Bitcoin’s price are not profound. The ecosystem seemingly, shrugs off the incessant amount of breaches against exchanges. Of course – this is not the fault Bitcoin infrastructure but the security measures, or lack thereof, adopted by exchanges.

Frequent exchange hacks incentivize Bitcoin holders to manage their private keys themselves and thus makes them trade less often and rather hold long term. The thefts diminish the trust in centralized exchanges and consequently increases the trust in a decentralized cryptocurrency that can be managed by users individually. But even decentralized exchanges haven’t found much of an audience and account for a negligible 1% of traded cryptocurrencies (Diar, 5 February).

Bitcoin Prices Post Exchange Hacks

Exchange Date BTC Stolen USD (Date of Theft) BTC Price 1-day effect 3-day effect 15-day effect 1-year effect
Mt. Gox February 25, 2014 650,000 $357,500,000 $534.71 7.93% 1.72% 18.08% -55.63%
Bitfinex August 2, 2016 119,756 $67,662,140 $552.82 2.25% 4.00% 3.42% 409.09%
PicoStocks November 30, 2013 5,896 $6,633,000 $1,124.76 -15.81% -4.99% -21.81% -66.47%
Bitstamp January 5, 2015 18,886 $5,193,650 $272.95 4.63% 3.77% -22.89% 58.36%
Cryptsy January 15, 2016 13,000 $5,005,000 $358.77 8.05% 7.55% 5.06% 129.23%
Yapizon April 26, 2017 3,816 $4,903,560 $1,284.84 3.45% 3.28% 40.67% -
OKEx October 30, 2017 600 $2,642,400 $6,121.80 5.32% 14.84% 7.79% -
BTER February 15, 2015 7,170 $1,684,950 $234.33 -0.33% 0.80% 15.80% 70.48%
Bitcurex October 28, 2016 2,300 $1,587,000 $688.10 3.60% 1.35% 2.25% 733.14%
KipCoin February 17, 2015 3,000 $735,000 $243.60 -3.03% 0.07% 11.63% 70.59%

US Regulatory Agencies Look to Concert Efforts on Cryptocurrencies

The US Securities and Exchange Commission (SEC) and US Commodity Futures Trading Commission (CFTC) Chairs, Jay Clayton and Christopher Giancarlo, testified infront of the US Senate last Tuesday in a session that looked to address concerns about virtual currencies. While the SEC and CFTC promised to protect US investors from fraudulent Initial Coin Offerings (ICOs), it was the shared view amongst the two regulators that they currently lack sufficient legislative powers, and that a broader coordinated effort with other agencies such as the Financial Crimes Enforcement Network (FinCEN) would be required. But will it be enough with the global outreach of cryptocurrencies, and the fairly self-side-lined regulators around the world?  


CFTC Chair Christopher Giancarlo was heralded by many as a new hero after the Bitcoin and cryptocurrency community tuned in to listen to the Senate hearing on virtual currencies last week. Mr Giancarlo who was seemingly upbeat about the prospect said “The 20-year “do-no-harm” regulation on the internet brought huge investments in internet companies and infrastructure. It brought mass adaptation, innovative technologies and revolutionized almost every aspect of life. I believe that we should also apply this “do no harm” regulation to distributed ledger technology”. Mr Giancarlo pointed out that regulating a market like Bitcoin and cryptocurrencies is a challenge that "requires new thinking" due to its international nature.

And his SEC counterpart Mr Clayton didn’t take a hard-line either against cryptocurrencies but stated that “semantic gymnastics” on whether or not a cryptocurrency is a security will not be tolerated by his agency. And most of the cryptocurrencies he has seen, are indeed securities.

But the global nature of cryptocurrencies and ICOs that have raised over $5Bn since 2017 (see graph) make a single country, let alone a single regulator as the sole authority almost impossible. Some countries have harnessed the new economic paradigm, such as Switzerland, whilst others, like South Korea, have banned ICOs all-together.

ICOs Raise Over $7Bn Since 2017 ($)


Source: TokenData.io, Diar


An idea did emerge last month at the World Economic in Davos when French President Emmanuel Macron said “I am in favor of the IMF having the mandate to monitor the entire international financial system, of which some areas escape regulation, like bitcoin, cryptocurrencies or shadow banking, which can trigger crises.” But the IMF hasn’t said that it wants the role of the policeman as of yet.

And while the SEC has amped up its rhetoric and actions against possible fraudulent ICOs, so have other regulatory agencies – each with a different opinion on which law was in fact broken (see table below).

There was a consensus between the two regulators that they may actually require more legislative power. However, with the lack of coordination between regulatory authorities, it’s difficult to assess who would indeed have authority and oversight over the digital currencies and assets market (see table 2 below). And that’s not necessarily the mistake of the authorities as cryptocurrencies can fall in all of the various classifications – currency, property, asset or commodity. What next steps will be taken remain unclear.

US Regulators Actions on Bitcoin & Cryptocurrencies

Regulator Date Action/Guidelines/Statements
FinCEN 18/03/2013 Released guidance saying that “convertible” virtual currencies are within its jurisdiction - even for non-US entities that provide services to US persons. Token issuers and exchanges that deal with convertible virtual currency must register with FinCEN as a money transmitter and they are subject to FinCEN’s regulations.
FinCEN 05/05/2015 Ripple Labs, who are the creators of the cryptocurrency XRP are charged with "wilful violation" of the Bank Secrecy Act and failure to adhere to AML Law. The company was fined $700,000.
FinCEN 27/07/2017 Fined BTC-e $110Mn for facilitating transactions involving ransomware, computer hacking, identity theft, tax refund fraud schemes, public corruption, and drug trafficking
IRS 29/11/2017 Coinbase ordered to report 14,355 users to the IRS
SEC 23/07/2013 Issued an alert warning investors to be on the lookout for Ponzi schemes involving virtual currencies
SEC 07/05/2014 Issued an alert to investors warning about the risks of trading virtual currencies
SEC 04/10/2015 Ceased a $32Mn cryptocurrency investment scam (US Fine Investment Arts)
SEC 25/07/2017 Some tokens may be securities and are thus subject to the federal securities laws
SEC 29/08/2017 Issued a warning about public companies making ICO claims and suspended trading of four companies
SEC 26/09/2017 Announces creation of a Cyber Unit targeting cyber-related misconduct including ICOs
SEC 29/09/2017 Charges ICOs REcoin and DRC with defrauding investors
SEC 01/11/2017 Celebrity endoresments of ICOs might be unlawful without the proper disclosure
SEC 04/12/2017 Emergency asset freeze to halt fraudulent ICO PlexCoin as Cyber Unit takes its first action
SEC 11/12/2017 Calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security
SEC 30/01/2018 Attempting to conceal what we allege to be fraudulent securities offerings under the veneer of technological terms like ‘ICO’ or ‘cryptocurrency’ will not escape the Commission’s oversight or its efforts to protect investors.
CFTC 02/06/2016 Orders Bitfinex to pay $75,000 for failing to register as a futures commission merchant and for other trading violations
CFTC 01/12/2017 Allows Bitcoin futures trading on three exchanges
CFTC 24/01/2018 Sues three virtual currency operators for fraud

US Regulators Opposing Views on Cryptocurrency Class

Year Country Regulator Classification Remarks
2013 US FinCEN Currency An administrator or exchanger is an MSB under FinCEN’s regulations, specifically, a money transmitter.
2014 US IRS Property For federal tax purposes, virtual currency is treated as property. Under currently applicable law, virtual currency is not treated as currency.
2015 US CFTC Commodity Bitcoin and other virtual currencies are encompassed in the definition and properly defined as commodities.
2017 US SEC Security Virtual coins or tokens may be securities and subject to the federal securities laws.

ECB: US Futures Could Lead EU Banks to Hold Bitcoin Positions

Bitcoin continues to creep up in every possible financial event. Last week, the discussion of Bitcoin and cryptocurrencies was raised by several speakers at the European Parliament in Strasbourg. And it didn't fall off the radar by European Central Bank (ECB) President Mario Draghi who said "recent developments, such as the listing of Bitcoin futures contracts by US exchanges, could lead European banks too to hold positions in Bitcoin, and therefore we will certainly look at that." And while the executive team of the ECB remain skeptical of the unregulated space, no actual task action plan has taken shape – unlike the recent US Senate hearings, and actions taken by various regulators.

ECB Finally Eying Central Bank Digital Currency?

Yves Mersch, a member of the ECB’s executive board, said he and other members of ECB believe that there is a strong case for regulating cryptocurrencies to ensure that any potential risks are contained. Mersch told Bloomberg that if the price of cryptocurrencies were to collapse, it could drain liquidity from the real world, which then becomes a concern for the central bank. He believes that unregulated exchanges should “report transactions in a harmonized way to repositories so that we would have access to information.” Despite its concerns, the ECB is looking at its own virtual currency but Mersch emphasized that it would be “more of a digital version of cash rather than a bitcoin-styled revolution”.

Binance Goes Down
Binance, a cryptocurrency exchange with more than 6 million users, suspended trading and halted withdrawals of funds for more than a day. Binance had undergone an unscheduled system upgrade as a result of a server issue - but it was enough to spread hacking fears.

Gibraltar to Introduce ICO Law
Gibraltar Financial Services Commission (GFSC) said that lawmakers are discussing a bill that would directly regulate the promotion, sale and distribution of ICO tokens. Amongst other requirements, the regulation will require full disclosure to ICO investors.

Arizona Passes Bill to Accept Tax in Crypt0
The Arizona Senate passed a bill in an effort to allow residents pay their income taxes with cryptocurrencies. If the bill is adopted by the House of Representatives, Arizona would allow tax payments in cryptocurrencies by 2020, following the lead of Chiasso, Switzerland.

Mike Novogratz To Start Bitcoin Merchant Bank
Former Goldman Sachs partner Mike Novogratz has raised $250Mn in a private investment round in an effort to launch a Bitcoin Merchant Bank in a complex structure and takeover that aims to be a publicly traded company on Toronto’s TSX Venture Exchange.

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