Background

The Global Crypto and Digital Currency Initiatives Series is our mechanism for tracking the global adoption rate of these technologies and platforms  – and their long-term impact on the traditional global financial system.

Moving forward, besides adoption rates, “crypto” (crypto exchanges, Defi, DAOs, etc.) will need to address:

1. Enhanced security measures; and
2. Regulation (or Overregulation).

In 2023, we will continue to track global adoption rates, but be on the lookout for a series of posts this year we as surface further research and analysis of the “disintermediation” of the global financial system, crypto (write large) and blockchain cybersecurity, enhanced security measures  – and the development of a regulatory environment of this space.

In fact, we had a draft post in the works for months with a working title of “Crypto Fraud Legal Consequences Will Need to Start Somewhere”, which was based on a report in April 2022 that New York State was mulling over a move to add crypto fraud to penal code:  “A New York state senator introduced a new bill that would add four different cryptocurrency-related crimes to the fraud section of the state’s penal code.  New York State Senator Kevin Thomas introduced Senate Bill S8839 this week and said the legislation was designed to ‘enhance consumer protections within the cryptocurrency industry ‘by giving prosecutors a legal framework to pursue crypto crimes.’  The bill specifically names four crimes – virtual token fraud, illegal rug pulls, private key fraud, and ‘fraudulent failure to disclose an interest in virtual tokens’ – and tags each with a maximum criminal fine of $5 million or 25 years in prison in most cases.” (1)

This legislation at the state level (which is languishing in Albany) was the first item to blip on our research radar after our series of posts entitled The New Normal (case studies of a few of the major cyber incidents in 2021).  Also included in our analysis at the time were new threat vectors that were met by new corporate, governmental, and legal mechanisms for response to cyber incidents of all kinds (cyber fraud, crypto theft, data breach, ransomware, etc.) – a trend in this ecosystem which continued over the course of 2022 as well.

It was clear that the New York State legislature and other signals from the regulatory entities of the financial system in New York City and New York state were the agencies to watch for early, precedent-setting legislative and legal regulatory actions of the crypto marketplace.  Keep in mind that Feds are no schlubs, however, with the February 2022 The Department of Justice (DOJ) seizure of $3.6 billion from the 2016 Bitfinex hack and arrest of a New York couple, the FBI arrest in New York in April for an alleged $1.8M crypto mining scam, and, of course, the recent FTX debacle with its ongoing investigations, criminal indictments, and trials at the state, federal and civil level – including the Bipartisan Bill that Aims to Prevent Money Laundering via Cryptocurrency Companies.

As you will find from this sampling of OODA Loop News Briefs (which captured New York-based regulatory and legal activity in 2022), New York’s Department of Financial Services (DFS) is an organization to watch if your organization is interested in up-to-the-minute risk awareness as it relates U.S. governmental regulation, as many of these events are precedent-setting nationwide (with the caveat that we still need to vet the regulatory climate in California, a state which also tends to be an early adopter):

• New York financial regulator issues cryptocurrency guidance for banks
• New York becomes the first state to restrict cryptocurrency mining
• Robinhood’s Crypto Unit Fined $30 Million by New York’s Top Financial Regulator
• PayPal gets its full New York BitLicense, and now lets users transfer crypto to external wallets
• New York’s Crypto Regulator Publishes Formal Stablecoin Guidance
• New York’s push to ban crypto mining triggers a response from the community

“Coinbase to pay $50 mln to settle NY state investigation, invest $50 mln in compliance”

A settlement on Wednesday of last week between U.S.-based cryptocurrency exchange Coinbase, Inc and New York’s DFS is where we begin in 2023 in our exploration of this emergent regulatory landscape – which this year is no longer on the strategic horizon (as the entire space is off to a rocky start in 2023 with outflows, layoffs, and a lawsuit).

OODA Loops News briefs related to Coinbase are also an interesting string to pull and can be found here.  Crypto crime is also an interesting tracking and search criterion.

As reported by Reuters on Wednesday, January 4,  2023:

“U.S.-based cryptocurrency exchange Coinbase Inc (COIN.O) has reached a $100 million settlement with New York’s Department of Financial Services (DFS), the exchange and the regulator said in statements on Wednesday.  The settlement, which includes a $50 million penalty, caps the regulator’s investigation into the firm’s compliance with requirements to prevent money laundering.  The department found Coinbase treated its onboarding requirements for customers as a “simple check-the-box” and had not done sufficient background checks, the regulator said.

‘Coinbase failed to build and maintain a functional compliance program that could keep pace with its growth. That failure exposed the Coinbase platform to potential criminal activity,’ said New York DFS Superintendent Adrienne Harris.  The exchange has addressed the problems, said Paul Grewal, Coinbase’s chief legal officer, in a statement.  In a blog post, Coinbase said the investigation centered on the company’s compliance program circa 2018 and 2019, as well as the compliance backlogs as the exchange grew in 2021.  ‘We took NYDFS’s concerns seriously and have taken substantial measures to address these historical shortcomings,’ the blog post said……The New York Times first reported the settlement.” (2)

The “shares of America’s leading cryptocurrency exchange fell to a new all-time low of $31.86 per share on December 28 before rebounding almost 7% on Thursday [12/29/22].” (3)

What Next?

• Further fines and third-party monitoring are required: “Coinbase, a publicly traded firm and one of the largest global crypto exchanges, will pay another $50 million to boost compliance efforts aimed at blocking potential criminals from using the exchange, the company said. The deal also requires Coinbase to work with a third-party monitor…”  (2)
• Coinbase remains in the regulatory crosshairs:  “Coinbase has been under scrutiny from DFS and other regulators. It has previously disclosed receiving investigative subpoenas and requests from the U.S. Securities and Exchange Commission for documents and information.” (2)
• The exponential growth of crypto exchanges equaled a collision of irrational exuberance and negative unintended consequences on steroids:  The entire crypto market is slowing down due to the recent FTX implosion, and that is a good thing.  As NYDFS’ Harris pointed out that:  the settlement is the result of Coinbase’s failure to scale its compliance infrastructure at the speed and scale of its exponential growth.  This is true broadly across the crypto exchange marketplace, so the correction by way of regulation is symptomatic of the trials and tribulations brought on by this exponential growth at speed and scale.
• Slow growth in the technology sector does not need to be heresy or counterintuitive.  Quite the contrary, it should also be considered as an opportunity for advantage.
• What does Cathie Wood over at Ark Invest Know that we don’t?:  “There’s no stopping Ark Invest, the investment house led by Wall Street veteran Cathie Wood, from pursuing its long-time dip-buying strategy as the firm snapped up another 158,116 shares of Coinbase shares (COIN) on [12/29/22].  The purchase is worth almost $5.5 million based on COIN’s price of $34.78 at the closing bell.  According to Ark’s daily trade information newsletter reviewed by Decrypt, the entire purchase was allocated to the ARK Fintech Innovation ETF (ARKF), which invests in equity securities for companies in the fintech space.  This represents Ark’s largest purchase of COIN since December 14, when the firm bought a total of 296,578 Coinbase shares worth more than $11.9 million to its funds.  This was followed by two smaller purchases last week, with the firm grabbing 5,000 and 23,509 COIN on December 22 and December 23, respectively.” (3)

Crypto, The Future of Money, Blockchain and National Security

Finally, the most important filter we will be applying to this space in 2023 is regulation and overregulation as it relates to national security.  OODA Loop CEO Matt Devost put a ‘stake in the ground’ on the subject in his post last year – Is Bitcoin a National Security Risk? – which expressed his general concern that overregulation of bitcoin would stifle American innovation and the strategic opportunities for advantage through the “future of money” and the underlying blockchain technology.  The collapse of FTX since Matt’s initial post, unfortunately, will severely pivot regulators in the direction of something that either feels uncannily similar to or is a clear movement toward an environment of overregulation (which is also clearly having an effect on innovation).   We will try to review and quant these impacts and outcomes as they emerge in 2023.

Also, various perspectives on “crypto’s threat to national security” have been voiced by the DOJ crypto chief, the CEO of Coinbase (‘crypto is up there with chips and 5G as a matter of ‘national security‘), and the Chair of the Commodities Futures Trading Commission (CFTC).  And DARPA, of course, is on the scene with research efforts we took a look at back in November.

We will synthesize these perspectives relative to Matt’s initial concerns in the weeks and months ahead.