CBDC Pilot Announced; Ethereum Upgrade Completed; U.S. Treasury Department Addresses DeFi Risks; Studies Analyze Crypto Taxation, Crime; Hacks Continue | BakerHostetler
Montenegro Announces CBDC Pilot, BIS Compares CBDCs to Stablecoins
According to a recent press release, “The Central Bank of Montenegro (CBCG) has agreed to collaborate with the enterprise crypto and blockchain solutions provider Ripple to develop a strategy and pilot programme to launch the country’s first digital currency in the form of a Central Bank Digital Currency (CBDC) or national stablecoin.” The press release notes that the project will analyze the benefits and risks of CBDCs, including “payment availability, security, efficiency, compliance with regulations, and most importantly, the protection of end users’ rights and privacy.”
In related news, the Bank for International Settlements (BIS) recently published a BIS Bulletin titled Stablecoins versus tokenised deposits: implications for the singleness of money. The bulletin compares asset-backed stablecoins to CBDCs with a focus on “singleness,” a key characteristic of money that “ensures that monetary exchange is not subject to fluctuating exchange rates between different forms of money” and enables “an unambiguous unit of account” that “allows money to serve its role as a coordinating device for economic activity.” The bulletin describes singleness as “[a] cornerstone of the modern monetary system.” According to the bulletin, stablecoins “may entail departures in their relative exchange values” in violation of singleness, and CBDCs or “tokenized deposits” are more conducive to singleness when compared to stablecoins. The bulletin also highlights other potential advantages of CBDCs, including “expanded functionality by building on the capacity of programmable ledgers to introduce contingent execution and composability of transactions.”
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Ethereum Network Completes ‘Shanghai’ Upgrade
Ethereum recently announced the completion of its “Shanghai” upgrade (also known as Shapella). This hard fork upgrade marks the completion of Ethereum’s multiyear transition from a proof of work consensus mechanism to proof of stake. Most notably, the upgrade enables network participants who had staked their ether (ETH) on the network to unstake and make withdrawals for the first time. Other technical improvements in the Shanghai upgrade are intended to improve the transactional aspects of the Ethereum network. Despite some concerns that the upgrade would cause ETH prices to drop, the price of ETH remained largely flat during the transition.
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U.S. Treasury Publishes DeFi Risk Assessment; Banque De France Analyzes DeFi
The U.S. Department of the Treasury recently published its report Illicit Finance Risk Assessment of Decentralized Finance. According to a press release, the report is “the first illicit finance risk assessment conducted on decentralized finance (DeFi) in the world.” The press release notes that threat actors “like the Democratic People’s Republic of Korea (DPRK), cybercriminals, ransomware attackers, thieves, and scammers are using DeFi services to transfer and launder their illicit proceeds” and are exploiting the fact that “many DeFi services that have anti-money laundering and countering the financing of terrorism (AML/CFT) obligations fail to implement them.” According to the press release, “DeFi services engaged in covered activity under the Bank Secrecy Act have AML/CFT obligations regardless of whether the services claim that they currently are or plan to be decentralized.” The risk assessment includes “recommendations for U.S. government actions to mitigate the illicit finance risks associated with DeFi services” including strengthening U.S. AML/CFT supervision, considering additional guidance for the private sector on DeFi AML/CFT obligations, and addressing AML/CFT regulatory gaps related to DeFi services.
In a related development, the French Central Bank recently published a discussion paper addressing DeFi risks. Among other risks, the paper cites the high volatility and complexity of DeFi products and risk of user capital loss. The paper further notes that future DeFi regulation “cannot simply replicate the systems that currently govern traditional finance” and must consider “a combination between traditional financial regulations and regulations inspired by other economic sectors.” The paper explores several proposals for mitigating DeFi risks, including strengthening the security of blockchain networks and smart contracts, further defining the legal status of decentralized autonomous organizations (DAOs), and establishing frameworks for the supervision of intermediaries that facilitate access to DeFi services.
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Study Analyzes 2022 Crypto Tax Compliance Across Various Countries
A recently published study conducted by a Swedish crypto tax firm estimates that globally only 0.53% of crypto investors paid taxes related to their cryptocurrency holdings in 2022. The study reportedly used a multistep methodology that analyzed “the relationship between the number of people who declared their cryptocurrency in their tax returns and the search volume for cryptocurrency tax-related keywords.” The study’s methodology used the search volume data “as a proxy to estimate the number of cryptocurrency taxpayers in each country where official figures … were not available” and considered the number of crypto holders in each country as reported by Statista’s Global Cryptocurrency Report.
Findings in the study include that Finland had the highest percentage of investors who paid taxes on their cryptocurrency holdings in 2022, at 4.09%, while the United States ranked 10th, at 1.62%. The study noted several potential reasons for differing tax payment rates among countries of the world, including variation in public awareness of tax reporting requirements, differences in government policies and enforcement that could affect tax reporting and collection, and that owning cryptocurrency does not always mean that taxes may be due. A report commenting on the study notes that tax experts have cast doubt on the study’s findings and methodologies, and further observes that the study itself acknowledges numerous limitations and assumptions upon which it is based that could undermine its conclusions.
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EU Report Analyzes Cryptocurrency Use on Darknet Markets
A recent report from the European Monitoring Centre for Drugs and Drug Addiction provides findings from an analysis of cryptocurrency use on darknet markets in the European Union and neighboring countries. According to the report, the darknet market (DNM) ecosystem, which “combine[s] the online anonymity-granting functions of Tor with traditional trust-building e-commerce trappings (e.g., vendor rating systems),” has grown significantly since 2011. The report utilizes Chainalysis data from 54 countries in the European Union, spanning April 1, 2019, to October 31, 2021, in reaching its conclusions. The report’s key findings include the following:
- DNM expansion grows periodically but is interrupted with market volatility.
- Most DNM activity clusters in one or two markets at any point in time.
- Moves toward larger DNM volume or higher-priced purchases are occurring over time.
- Different regions have sizable differences in total revenue engagement with the DNM.
- All regions have a similar pattern showing revenue sent to the DNM is typically less than that received back.
- There are notable gaps between the most- and least-engaged countries in the DNM.
The report notes that exchanges are “a common way of initially obtaining cryptocurrency to fund on-chain wallets” despite exchanges being governed by “know your customer (KYC) and anti-money laundering (AML) rules.” The report also notes that “[n]ot all countries in the sample have KYC and AML rules in place for exchanges working within their jurisdictional boundaries” and that “[s]ome national rules are inconsistent in design or application.” Of the 54 European countries included in the sample, eight have banned cryptocurrencies but continue to engage in DNM activity.
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Hackers Drain Millions from Crypto Exchanges and DeFi Protocol
By Lauren Bass
According to reports, hackers recently stole nearly $13 million in cryptocurrency from a South Korean centralized exchange. The thieves reportedly siphoned 61 BTC, 350 ETH, 10M WEMIX tokens, and 220k USDT – almost 23% of the exchange’s total custodial assets.
In another recent hack, a DeFi protocol reportedly suffered a similar fate when hackers withdrew almost $11 million. According to reports, hackers exploited a bug in one of the protocol’s tokens to mint 1.2 quadrillion in fake coins, and then traded the counterfeit coins for millions in stablecoins.
In a third recent hack, a Singapore-based cryptocurrency exchange reportedly lost $23 million in ETH, QNT, GALA, SHIB, HOT, and MATIC in an attack that targeted a hot wallet used by the exchange. According to reports, the compromised wallet contained less than 5 percent of the exchange’s reserves.
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