THE GLOBAL CRYPTOASSET HUB IS LONDON?
Blockchain Coinvestors Letter From London
Vol. 1, No. 6, December 2022
THE GLOBAL CRYPTOASSET HUB IS LONDON?
Before beginning this month’s Blockchain Coinvestors ‘Letter from London’, we would like to thank all of our investors for their support in 2022, and wish you all a happy and safe holiday period and New Year.
We have recently recorded our Wrap Up webinar for 2022, which can be watched by clicking on the highlighted link. We also would like you to be aware that our two direct funds, Fund IV (Early Stage Token) and Fund VI (Mid Stage Growth) are accepting new and increased commitments, while if you have an interest in our next Fund of Funds (Fund VII), please let us know at ir@blockchaincoinvestors.com.
Now for the subject of this month’s ‘Letter from London.’
Stumbling Out of the Gate: The Post-Brexit United Kingdom
2022 has been full of twists and turns few expected. In a previous monthly newsletter, we have covered how public crypto markets receded, giving way to a painful credit crunch in the industry. This in turn exposed traders and shadow banks who were over-levered in poorly understood markets. As the dust settled, we learned that one of the most prominent companies in the space was (allegedly) a criminal enterprise from the outset. We have discovered who was swimming naked all along...
As long term, early-stage, private market investors, we also spent time focusing on the remarkable innovation steadily progressing within blockchain. The emergence of the modular blockchain thesis and corresponding rollup technology has put scalable, secure and decentralized blockchains within reach. We covered the overwhelmingly successful Ethereum ‘Merge’, which is likely the most complicated open source technological upgrade ever to occur. Finally, we took time to look at actual adoption trends, which demonstrate that digital asset adoption is on par with - or more progressed than - Internet adoption in the early 1990s. We found this to be particularly true in developing markets where the use cases for digital assets are salient and immediate.
Yet, we must acknowledge that this column’s author has thus far overlooked major developments on this side of the pond – indeed, the political economic situation in the United Kingdom (UK) has been unprecedented. Since the beginning of this year, the UK has seen near currency collapse, central bank intervention to save its pension system, and three different Prime Ministers, all of which have made the UK one of the most unstable economies in the G20. The political apparatus has struggled to navigate the post-pandemic economy and Brexit transition, fostering a growing cost of living crisis and the largest organized strikes since the 1970s [this report’s author is still waiting for a backlog of packages from the Royal Mail].
From afar, it appears the UK has stumbled out of the gate in its transition to a fully independent nation – indeed the OECD expects that in 2023 the UK will be the slowest growing economy in the G20, except for Russia.
Yet, close observers will note that in one area, the UK appears ahead of its peers: blockchain policy and industry development. In fact, despite the revolving door of Prime Ministers, UK policy makers have rolled out steady announcements and made unhurried progress toward comprehensive blockchain policy, which may go into law by Spring next year.
The UK made headlines when, in April of this year, the Chancellor of the Exchequer stated: “It’s my ambition to make the UK a global hub for cryptoasset technology”.
That Chancellor was Rishi Sunak, who became the UK’s Prime Minister almost 2 months ago on October 31, 2022.
Hence, it’s about time that in this month’s Letter from London, we focus on understanding where British blockchain policy is trending. While much remains to be decided, the UK may be positioning itself as a future leader in financial innovation and digital assets. By implementing prudent regulation for one of the most innovative industries, the UK may just find the growth it needs for its post-Brexit economy.
Steady March Toward Policy, Despite Chaotic Leadership
For anyone paying attention, British politics have been tumultuous, to say the least. Since the public referendum to leave the European Union (EU) in June of 2016, the UK political establishment has struggled to find consistent footing. Yet, policymaking with regards to digital assets – or cryptoassets as British technocrats prefer to call it – has sustained despite the inconsistency at Number 10.
Recent Timeline of Major Political Events and Blockchain Policy Initiatives:
January 2018: The UK Treasury Committee launches an inquiry into the use and regulation of cryptocurrencies
January 2019: Prime Minister Theresa May's Brexit deal is voted down by parliament, leading to a series of votes of no confidence and political turmoil
July 2019: The Financial Conduct Authority (FCA) publishes its first set of guidelines for firms dealing with cryptocurrencies, outlining the regulatory framework for the industry.
July 2019: Boris Johnson is elected as leader of the Conservative Party and becomes Prime Minister of the UK
December 2019: Johnson's Conservative Party wins a majority in the general election, allowing him to push through his Brexit deal
January 2020: The UK officially leaves the EU
October 2020: The FCA introduces a ban on the sale of certain types of crypto-derivatives to retail investors.
November 2021: HM Treasury (HMT) and Bank of England (BoE) issue a joint statement announcing plan to consult on the exploration of a UK Central Bank Digital Currency (CBDC)
April 2022: The UK government announces plan to make UK a ‘global cryptoasset technology hub’
July 2022: Boris Johnson announces his resignation
July 2022: Financial Services and Markets bill (FSM), which includes regulation of stablecoins and other aspects of digital assets, is introduced in the House of Commons
September 2022: Liz Truss confirmed as Prime Minister
September 2022: Finance minister Kwasi Kwarteng presents his ‘Mini Budget’; the pound falls to an all-time low against the dollar and the BoE announces its emergency intervention into the bond market
October 2022: Liz Truss resigns as Prime Minister after just 7 weeks in office, officially the shortest premiership in the history of the UK
October 25, 2022: House of Commons votes to add cryptoassets to scope of activities regulated via FSM
October 31, 2022: Rishi Sunak confirmed as Prime Minister
November 2022: The FSM moves to the House of Lords for debate
December 2022: The Chancellor of the Exchequer announces a set of reforms to drive growth and competitiveness in the financial services sector, including provisions related to cryptoassets
It is impressive, that in the midst of such sustained political turmoil, blockchain policy has continued its slow and steady march. We find it hard to imagine something similar occurring in the US, where legislation effectively stalls in the months running up to any election. Here in the UK, the same month that Boris Johnson resigned, the FSM, a consequential piece of legislation aimed at creating a new post-European regulatory regime, was introduced in the House of Commons. As Liz Truss was resigning, debate continued, with important amendments being added. All of this of course now culminates with Rishi Sunak, the initial inspiration behind much of the cryptoasset portion of the bill, taking the helm of the government. The Conservative party appears to have little appetite for yet another change at the top in advance of elections in two years time, effectively giving Rishi runway to implement his vision.
But what did Rishi say back in April? Is this actually shaping up to be a positive catalyst for the blockchain industry?
The Global Cryptoasset Technology Hub: Fact or Wishful Thinking?
In April this year, many were surprised when then Chancellor of the Exchequer, Rishi Sunak, unveiled a plan to make the UK a global hub for cryptoassets. To summarize, in a series of speeches and papers, Rishi and other officials at the Treasury called for:
Stablecoins to be brought within the current regulation, paving way for use as a recognized form of payment
Legislating a financial market infrastructure ‘sandbox’ to help firms innovate
A series of measures to make UK a global hub for cryptoasset technology and investment, including:
FCA-led ‘cryptosprint’
Working with Royal Mint on an NFT
Creation of an engagement group to work closely with the industry
Proactively explore the benefits of Distributed Ledger Technology in UK financial markets
Explore ways of enhancing the competitiveness of the UK tax system to encourage further development of the cryptoasset market in the UK
Review how DeFi loans are treated for tax purposes
A few months later, British politicians put pen to paper, and started debate on the Financial Services and Markets (FSM) bill, a broad piece of legislation related to economic planning post-Brexit. While the bill covers much more than cryptoassets and blockchain, many key provisions are included in the most recent draft.
Financial Services and Markets Bill (current form):
Regulation of stablecoins to pave the way for their adoption as a form of payment
Allow the government to establish regulatory sandboxes for financial market infrastructure to allow firms to experiment with new technologies and practices
Recognition of cryptoassets as regulated financial instruments
Stricter advertising rules to require crypto service providers to comply with local advertising regulations
The bill is still under debate in Parliament, and having passed the House of Commons, now moves to the House of Lords. Should the bill pass the upper chamber, Royal Assent (or the King’s final blessing) of the bill is expected in late April/early May 2023, before the end of the Parliamentary session.
Meanwhile, the government hasn’t stopped there. On 9 December, the current Chancellor of the Exchequer announced a set of reforms alongside the FSM to drive growth and competitiveness in British financial sector. In particular, the government continues to seek to “support innovation and leadership in emerging areas of finance, facilitating the adoption of cutting-edge technologies.”
In addition to supporting the current FSM provisions, the government also intends to consult on a UK retail CBDC alongside the BoE, take steps to expand an Investment Manager Exemption to include cryptoassets, and implement a Financial Market Infrastructure Sandbox in 2023.
It seems Rishi’s government is holding true to his April ambitions.
The View From London
It’s been a difficult year for British households as the economy has continuously faltered. The near collapse of the pound only highlighted how the Brits find themselves alone on the global stage; as a single nation the UK has a smaller economy unable to act independently against global financial sentiment. Economists are now are pencilling in lower long-term growth rates. It is against this backdrop that Rishi’s ambition sticks out to us. Below we outline some of our key takeaways:
Regulation Remains Key Question and Potential Catalyst for Industry Writ Large
We’ve been saying it all year, but regulation remains the largest potential catalyst in the blockchain industry. We continue to believe prudent regulation will spur innovation and foster consumer confidence while overly burdensome regulation will push activities to other jurisdictions. Lack of clarity leaves the industry in regulatory purgatory, as good actors struggle to comply with uncertain legal interpretation.
EU Moving Quickly; Contentious Fight Brewing in the US
FTX has created an absolute circus on Capital Hill. Gary Gensler’s meetings with FTX, its affiliates, and its now disgraced founder Sam Bankman-Fried have brought the SEC under scrutiny – as many justifiably question how this happened right under the noses of regulators, and whether the SEC’s lack of clarity on policy gave advantage to offshore entities such as FTX. Undoubtably, opportunists are taking advantage of the negative media attention; Senator Elizabeth Warren has released a new bill which would severely restrict the American blockchain industry; while this legislation has little chance of ever passing, it’s clear that as the Presidential election kicks into full swing in the second half of next year, blockchain could take center stage.
Meanwhile, the EU is set to have its own regulatory regime go into affect next year. As we previously covered, the most antagonistic policies – such as a proof of work ban or ban on self-custody – did not make the final cut; the regulations as a whole were relatively well received and focused on stablecoins. The EU is hoping their regulatory regime will serve as a model for the globe.
UK Well Positioned to Serve as Crypto Hub
Taken as a whole, we think the UK is uniquely positioned to lead on blockchain policy. The US has been slow to move and with the upcoming Presidential election in 2024, it’s getting harder to imagine a comprehensive bill passing before that time, aside from perhaps stablecoin-related provisions. With more blockchain advocates in Congress than ever before, we’re confident that regulation in the US will ultimately be positive for the industry. Meanwhile, while the EU has moved quickly, they haven’t moved to foster innovation.
This then appears to leave space for a newly independent, and perhaps nimbler Great Britain. While we continue to monitor developments in the UK closely, the current text of the Financial Services and Markets bill appears to live up to many of the aspirations of Rishi’s April plan. In particular we’re hopeful that the creation of regulatory sandboxes has the potential to give financial infrastructure firms the necessary time and space to adequately develop.
The City of London has a storied history in financial markets, and the UK economy is reliant on it retaining its place on the global stage. The British economy faces an uncertain future as an independent nation but it must have a City of London that is a leader in the digitalization of financial products, services and markets or it, and the entire country, will not be competitive. With Rishi leading for what appears to be at least two more years, the government may just look to this high potential industry to write the next chapter of British innovation.
Thanks for reading,
Mitch Mechigian
Partner, Blockchain Coinvestors, London
Thank you for reading.
Alison Davis
Matthew Le Merle
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Blockchain Coinvestors Fund III (Fund of Funds) was created to provide diverse coverage of the best blockchain pure play venture funds in the Americas, Asia, and Europe. Blockchain Coinvestors Funds I and II have already experienced significant appreciation. Fund I Net TVPI is 4.82x with an IRR of 67%. Fund II shows equally impressive early results with Net TVPI of 1.42x and an IRR of 42%. Almost all of our fund investments are performing as top quartile against the Cambridge Associates Venture Benchmark.
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