The securities have not been and will not be registered under the U.S. Securities Act of 1933, as amended or with any other regulatory authority of any State or other jurisdiction of the United States or Canada and (i) may not be offered, sold or delivered within the United States or Canada, or to, or for the account or benefit of any U.S. Person or Canadian, and (ii) may be offered, sold or otherwise delivered at any time only to transferees that are Non-United States Persons and Non-Canadians.

September 7, 2022

Bruxelles effect; The Merge; The Fed

Welcome to Swarm Markets’ media memo. This weekly update provides comments from Swarm Markets’ co-founders, Philipp Pieper and Timo Lehes, on key industry news that has caught our eye, plus our own developments. 

Comments available on the following news items:

  • The ‘Bruxelles effect’ of US digital asset regulation
  • The Merge is coming, here’s some important things to consider
  • The Fed can see a DeFi revolution

Want guidance on the direction of US digital securities regulation? Look for the ‘Bruxelles effect’

Crypto securities laws could follow a similar path to privacy regulation. Crucial to charting a path for legislation around the world is to understand the difference between a regulation, directive and decision, and by way of example, the spread of privacy legislation.

Privacy regulations started with an EU directive, which is a guiding recommendation. This then developed into well-known GDPR legislation, a regulation that is lawfully binding. This pioneering legislation from the EU influenced other jurisdictions and was ultimately exported to the US, what is called “the Bruxelles effect”. GDPR-like legislation arrived via California, then expanded into the wider US (dubbed the “California effect” stateside).

It may be that for digital securities trading to be adopted on a wider scale in the US that it needs a progression of adoption. In terms of current progression for digital securities regulation: Germany’s BaFin would be the first, then MiFID II (a directive) and MiCAR (a regulation). This in turn demonstrates what it does for markets, before the US regulators should proceed to adopt it.

We have other global examples of this as a regulatory adoption path. This is very much the way that the Israeli government approaches things by observing what the EU does and following its lead. I was invited to be one of six industry leaders to join a delegation organised by the German Federal Ministry of Finance to travel to Israel to share knowledge on startup innovation. In the presentations by the Israeli Finance Ministry, the appreciation for taking input from German and EU regulation is very evident from examples such as Open Banking, following PSD2.

From left to right, Swarm co-founder Philipp pieper and Dr Florian Toncar ParliamentaryState Secretary, German Federal Ministry of Finance

The delegation, comprising senior finance ministers and financial market and tech innovators

What to expect when you’re expecting The Merge

Talk of The Merge of the Ethereum network is reaching fever pitch as we get closer to it becoming a reality. There are a few things users and investors should keep an eye out for as we get closer. Here’s what we see as potential secondary impacts: 

  • miners business model will be affected overnight and could have a noticeable impact on those firms with heavy reliance on the activity
  • the Ethereum Classic price could rise in reaction – but it doesn’t have the same features as Ethereum 2.0
  • the community could fork to a third chain
  • holders should expect considerable volatility in the build up. It will likely be hard to trade so anyone with liquidity considerations might want to plan accordingly
  • uncertainty remains around redemptions and whether assets will come out at a discount – this is where liquid staking is an alternative trading option.

Essentially we’re at an unknowable inflection point for the blockchain and the wider market. No crypto or DeFi project has made such a big shift at such a critical time for markets, when the network itself is so influential. 

Working with such ‘unknown unknowns’ would suggest a degree of risk management is a sensible policy to apply to assets and functions that might rely on ETH or its related entities. It is an exciting time, but certainly won’t come without bouts of nerves for many. 

The Fed sees a DeFi revolution in TradFi

A report published by the Federal Reserve last week paints a picture where DeFi could take on much of the responsibility for global financial infrastructure currently managed by TradFi. While the paper underlines the small scale of DeFi currently, it sees a vast potential for blockchain application in the world’s financial plumbing.

The Fed notes that interoperability is a major hurdle which, once overcome, could prove a major breakthrough for DeFi technology. Critical to this interoperability is the use of stablecoins. With regulatory approaches emerging in the EU and UK in particular, we could be nearing a key tipping point for this approach. 

The other alternative the Fed proposes is a totally parallel financial system developing. This would appear a much more fanciful scenario as major stability risks are inherent in this. Adoption simply wouldn’t be practicable on such a large scale without the involvement of major financial institutions, which already exist and exert an influence. 
While there is much to digest from the report, one of the key aspects the paper sees as an issue—regulatory compliance—is more tricky for a decentralised entity to comply with. Our approach, with early-days regulation by BaFin, has been to take a regulatory-first mindset, which directly cures this as an issue.