December 16, 2021 • 24 mins
In episode 8 of KPMG in Canada’s state of cryptoassets podcast series, Host and National Lead, Digital Services Adam Rodricks is joined by Kareem Sadek, Partner, Technology Risk Consulting; Kunal Bhasin, Senior Manager, Technology Risk Consulting; Mitchell Nicholson, Manager, Technology Risk Consulting; and Ken Viegas, Consultant, Technology Risk Consulting to take a look back at the big stories from 2021 and look ahead to what may be in store for the crypto space in 2022.
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Episode Transcript
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(00:00):
Hello, everyone and welcome back to KPMG in Canada's state of cryptoassets podcast series. After a brief break, we are back with a very special episode, focusing both on the year that was for cryptoassets in 2021 and what could be in store for 2022. For today's episode, I am very excited to welcome back Kareem Sadek, Kunal Bhasin, Ken Viegas and Mitch Nicholson, all of whom have become mainstains in the series. So first and foremost, welcome gents. It is a pleasure to be back with each of you, Maybe to get us going, Kareem - crypto seems to be everywhere these days. Can you talk a bit about how adoption picked up in 2021?
(00:46):
Thanks, Adam and I'll be honest with you - we've done a lot of these PodBytes together and I'm very excited whenever we're looking back or we're just talking about what we're going to see in the future. It just becomes more of a casual discussion, so I'm looking forward to a lot.
Maybe I'll jump right into it and I'll just say that we've all seen such huge uptick and adoption. I mean, there's several major players entering the space. However, what we saw in 2021 might just be the tip of the iceberg when it comes to adoption; when I say it's, it's sort of like the tip of the iceberg or there's an uptick in adoption, it's broad right? There are many types of adoption that we've seen.
(01:31):
I want to start off with the team and we've seen together guys; we've worked together through many, many different discussions, engagements, projects, so, maybe I'll start off with Kunal. Maybe you can get us going; let's start off with institutional adoption. I'm just curious about your thoughts in terms of what happened in that space over 2021.
(01:55):
All right thanks, Kareem. Hi, Adam - very nice to be back. When we talk about institutional adoption, I think 2021 was a landmark year for adoption by institutions. We saw a lot of key milestones being achieved this year. The different ways that institutions are getting involved with the cryptoasset ecosystem is just amazing to see.
(02:23):
One of the ways that we have seen how institutions are engaging themselves in crypto assets is they are getting direct exposure to these crypto assets. When you think about direct exposure, think about any organization that is investing their corporate treasuries into cryptoassets directly. We've seen hedge funds, family offices, insurance companies and even a lot of these companies that are adding crypto punk NFTs to their to their art collection. This is how they're getting a lot of the data direct exposure in crypto assets.
(03:02):
We've also seen indirect exposure from these institutions. We've seen one of the large Canadian pension funds with its private equity investment in a top crypto exchange in the U.S. and we've also seen retail creating applications, adding crypto assets services and providing those services to their retail clients, allowing their clients to buy and sell crypto assets directly from their platform. We've seen banks exploring crypto custody and how they can engage in the crypto asset ecosystem as well. We've also seen NFTs being sold that these large international art galleries. I think a lot of this is to do with just how the market infrastructure is maturing for crypto assets. In Canada, we recently saw one of the large asset managers start to provide crypto custody services for institutions, and they are regulated, so that was that was a huge milestone for the industry as well.
(04:13):
Yeah, thanks Kunal. You know, even outside the increase in institutional adoption, we as a team and broader consumers, we've seen some measurable increases in in retail adoption.
You've talked a little bit about the institutional side of NFTs and all of that, but even as a consumer or just a retail Investor, Mitch, Ken, what are you seeing? What do you think about what's been happening in that space?
(04:43):
For sure. Thanks, Kareem. There's been a significant amount of retail investors flooding into the crypto space over the last year. We've seen significant revenue from trading coins like Doge and Shiba Inu, as they're becoming more available on different exchanges. We've seen an influx of NFTs; NFTs have been some of the hottest tradable assets out there within the crypto space right now. Throughout September, there's been new projects with music artists, video games, and art, all have been making headlines within the media for some serious price tags.
(05:19):
Right, Ken and I've certainly been seeing it everywhere. That is terrific. You know, I think our listeners will agree that it is impressive to not only hear the different types of institutions who are adopting crypto, but also the different ways in which they are adopting crypto. So, as we head into 2022, do you anticipate adoption will increase? And if so, why do you feel this way? Mitch, why don't you get started?
(05:43):
Sure. Thanks Adam. Yeah, let's start on the institutional side. Kunal also gave some background; we had corporate treasuries, insurers, hedge funds get in the space. I think the next wave of institutional buying is gonna come from the larger investors, the pension funds and the sovereign wealth funds.
On the sell side, they're just starting to get involved in the space and I think that that trend is going to continue much more quickly in 2022. Traditional, financial institutions, brokerages, custodians - we're going to see the growing demand from the buy side from the investors, encouraging action from the sell side to provide their products and services.
(06:18):
Also, the sell side, I think, is going to face growing pressure from competitors as they all begin to race to provide these services. And as what we've seen so far with the existing traditional financial services in the space, it's the earliest movers who tend to capture significant market share. Likely, there'll be significant mergers and acquisitions activity by traditional companies for crypto startups.
I also think the meta verse in 2022 is going to be massive. The meta verse is really a combination of different technologies (06:45):
augmented reality, virtual, NFTs and crypto. There's been massive growth in developing products for consumers online. Submersive games like Axie Infinity, where it's a play to earn model, is going to bring in tons of users in 2022,
(07:09):
Social media technology companies are getting into the meta verse space and NFTs in the same way traditional finance companies are being disrupted by and adopting DeFi. So 2022 will see many technology companies offer products and services directly related to the meta verse.
Yeah, I totally agree, Ken. I think there's, there's so much happening in the meta verse space. It's just absolutely amazing to see. I mean, people are buying real estate in the meta verse. They're buying apparel and accessories in the meta verse where it's really, really exciting to see.
(07:46):
Yeah, I'll tell you guys – when first reading about this, I'd even talk to my partner and she was saying “I don't think anybody's going to be using that”. If history has sold us anything just in terms of what we've seen with crypto and adoption, I think it's a very interesting space and I think that we're going to continue to see a lot of it in 2022 for sure.
(08:12):
So that, so that's all great. I mean, we'd be remiss if we're thinking and talking about the increased adoption. It's equally important to discuss some of the regulatory changes that quite frankly, we saw come into effect in 2021 and they both accommodated and fueled the wider adoption in general.
I think it's fair to say that many of these changes have gone a long way to further legitimize crypto. I don't know if you all agree with me, but I think that's sort of the viewpoint or what we've seen overall. I mean, one of the most recent ones is a good example is coming out of El Salvador where not too long ago, they became the first country to approve Bitcoin as a legal tender. So with changing or legalizing that tender status, I think we've seen what that has done (08:34):
an increase in access to Bitcoin for many people and businesses around the country. But it's increased growth in the lightning network for scaling as Bitcoin everybody knows or heard like, Bitcoin is a layer; transaction fees tend to be very expensive and slow to settled. So, I think more likely we're going to see benefits in developing countries, just relying on dollars to adopt stable coins. Especially on the sort of performance block chain, like Solana and Eth Layer 2, we're going to see a lot of these changes coming through.
(09:43):
Thank you for that, Kareem. I know this is one of the more noteworthy examples of regulatory change and I'm curious to hear about some of the newly introduced regulations that stick out to each of you. So Kunal, why don't you start us off.
Yep, thanks Adam. In the regulatory space, my personal opinion is the more regulated the space is, the more clarity we have in what we are able to do and what we are not able to do. We've seen regulators provide more and more clarity. Especially in 2021, from a security standpoint, we saw ETF approvals. Canada was one of the first North American countries to actually prove a spot ETF for Bitcoin and Ether. We've seen in the U. S. recently a futures-based ETF being approved as well. We're continuing to see other ETPs being created in Europe and Germany as well.
(10:47):
You know, we have seen the growing attention and the scrutiny from securities regulators around the globe. Although, there is limited action currently in this space and based on our experience working with some of these providers in the space, they're doing everything they can, keeping in mind the investor protection aspect of it. So, I think everyone wants to play by the rules. It's just the more clarity we get in these rules, the better it is for the space.
(11:19):
We've seen more guidance coming from the Financial Action Task Force, FATF, around their travel rule for AML.
We've seen this guidance being applied across the various regulatory environments across the globe, be it FINTRAC, FinCEN in the U.S.; these are primarily requirements to DeFi, especially for the autonomous code executed via smart contracts.
(11:45):
We've also seen quite a bit of regulatory clarity and these updates in a stablecoin market. The stablecoin market has grown tremendously over the past year. I believe it's now over over 120 or over $130 billion in reserves. We're seeing a lot more stable coins gain adoption because we know in the past, it was primarily Tether, which recently also settled its case with the CFTC. We're seeing enterprise stablecoins come up from traditional banks and technology companies as well.
(12:25):
All of these stable coins have increased their transparency of reserves. They're providing detailed information on their monthly attestation reports, also known as the proof of reserve reports. We've seen these companies display what their composition of holdings are, right? Some of them even break down to the credit ratings of the assets held by them. Based on what we've seen so far, PAX, which is from Paxos, is the most transparent and conservative in its reserve policy.
(13:01):
Despite all of this progress, we know that the Ontario Securities Commission has disallowed the use of Tether on crypto exchanges in Canada; a lot of updates and clarity coming in and we're continuing to see what we can and cannot do and where that lining is.
I think that's an understatement. I mean, there really have been just an onslaught of regulatory changes implemented in 2021. Kareem, I'm going to start with you for this one. Do you anticipate the number of regulations implemented to be similar in 2022? What does this number of regulatory changes say about the crypto industry? Is there any underlying message?
(13:43):
I mean, that's a that's a good question. I think is it gonna be the same or more? I can give you a few examples of where we think it's gonna go. So, when you think about the DeFi space, there’s probably harsher securities regulation on DeFi and I think that's where you're gonna see that industry split.
So, on one side, you're gonna have regulatory compliant apps and the other side, you’ll have others a little bit by the anonymous founders that are just globally distributed and governed by Dows.
(14:11):
So that's going to be a little bit different when it comes to the regulation on the DeFi space. I think it's, it's fair to say that users and countries in general that are going to have more of these stringent regulations are just going to suffer more. That’s just the reality of it as stricter, harsher security regulations on DeFi come about.
(14:35):
The other thing - I think they're going to see more about around stablecoin issuers. I think they're going to be forced to meet high regulatory requirements. I think it's including even obtaining a, a banking charter. We believe that's where things are gonna evolve; it's just going to require just more transparency requirements about reserve holdings, perhaps a set of permissible reserve assets.
(15:03):
The last thing is around tax enforcement. So there are two sides to that when it comes to tax and when we talk about tax. I think we're going to see widespread investigation on underreported cryptocurrency holdings. That’s honestly just driven by just the mass adoption and rising valuation. I think that's bound to happen. You're going to see more and more. We've seen that in 2021. We're going to see more of that in 2022.
The flip side of it (15:31):
I think that when we're talking about the tax performance, there’s gonna be more regulatory clarity. And I think Kunal talked a lot about that. With that regulatory credit clarity, it is going to give more clarity on the applicability of taxes for crypto transactions because there are many different variations of crypto transactions. Especially for complex transactions, like providing liquidity due DEXs or even experiencing a rug, which, as a consumer, maybe at some point, or an investor, you've actually experienced that. I think you're gonna see a lot more clarity when it comes to that from a tax perspective.
(16:10):
So, what I'm hearing is that, at least generally speaking, these regulatory changes or enhancements, if you will, there are positive sign for the industry. Now, we have all danced around one thing throughout this entire episode. And that one thing is, of course, technology, innovation and DeFi. Mitch, I know this is going to be a bit of a tall ask, but can you kick us off with some of the major innovations that we saw in 2021 in the DeFi space?
(16:34):
Yeah, sure I'd love to. DeFi, decentralized finance, is really about the applications built on top of crypto networks like Ethereum that enable more complex transactions.
So, for example, a money market, a decentralized money market like Aave or Compound, it gives the ability to borrow and lend tokens peer to peer where lenders contribute capital to a pool that borrowers can then borrow from.
(16:59):
And the application is like the intermediary the way a bank would be normally for lenders with customer deposits, and then borrowers, like, people trying to obtain a mortgage.
The pool's utilization, the capital in there, determines the interest rate that is paid to the lenders.
(17:20):
The borrowers, if they want to take money out, they actually have to overcollateralize their loan. So, for example, if they bought 100 dollars worth of stable coins, they would have to post maybe 150 or 200 dollars worth of Ethereum.
I know Kareem talked about tax just before; this is a strategy people are using to be able to have dollars or stablecoins, but still hold on to their cryptoassets.
(17:48):
Another type is decentralized exchanges, DEXs, which Kunal mentioned. Those allow users to swap their assets peer to peer rather than using a company or a centralized exchange. One key benefit here is that users get to retain custody of their coins and that avoids the risk of the exchange or trading venue being hacked.
(18:10):
The last type that's really interesting is decentralized asset managers, where they create similar bundles of tokens that resemble almost an ETF, where these baskets of tokens enable broad market exposure. They can even use the decentralized exchanges to rebalance the weights of the tokens.
We've spoken about governance before. The governance token holders can vote on new types of ETFs or changing the structure, maybe adding 1 token in there or removing another. Now, that's at the application layer for DeFi; more generally at the protocol layer, I've spoken a lot about Ethereum, but there's been the emergence of alternative layer ones.
(18:54):
So those are other block chains, such as Avalanche, Solana, Luna, or Phantom where they are other block chains that have applications built on them. Some may be the same application such as Aave being on both Ethereum and Avalanche or a new native application.
(19:15):
What's interesting is each of these layer 1 protocols have an ecosystem fund, or basically a set of tokens that are used to incentivize adoption where users of the platform will be compensated in terms of rebates or extra rewards for trying out the applications on the platform and the goal there is to help drive overall adoption. I'll throw it over to Ken to talk a bit about some of the data we're seeing in terms of the usage and the total value locked.
(19:48):
TVL, total value locked, has been increasing since October 2020. The amount of money that's being locked within smart contracts is incredible. This really just shows that people are interacting within these ecosystems. Mitch mentioned, there's been a rise in alternate layer 1s outside of Ethereum, Avalanche, Lana, Luna, Phantom; this has been enabled by the Ethereum virtual machine being all of these applications are usually EVM compatible. A lot of the work that's going into Ethereum is not going to waste on these other layer 1s. What these applications can be brought across and be made more efficient. We have lower fees, we have higher throughput and it's really incentivizing users to stay on the platform or stay on the network and interact more frequently.
(20:46):
We've also seen some link liquidity incentivization programs where layer 1s give applications tokens from their ecosystem fund to incentivize end users for interacting with their applications. Phantom and Avalanche have programs of in excess of 250,000,000 and tens of billions of dollars of assets have been bridged from Ethereum to these alt layer 1s.
(21:08):
That's so interesting; as you're going through the numbers (and I’m obviously aware of them), when you're saying them out loud Ken, the numbers are incredible. If I may ask a question, we've seen a lot of these, the total value locked increasing and the dollars that are flowing into this. 1 thing you were saying - liquidity incentivization programs. I'm just curious - It's not something that that I would know about, but curious to know your thoughts in terms of whether these platforms are going to continue to incentivize people with their tokens or otherwise going into 2022 and maybe even broader to 2023.
(21:59):
Yeah, I can start off there. It's a very competitive landscape where there's users growing by the day, but each protocol is really vying for their attention and vying for the applications to build on their platform. It's almost like having an app store that's empty and trying to encourage applications to come there.
(22:22):
It really empowers the users and rewards the users for being open minded and trying out different applications and platforms and exploring. I think that's one appeal of crypto and DeFi is there's a lot of learning involved continually.
No, great. Thanks. A lot of incentives, but there's a lot; I can see that throughout a lot of uptick and adoption in general.
(22:46):
I can see that as well. I am curious though, and, you know, understanding from what your responses will be, this is probably speculative, but should we expect to see as much innovation in 2022? Ken, what do you think?
Definitely. I think we're gonna see even more innovation in 2022. I think 2022 is going to be a massive year for DeFi and the whole crypto eco system as a whole. We're going to see institutional adoption of DeFi increase exponentially and applications like Aave, Ark, where institutional lenders can select a whitelisted group of borrowing counter parties. These will become more attractive to them. With these institutions coming in, we're going to see an influx of capital, so that's going to compress the yields overall but that's going to be still way more competitive than traditional finance. We're gonna see quicker solutions for bridging assets across chains, including be able to hold collateral on one chain and then use borrow assets on another so more interrupt. More interoperability will also be applied to Bitcoin directly, rather than relying on a trusted intermediary with WBTC or wrapped BTC.
(23:59):
I love that and the excitement is down right when you say it, so we've got a lot to look forward to. Kareem, Kunal, Ken and Mitch, this has been a downright impressive time for me to just hear about not only some of the big stories from the world of crypto in 2021, but also, some of your predictions for 2022.
Unfortunately, that does bring us to a close for today's episode but before we go, I want to extend my most sincere thank you to each of you for joining us today. I know our listeners have enjoyed your insights as much as I have. To our fantastic community of listeners across all platforms, thank you once more for tuning in, be sure to check us out next time on KPMG in Canada's series on the state of cryptoassets. Bye, everybody.
Hello, everyone and welcome back to KPMG in Canada's state of cryptoassets podcast series. After a brief break, we are back with a very special episode, focusing both on the year that was for cryptoassets in 2021 and what could be in store for 2022. For today's episode, I am very excited to welcome back Kareem Sadek, Kunal Bhasin, Ken Viegas and Mitch Nicholson, all of whom have become mainstains in the series. So first and foremost, welcome gents. It is a pleasure to be back with each of you, Maybe to get us going, Kareem - crypto seems to be everywhere these days. Can you talk a bit about how adoption picked up in 2021?
(00:46):
Thanks, Adam and I'll be honest with you - we've done a lot of these PodBytes together and I'm very excited whenever we're looking back or we're just talking about what we're going to see in the future. It just becomes more of a casual discussion, so I'm looking forward to a lot.
Maybe I'll jump right into it and I'll just say that we've all seen such huge uptick and adoption. I mean, there's several major players entering the space. However, what we saw in 2021 might just be the tip of the iceberg when it comes to adoption; when I say it's, it's sort of like the tip of the iceberg or there's an uptick in adoption, it's broad right? There are many types of adoption that we've seen.
(01:31):
I want to start off with the team and we've seen together guys; we've worked together through many, many different discussions, engagements, projects, so, maybe I'll start off with Kunal. Maybe you can get us going; let's start off with institutional adoption. I'm just curious about your thoughts in terms of what happened in that space over 2021.
(01:55):
All right thanks, Kareem. Hi, Adam - very nice to be back. When we talk about institutional adoption, I think 2021 was a landmark year for adoption by institutions. We saw a lot of key milestones being achieved this year. The different ways that institutions are getting involved with the cryptoasset ecosystem is just amazing to see.
(02:23):
One of the ways that we have seen how institutions are engaging themselves in crypto assets is they are getting direct exposure to these crypto assets. When you think about direct exposure, think about any organization that is investing their corporate treasuries into cryptoassets directly. We've seen hedge funds, family offices, insurance companies and even a lot of these companies that are adding crypto punk NFTs to their to their art collection. This is how they're getting a lot of the data direct exposure in crypto assets.
(03:02):
We've also seen indirect exposure from these institutions. We've seen one of the large Canadian pension funds with its private equity investment in a top crypto exchange in the U.S. and we've also seen retail creating applications, adding crypto assets services and providing those services to their retail clients, allowing their clients to buy and sell crypto assets directly from their platform. We've seen banks exploring crypto custody and how they can engage in the crypto asset ecosystem as well. We've also seen NFTs being sold that these large international art galleries. I think a lot of this is to do with just how the market infrastructure is maturing for crypto assets. In Canada, we recently saw one of the large asset managers start to provide crypto custody services for institutions, and they are regulated, so that was that was a huge milestone for the industry as well.
(04:13):
Yeah, thanks Kunal. You know, even outside the increase in institutional adoption, we as a team and broader consumers, we've seen some measurable increases in in retail adoption.
You've talked a little bit about the institutional side of NFTs and all of that, but even as a consumer or just a retail Investor, Mitch, Ken, what are you seeing? What do you think about what's been happening in that space?
(04:43):
For sure. Thanks, Kareem. There's been a significant amount of retail investors flooding into the crypto space over the last year. We've seen significant revenue from trading coins like Doge and Shiba Inu, as they're becoming more available on different exchanges. We've seen an influx of NFTs; NFTs have been some of the hottest tradable assets out there within the crypto space right now. Throughout September, there's been new projects with music artists, video games, and art, all have been making headlines within the media for some serious price tags.
(05:19):
Right, Ken and I've certainly been seeing it everywhere. That is terrific. You know, I think our listeners will agree that it is impressive to not only hear the different types of institutions who are adopting crypto, but also the different ways in which they are adopting crypto. So, as we head into 2022, do you anticipate adoption will increase? And if so, why do you feel this way? Mitch, why don't you get started?
(05:43):
Sure. Thanks Adam. Yeah, let's start on the institutional side. Kunal also gave some background; we had corporate treasuries, insurers, hedge funds get in the space. I think the next wave of institutional buying is gonna come from the larger investors, the pension funds and the sovereign wealth funds.
On the sell side, they're just starting to get involved in the space and I think that that trend is going to continue much more quickly in 2022. Traditional, financial institutions, brokerages, custodians - we're going to see the growing demand from the buy side from the investors, encouraging action from the sell side to provide their products and services.
(06:18):
Also, the sell side, I think, is going to face growing pressure from competitors as they all begin to race to provide these services. And as what we've seen so far with the existing traditional financial services in the space, it's the earliest movers who tend to capture significant market share. Likely, there'll be significant mergers and acquisitions activity by traditional companies for crypto startups.
I also think the meta verse in 2022 is going to be massive. The meta verse is really a combination of different technologies (06:45):
augmented reality, virtual, NFTs and crypto. There's been massive growth in developing products for consumers online. Submersive games like Axie Infinity, where it's a play to earn model, is going to bring in tons of users in 2022,
(07:09):
Social media technology companies are getting into the meta verse space and NFTs in the same way traditional finance companies are being disrupted by and adopting DeFi. So 2022 will see many technology companies offer products and services directly related to the meta verse.
Yeah, I totally agree, Ken. I think there's, there's so much happening in the meta verse space. It's just absolutely amazing to see. I mean, people are buying real estate in the meta verse. They're buying apparel and accessories in the meta verse where it's really, really exciting to see.
(07:46):
Yeah, I'll tell you guys – when first reading about this, I'd even talk to my partner and she was saying “I don't think anybody's going to be using that”. If history has sold us anything just in terms of what we've seen with crypto and adoption, I think it's a very interesting space and I think that we're going to continue to see a lot of it in 2022 for sure.
(08:12):
So that, so that's all great. I mean, we'd be remiss if we're thinking and talking about the increased adoption. It's equally important to discuss some of the regulatory changes that quite frankly, we saw come into effect in 2021 and they both accommodated and fueled the wider adoption in general.
I think it's fair to say that many of these changes have gone a long way to further legitimize crypto. I don't know if you all agree with me, but I think that's sort of the viewpoint or what we've seen overall. I mean, one of the most recent ones is a good example is coming out of El Salvador where not too long ago, they became the first country to approve Bitcoin as a legal tender. So with changing or legalizing that tender status, I think we've seen what that has done (08:34):
an increase in access to Bitcoin for many people and businesses around the country. But it's increased growth in the lightning network for scaling as Bitcoin everybody knows or heard like, Bitcoin is a layer; transaction fees tend to be very expensive and slow to settled. So, I think more likely we're going to see benefits in developing countries, just relying on dollars to adopt stable coins. Especially on the sort of performance block chain, like Solana and Eth Layer 2, we're going to see a lot of these changes coming through.
(09:43):
Thank you for that, Kareem. I know this is one of the more noteworthy examples of regulatory change and I'm curious to hear about some of the newly introduced regulations that stick out to each of you. So Kunal, why don't you start us off.
Yep, thanks Adam. In the regulatory space, my personal opinion is the more regulated the space is, the more clarity we have in what we are able to do and what we are not able to do. We've seen regulators provide more and more clarity. Especially in 2021, from a security standpoint, we saw ETF approvals. Canada was one of the first North American countries to actually prove a spot ETF for Bitcoin and Ether. We've seen in the U. S. recently a futures-based ETF being approved as well. We're continuing to see other ETPs being created in Europe and Germany as well.
(10:47):
You know, we have seen the growing attention and the scrutiny from securities regulators around the globe. Although, there is limited action currently in this space and based on our experience working with some of these providers in the space, they're doing everything they can, keeping in mind the investor protection aspect of it. So, I think everyone wants to play by the rules. It's just the more clarity we get in these rules, the better it is for the space.
(11:19):
We've seen more guidance coming from the Financial Action Task Force, FATF, around their travel rule for AML.
We've seen this guidance being applied across the various regulatory environments across the globe, be it FINTRAC, FinCEN in the U.S.; these are primarily requirements to DeFi, especially for the autonomous code executed via smart contracts.
(11:45):
We've also seen quite a bit of regulatory clarity and these updates in a stablecoin market. The stablecoin market has grown tremendously over the past year. I believe it's now over over 120 or over $130 billion in reserves. We're seeing a lot more stable coins gain adoption because we know in the past, it was primarily Tether, which recently also settled its case with the CFTC. We're seeing enterprise stablecoins come up from traditional banks and technology companies as well.
(12:25):
All of these stable coins have increased their transparency of reserves. They're providing detailed information on their monthly attestation reports, also known as the proof of reserve reports. We've seen these companies display what their composition of holdings are, right? Some of them even break down to the credit ratings of the assets held by them. Based on what we've seen so far, PAX, which is from Paxos, is the most transparent and conservative in its reserve policy.
(13:01):
Despite all of this progress, we know that the Ontario Securities Commission has disallowed the use of Tether on crypto exchanges in Canada; a lot of updates and clarity coming in and we're continuing to see what we can and cannot do and where that lining is.
I think that's an understatement. I mean, there really have been just an onslaught of regulatory changes implemented in 2021. Kareem, I'm going to start with you for this one. Do you anticipate the number of regulations implemented to be similar in 2022? What does this number of regulatory changes say about the crypto industry? Is there any underlying message?
(13:43):
I mean, that's a that's a good question. I think is it gonna be the same or more? I can give you a few examples of where we think it's gonna go. So, when you think about the DeFi space, there’s probably harsher securities regulation on DeFi and I think that's where you're gonna see that industry split.
So, on one side, you're gonna have regulatory compliant apps and the other side, you’ll have others a little bit by the anonymous founders that are just globally distributed and governed by Dows.
(14:11):
So that's going to be a little bit different when it comes to the regulation on the DeFi space. I think it's, it's fair to say that users and countries in general that are going to have more of these stringent regulations are just going to suffer more. That’s just the reality of it as stricter, harsher security regulations on DeFi come about.
(14:35):
The other thing - I think they're going to see more about around stablecoin issuers. I think they're going to be forced to meet high regulatory requirements. I think it's including even obtaining a, a banking charter. We believe that's where things are gonna evolve; it's just going to require just more transparency requirements about reserve holdings, perhaps a set of permissible reserve assets.
(15:03):
The last thing is around tax enforcement. So there are two sides to that when it comes to tax and when we talk about tax. I think we're going to see widespread investigation on underreported cryptocurrency holdings. That’s honestly just driven by just the mass adoption and rising valuation. I think that's bound to happen. You're going to see more and more. We've seen that in 2021. We're going to see more of that in 2022.
The flip side of it (15:31):
I think that when we're talking about the tax performance, there’s gonna be more regulatory clarity. And I think Kunal talked a lot about that. With that regulatory credit clarity, it is going to give more clarity on the applicability of taxes for crypto transactions because there are many different variations of crypto transactions. Especially for complex transactions, like providing liquidity due DEXs or even experiencing a rug, which, as a consumer, maybe at some point, or an investor, you've actually experienced that. I think you're gonna see a lot more clarity when it comes to that from a tax perspective.
(16:10):
So, what I'm hearing is that, at least generally speaking, these regulatory changes or enhancements, if you will, there are positive sign for the industry. Now, we have all danced around one thing throughout this entire episode. And that one thing is, of course, technology, innovation and DeFi. Mitch, I know this is going to be a bit of a tall ask, but can you kick us off with some of the major innovations that we saw in 2021 in the DeFi space?
(16:34):
Yeah, sure I'd love to. DeFi, decentralized finance, is really about the applications built on top of crypto networks like Ethereum that enable more complex transactions.
So, for example, a money market, a decentralized money market like Aave or Compound, it gives the ability to borrow and lend tokens peer to peer where lenders contribute capital to a pool that borrowers can then borrow from.
(16:59):
And the application is like the intermediary the way a bank would be normally for lenders with customer deposits, and then borrowers, like, people trying to obtain a mortgage.
The pool's utilization, the capital in there, determines the interest rate that is paid to the lenders.
(17:20):
The borrowers, if they want to take money out, they actually have to overcollateralize their loan. So, for example, if they bought 100 dollars worth of stable coins, they would have to post maybe 150 or 200 dollars worth of Ethereum.
I know Kareem talked about tax just before; this is a strategy people are using to be able to have dollars or stablecoins, but still hold on to their cryptoassets.
(17:48):
Another type is decentralized exchanges, DEXs, which Kunal mentioned. Those allow users to swap their assets peer to peer rather than using a company or a centralized exchange. One key benefit here is that users get to retain custody of their coins and that avoids the risk of the exchange or trading venue being hacked.
(18:10):
The last type that's really interesting is decentralized asset managers, where they create similar bundles of tokens that resemble almost an ETF, where these baskets of tokens enable broad market exposure. They can even use the decentralized exchanges to rebalance the weights of the tokens.
We've spoken about governance before. The governance token holders can vote on new types of ETFs or changing the structure, maybe adding 1 token in there or removing another. Now, that's at the application layer for DeFi; more generally at the protocol layer, I've spoken a lot about Ethereum, but there's been the emergence of alternative layer ones.
(18:54):
So those are other block chains, such as Avalanche, Solana, Luna, or Phantom where they are other block chains that have applications built on them. Some may be the same application such as Aave being on both Ethereum and Avalanche or a new native application.
(19:15):
What's interesting is each of these layer 1 protocols have an ecosystem fund, or basically a set of tokens that are used to incentivize adoption where users of the platform will be compensated in terms of rebates or extra rewards for trying out the applications on the platform and the goal there is to help drive overall adoption. I'll throw it over to Ken to talk a bit about some of the data we're seeing in terms of the usage and the total value locked.
(19:48):
TVL, total value locked, has been increasing since October 2020. The amount of money that's being locked within smart contracts is incredible. This really just shows that people are interacting within these ecosystems. Mitch mentioned, there's been a rise in alternate layer 1s outside of Ethereum, Avalanche, Lana, Luna, Phantom; this has been enabled by the Ethereum virtual machine being all of these applications are usually EVM compatible. A lot of the work that's going into Ethereum is not going to waste on these other layer 1s. What these applications can be brought across and be made more efficient. We have lower fees, we have higher throughput and it's really incentivizing users to stay on the platform or stay on the network and interact more frequently.
(20:46):
We've also seen some link liquidity incentivization programs where layer 1s give applications tokens from their ecosystem fund to incentivize end users for interacting with their applications. Phantom and Avalanche have programs of in excess of 250,000,000 and tens of billions of dollars of assets have been bridged from Ethereum to these alt layer 1s.
(21:08):
That's so interesting; as you're going through the numbers (and I’m obviously aware of them), when you're saying them out loud Ken, the numbers are incredible. If I may ask a question, we've seen a lot of these, the total value locked increasing and the dollars that are flowing into this. 1 thing you were saying - liquidity incentivization programs. I'm just curious - It's not something that that I would know about, but curious to know your thoughts in terms of whether these platforms are going to continue to incentivize people with their tokens or otherwise going into 2022 and maybe even broader to 2023.
(21:59):
Yeah, I can start off there. It's a very competitive landscape where there's users growing by the day, but each protocol is really vying for their attention and vying for the applications to build on their platform. It's almost like having an app store that's empty and trying to encourage applications to come there.
(22:22):
It really empowers the users and rewards the users for being open minded and trying out different applications and platforms and exploring. I think that's one appeal of crypto and DeFi is there's a lot of learning involved continually.
No, great. Thanks. A lot of incentives, but there's a lot; I can see that throughout a lot of uptick and adoption in general.
(22:46):
I can see that as well. I am curious though, and, you know, understanding from what your responses will be, this is probably speculative, but should we expect to see as much innovation in 2022? Ken, what do you think?
Definitely. I think we're gonna see even more innovation in 2022. I think 2022 is going to be a massive year for DeFi and the whole crypto eco system as a whole. We're going to see institutional adoption of DeFi increase exponentially and applications like Aave, Ark, where institutional lenders can select a whitelisted group of borrowing counter parties. These will become more attractive to them. With these institutions coming in, we're going to see an influx of capital, so that's going to compress the yields overall but that's going to be still way more competitive than traditional finance. We're gonna see quicker solutions for bridging assets across chains, including be able to hold collateral on one chain and then use borrow assets on another so more interrupt. More interoperability will also be applied to Bitcoin directly, rather than relying on a trusted intermediary with WBTC or wrapped BTC.
(23:59):
I love that and the excitement is down right when you say it, so we've got a lot to look forward to. Kareem, Kunal, Ken and Mitch, this has been a downright impressive time for me to just hear about not only some of the big stories from the world of crypto in 2021, but also, some of your predictions for 2022.
Unfortunately, that does bring us to a close for today's episode but before we go, I want to extend my most sincere thank you to each of you for joining us today. I know our listeners have enjoyed your insights as much as I have. To our fantastic community of listeners across all platforms, thank you once more for tuning in, be sure to check us out next time on KPMG in Canada's series on the state of cryptoassets. Bye, everybody.
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