Hidden Challenges and Opportunities in Crypto Finance

When we compare and contrast today’s institutional investor interest in the cryptocurrency market with where it was a year ago, it's the difference between night and day. From Canadian Bitcoin ETFs to decentralized finance (DeFi) protocols running on smart contract blockchains, all the prerequisites for Finance 2.0 are set in motion.

Both tokenized fiat currencies (stablecoins) and tokenized stocks (synths) opened the bridge between blockchain and traditional finance. However, the establishment soon realized the threat looming from DeFi, even more so than from Bitcoin as a digital property. The largest American banks saw that DeFi could be a one-way bridge, drawing out money from the banking sector into the decentralized blockchain space.

The only stop-gap would be governmental regulation. Let's take a look at some of the obstacles in crypto finance and their causes, with an emphasis on the Australian market.

Since the second half of 2020, it is safe to say that we have entered the new financial territory. Two unprecedented moves happened in parallel to each other. In the wake of pandemic lockdowns, The Dow dropped by nearly 10%, while The S&P 500 blue-chip index fell by 12%. To restore confidence, the Federal Reserve urgently pumped unprecedented levels of money into the economy. As a result, at least 40% of all USD in existence was printed over the course of one single year.

Economic Uncertainty Pushes Trust in Blockchain’s Direction

The measures worked, and the stock market rallied by 76% following Black Thursday (12th March) till March a year later. However, it soon became clear there would be severe consequences to the Fed’s interventions, deemed to be “working.”

The first is that the inflation target of 2.4% was overshot by more than double, even catching the Fed Chain Jerome Powell off guard. After on 24th March, he said the following in a letter, and the inflation rate soon entered the 5% range.

“We do not seek inflation that substantially exceeds 2 percent, nor do we seek inflation above 2 percent for a prolonged period,” Jerome Powell - Fed Chairman.

Other nations went on a debt splurge as well. The Reserve Bank of Australia took money printing, i.e., quantitative easing (QE), to a new level in February 2021, when it announced the QE continuation with another round of $100 billion. Suffice it to say; this indicated a fragile economic recovery.

That is one side of the story — the unprecedented market interventions to stave off a stock market collapse, resulting in fiat currency devaluation. It’s had a strong psychological impact, triggering people into seeking investment avenues outside of traditional finance. Decentralized finance, largely carried on the back of Ethereum, has experienced a massive boom since the Summer of 2020 and is presently nearing $200 billion worth of crypto assets locked into the DeFi ecosystem.

From lending and borrowing to decentralized exchanges, DeFi dApps replicate the functions of the entire banking system, but without oversight from overbearing central bodies. As such, DeFi represents the free market in its pure form, delivering major interest rate yields at a time when traditional finance is taking a plunge towards near-zero or even negative interest rates.

Yet, this new form of the tokenized free market still exists within the old one, with stablecoins serving as the bridge to making it possible. This bridge could easily be over-regulated out of existence. However, this regulatory push would have to go against the inevitable — carrying virtual banks in your pocket in the form of smartphone apps.

As we will see shortly, the more likely scenario is that the financial establishment will create its own blockchain ecosystem in union with governments.

Blockchain Reinvented

Because Bitcoin introduced the concept of blockchain into the public consciousness, it is often equated with a permissionless and decentralized money network. However, there is nothing to prevent blockchain from being made to be both permissioned and more centralized while still retaining its security and scalability features.

For instance, according to Food Innovation Australia Limited (FIAL), Australian exporters lost at least $1.68 billion on food and wine counterfeiting in 2017 alone.

Meat, in particular, is Australia's 4th largest export product, accounting for $10.4 billion (4.1%) of export business. Yet, according to the Australian Government:

“Australia’s export beef brands command premium price tags, especially in the Chinese marketplace, but just under half of the Australian-branded beef on offer actually originates in Australia.” — From the National Blockchain Roadmap published by the Department of Industry, Science, Energy and Resources.

Australia's number one export — ores — makes up $91.3 billion (35.9%) of its total exports. Although vastly different in application, both food and ores could be tokenized to greater utilization. Instead of relying on the heavy and unwieldy hand of regulation, blockchain technology can be put to use, providing unfalsifiable, scalable, and secure tracking of provenance. Via smart contracts, this could then easily extend to payments as well.

There is no better example of tokenizing Australian assets than the Perth Mint Gold Token. In 2019, the world's largest company in charge of refining gold issued a PMGT token to give investors entitlement over physical gold via digital, blockchain-powered tokens that are 100% collateralized by physical gold. Not only is PMGT government-guaranteed gold, but it is also auditable, redeemable, stable, and scalable.

Examples like these make the Financial Services Industry (FIS) confident that blockchain products will enter every sector of the economy.

Australia's Regulatory Landscape

However, digital assets could also come in the form of CBDC — Central Bank Digital Currency. Surprisingly, considering Australia's proximity to China (the leader in CBDC deployment), the Reserve Bank of Australia (RBA) has not yet issued concrete plans to release a CBDC of its own.

On the other hand, cryptocurrencies are still not recognized as money and merely fall under Australia's anti-money laundering framework — Australian Transaction Reports and Analysis Centre (AUSTRAC). Like most countries, Australia taxes the proceeds from crypto-finance as capital gains. If they are used for business, they are viewed as traded stocks.

Simultaneously, both AUSTRAC and the Australian commercial banks are hostile to cryptocurrencies, with many cases of de-banking having occurred.

One crypto user even reported disturbing labeling as a “terrorist”: “I’ve had banks go so far as to report me as being like a terrorist on some databases and that’s what stopped me from being able to get some of these services,” Michaela Juric of Bitcoin Babe, one of the de-banked for crypto trading.

Given the current state of Australia, which is rapidly advancing towards a total surveillance police state, perhaps this was an omen of things to come? After all, decentralized finance provides a degree of financial independence. In turn, financial independence is historically linked to political freedoms.

For now, the trend is clear. Under the RBA, commercial banks continue to de-bank FinTech businesses dealing in cryptos, regardless of whether they comply with AML/CTF protocols or not. Such an informal approach can only be considered as a holding pattern to not further degrade Australia's depleting reputation when it comes to citizens’ rights.