The Tide is Shifting: Cryptocurrency Regulations and Growth

The interview was conducted by CoinDesk Indices and is not associated with CoinDesk editorial. Authors' views and opinions are their own and not associated with CoinDesk Indices.

In a recent article you say “the tide is shifting” in Washington regarding bipartisan support for cryptocurrencies. What do you think is prompting this change in sentiment?

A recent poll by DCG said 20 percent of individuals in swing states believe cryptocurrency is important. Around the time that came out, former President Trump signaled for the first time that he was in favor of crypto, and soon after he started accepting cryptocurrency for his campaign. Right after that, famed investor Mark Cuban said to the Democrats, “Wake up, we’re going to lose this election if we don’t have more favorable cryptocurrency policies.” About 50 million people hold cryptocurrency in the US, it’s a very passionate demographic, and while you’re looking at the slimmest of margins heading into election season, it matters.

Next, we saw Congress vote to repeal SEC Staff Accounting Bulletin (SAB) 121 which is a very punitive measure that essentially restricts access to custody for crypto assets. Fast forward to FIT21, the first bill that would establish a regulatory regime for crypto, and also hopefully enhance customer protections, passed with 71 Democrats joining their Republican counterparts. What we’re seeing is bipartisan momentum; Nancy Pelosi even signed up for this bill.

Now, none of these bills or resolutions have gone into effect and become law, but you’re seeing a market and political sea change. Finally, we saw the SEC approve an spot ether ETF listing rule change which likely wouldn’t have been possible without this incredible policy shift, particularly among the Democrats. We’ve always talked about this generational divide, but now we’re seeing some of the more seasoned government officials on both sides stepping up and realizing that technology is not political. However, voting against technology innovation is un-American.

How could the introduction of a spot ether ETF affect the liquidity and volatility of ether in the broader cryptocurrency market, and what measures can be taken to mitigate potential negative impacts?

I think the impact of the spot ether ETF is going to be overwhelmingly positive because you’re going to attract a new generation of institutional investors who start to gain an appreciation of the value of the crypto industry in its entirety. Bitcoin is exciting because traditional minds and institutions understand this concept of limited supply and, essentially, digital gold. Next is a pivot to the Ethereum network and where they realize ETH has a stable supply as well. Ether also delivers utility because you need it for smart contracts to pay for gas. Then you realize, oh my gosh, it has this yield, which is very competitive – it’s between three and four percent when staked. When you look at it from a real yield perspective (adjusting for inflation), it outperforms its fiat counterparts in many cases – particularly in the US. And so, it’s a very accessible, exciting financial product for people who’ve not spent the time to study it.

I expect a new generation of people to get excited once they understand the nature of the technology. So, therein is an opportunity and a challenge. We do not expect the initial approval to allow the ETFs to stake their holdings, which will make it an imperfect product, but I do think we’re going to be able to offer yield via staking in the future. What it means for the ecosystem is that it’s overwhelmingly positive because people are going to say, “Wait a second, this ETF is correlated to spot price, but how do I get yield?” The desire for yield is going to bring a new generation of participants into the native staking ecosystem, which is a positive thing. Currently, about 30 percent of ETH is staked – it’s going to be interesting to see what happens in the ecosystem if that spot ETF scales materially because people are going to need to buy ETH on the market. If that ETF grows materially and you can’t stake it, there’s going to be a proportionate reduction in stake. Now I don’t think this is going to impact the network from a security perspective, not even close, but when you lower the staking, the rewards are shared by fewer. That could have the impact of making staking rates higher.

Has staking been growing in adoption, is it important that it does, and why would staking a benchmark be attractive to institutional investors?

Staking has been growing materially with the advent of liquid staking tokens. The issue we’ve seen in staking is that today it’s not so transparent. Effectively if you go to a staker and say, “What’s my price,” and they say, “Well, you get what I get and I take 10 percent,” that’s not institutional. What’s more institutional is saying, “Wait a second, what is the benchmark out there?” We developed a benchmark called CESR (composite ether staking rate), which we launched with CoinDesk Indices. Here, we look at the mean annualized returns across approximately a million eligible validators. We look at their returns over a 24-hour look back and we annualize it; that’s the baseline rate for staked ETH. And so, when you’re looking for a provider or a return, benchmark rates provide much better transparency of the performance you’re receiving versus some arbitrary rate. I think this makes it much more institutionally appealing. What we’ve seen is that most professional validators outperform the benchmark. This makes it good for validators themselves because they can price to that benchmark and outperform that benchmark. The benchmark determines how strong a yield you’re receiving as compared to the mean across the baseline rate.

How will the next wave of innovation in the digital asset market further bridge the gap between traditional TradFi and DeFi, and what new products or services would you like to see emerge from this integration?

Interest rate swaps, a $500 trillion market in TradFi, didn’t really exist in crypto before CESR. This brings utility to investors in many ways to hedge rates. This is an improvement over previously constructed traditional rates because it’s not closed – it’s open, transparent, observable and replicable. I believe a benchmark yield rate has the potential to unlock incredible utility by offering some of the same capabilities that we see across the $500 trillion interest rate derivative space. It’s that big for a reason. Swaps, structured products, ETPs – benchmarks are everywhere. If you turn on Bloomberg in the morning, in traditional news, they talk about the Federal Reserve and its rates outlook non-stop. Rates power the global economy.

For the first time, we have an exciting new rate that’s decentralized, open and very difficult to manipulate. I believe that benchmark rates like CESR have the opportunity to unlock an entire new class of financial products. We can extend this to other proof of stake tokens and see how their yield rates compare. But you really can’t scale these types of derivative products that are used for hedging or speculating without a foundational benchmark. That’s why we’re so excited.

What specific criteria and strategies does CoinFund use when evaluating potential investments in the Web3 space, and how do you identify projects with the most potential for long-term success and innovation?

CoinFund has been around for nine years. We have four core strategies:

Our investment criteria depend on the strategy. So, in the very early stages of pre-seed and seed, you’re looking to find the best founders in the world, and you want to make sure they’re building something special. As you move into Series A and Series B, you have a business model, and the business model is working. You are starting to have revenue. And so what we can do is work closely with founders differentiating our approach due to our crypto native expertise, our traditional markets expertise, and all the resourcing we bring to bear, whether it is people and recruiting resourcing, marketing, infrastructure, or regulatory support, and we get into the trenches and work with these founders.

If you look at our model, it’s really that we champion the leaders of the new internet and we want to be perceived as very strong partners that will help these businesses scale. The liquid strategy is looking at public markets and performance, and we also seek to actively risk-manage those assets. And then there’s CESR, our risk-based strategy, which is gaining global momentum.

For more information visit https://coinfund.io/.