Wendy Harrison, founder and CEO at 1st Idea, and James Burnie, partner at Gunnercooke, joined host Ian Taylor to discuss a crypto asset taxonomy system. Wendy has been in the financial markets for the past 20 years and has been investing in the crypto space for just over 2.5 years in helping to define a taxonomy for crypto assets. For his part, James specializes in blockchain, crypto assets and DeFi.
(2:38) 1st Idea is focusing on developing a taxonomy for crypto assets of all distinctions and across all classifications. They have PI-AXIOM, which exposes the DNA of financial products, cryptocurrencies and digital assets to understand what they are and the regulatory impact in specific jurisdictions. AXIOM means a single version of the truth, and as such anything you’re defining can only appear once in that definition in the taxonomy.
The solution they have is wrapped around the taxonomy element at its core, to which they can then apply regulatory information in terms of what the regulatory view is and play that back to the regulators and companies that are interested in issuing or investing in a security token or want to host it on an exchange.
James has been involved in the crypto space since the early days and worked on the first successful ICO in the U.K. The idea of being able to classify things immediately has an appeal to anyone in the legal profession.
(4:54) “And actually from the very beginning, I had a very broad-brush approach to lumping it into, ‘is it a security, is it not a security? Is it e-money?’ And that was simply based on the UK legal system,” said James.
But there’s much more to it than that, such as does the asset have smart contracts behind it? What does it actually do? Do the different protocols work together? And that is what he loved about what Wendy is doing because it’s far more than just a lawyer telling you what the law is. It’s actually quite useful.
(6:12) When 1st Idea is looking at defining crypto assets, they don’t focus on the regulatory aspect to start off with. That just muddies the waters, Wendy said. What they are interested in is just focusing on the asset itself in terms of what makes this different from anything else that’s out there in the market. And that’s what gives them the definition.
(6:47) Crypto assets are likely to have similar characteristics. So then they group those into a particular family. Within that family, they’ll look at things that they call out to be a distinguishing feature. They end up with a very concise and comprehensive definition of all the different crypto assets to which they can then start to review the regulator side.
BSI Security Token Standard
(9:07) A group of companies was asked to participate in a steering group for the definition of a security token standard. The BSI’s PAS-19668 is designed to standardize the way security information is captured and publicized to exchanges to harmonize those definitions. The standard they produce is not for any specific jurisdiction — it’s an international standard that can be adopted by anyone around the world.
The group still meets on a regular basis in part to assess when the standard needs to change to accommodate new security tokens.
(10:04) BSI would say this standard is the first of its kind in the world in terms of blockchain standards for security tokens. It sets out the requirements for what is the relevant information to be included in terms of technical attributes and the specifics of the security token itself that should be in place to publicize that and share the information on an exchange.
(10:32) The advantage of this is that it not only harmonizes those definitions but it makes it a lot easier for exchanges to adopt security tokens as well as to do a comparative analysis and have an understanding of what makes these security tokens different, explained Wendy.
1st Idea is looking to make it simpler for people to adopt this wider standard. It has introduced a BSI module in its taxonomy product to allow people to define their security tokens against a standard as well as to identify any gaps, in response to which 1st Idea will publicize the information for them.
(13:50) One important area of focus from a legal perspective is when you’ve both something, do you understand what you’ve purchased? The reason this is important, James explained, is we’re starting to see features like the ability to earn interest on bitcoin, which is starting to look suspiciously like traditional financial products. But because it involves using unregulated tokens, it’s actually an unregulated activity.
And with negative interest rates, investors are looking for other opportunities. So you’re seeing a rivalry between the two systems in addition to macro-political changes. A key requirement for a token is who is participating and where they are based. This taxonomy will give users far greater knowledge.
(15:50) “What we’re also seeing is a split between certain people, for example, fund managers who focus on just bitcoin and Ethereum and those who go for altcoins, yield farming and that group. And again we’re seeing that split, and what’s going to be interesting is whether one of those takes precedence over the other in the public eye,” said James.
(18:14) If you’re an investment manager and you’re buying and selling tokens with a view to making profits, the more you know the better. If you are the custodian holding these things, you want to have in-depth knowledge from a security risk perspective as to what might go wrong.
(20:59) One of the first challenges you’re going to see from a jurisdictional perspective is the terminology being used. And part of what a standard will do is help to start to standardize certain terms and around that have a definition.
21:48 – “Like the World Wide Web, there is no global overseer for any of this crypto market. So we’re just going to have to accept that whatever definitions come out in various jurisdictions, that’s going to be the norm…It’s not going to be on a global scale,” said Wendy.
The industry can help promote the use and adoption of standards, which can be used on a global scale. And that will help to standardize the terminology and give some foundation to help with this concept of different definitions across jurisdictions.
DeFi and the Law
When it comes to DeFi, firms either want to be the first-mover or want to raise the standard in the sector. Established players, meanwhile, are trying to grow the market.
(24:48) DeFi means one of two different things to people. The first idea is the cyber libertarian idea, which believes this is a decentralized thing so no rules apply and I am above everything and can do anything I’d like. There’s also an issue around privacy and AML. The other form of DeFi is the question of operating resilience, which has been thrust into the spotlight as a result of COVID.
(29:58) There is an acceleration from analog to digital assets, Wendy believes, and that will only continue. But there remains a long-term dependency for transparency of regulation, especially for the large institutions to get involved. That’s been the hold-up at the moment in terms of the regulatory landscape being a bit opaque, especially for the securities token market. On the client-side, however, demand is only going to continue to grow, and that’s pushing companies to respond. There is clearly a demand for this kind of digital asset token, Wendy added.
(31:05) In addition, the growth of CBDCs is also spurning the capital markets to sit up and take note. Underpinning all of this, however, is the regulatory climate.