Bringing digital assets into the regulatory architecture


Angie Lau: Hi, everyone. Welcome to Word on the block. I’m Editor-in-Chief Angie Lau. I want to introduce you to someone you may or may not know — but should.

Caroline Malcolm is inarguably one of the most powerful voices in the blockchain industry today, with Organisation for Economic Co-operation and Development member countries looking to her and her team at the Global Blockchain Policy Center for the past couple of years for education and guidance on policy. Well, now she’s left the OECD as the former inaugural head of the Blockchain Policy Center, and she’s on the move. She’s landed right here on Forkast to share more.

Caroline, it’s a pleasure to see you again.

Caroline Malcolm: And it’s a pleasure to be with you. Thank you very much for the invitation to join you and the Forkast team.

Lau: All right. Let’s start with some breaking news here. What is the new role for you?

Malcolm: Great. So, I’m very, very excited to announce that I have joined the really exceptional team at Chainalysis to lead the policy function internationally, right through from Latin America through Europe to Asia and, of course, the Pacific, to really work out what’s happening when it comes to policy issues in the blockchain space — in particular in digital assets as we move into 2022.

Lau: Why are you making the move now?

Malcolm: Good question. Look, working at Chainalysis means really being at the forefront of the data and technology that will shape the future of the industry. In the eight years since its inception, the company has demonstrated a really strong commitment to working closely with its clients — which include, obviously, leading law enforcement, tax agencies, financial crime agencies from across the world — to really build the best investigative solutions that allow them to understand blockchains and what their data can tell us about the movement of digital assets.

And really, with policy discussions heating up across the globe, being able to bring that approach to Chainalysis’ contribution to policy discussions across the world. So, being informed by perspectives from that diverse client base that I just mentioned — from government agencies and traditional financial institutions through to the crypto companies, which are really at the cutting edge of this sector — is obviously an incredibly exciting opportunity. And, of course, digital assets are booming.

Lau: Digital assets are booming. We’ve been chatting over the past year, and now we kick off a new year, but it just seems that with increasing cadence, we are seeing more and more policymakers… at times it really feels like the spectrum of policy response. How do you feel that you can bring to the private sector — at least at Chainalysis — all the experience that you’ve had at the OECD in talking with governments and sovereign heads and jurisdictions worldwide, to bring that same sort of gravitas to the private sector of our industry?

Malcolm: It’s a great question. Obviously, what I thought a lot about as I made this move, something that I really saw over my time at the OECD was a huge shift in government perspectives on the underlying technology, through to its applications, that’s really gained attention today. We really moved — when I was in that role — from sort of encouraging policymakers to think about this as an important issue to have on the radar through the process of education, understanding the technology, understanding how it is being applied, how these digital assets fit into the ecosystem — not just financial services, where obviously we see a huge amount of action today, but also in many other permutations across a whole different range of sectors.

And then, finally, kind of moving into the specifics of policy. What this opportunity with Chainalysis really allows us to do is really deep-dive into the data, into the analytics, to have a very strong understanding and to really work with our clients. What’s very interesting about Chainalysis in this space is that a lot of our clients obviously are government agencies. They are coming from that perspective, whether it be law enforcement, but also, you know, as I mentioned, sort of financial crime investigations or even tax agencies. So bringing that perspective… but we’re also working a lot — whether it be with traditional financial institutions who might be dipping a toe into this space or some of the cryptocurrency exchanges, which obviously have been far more established over the last decade. And it’s really that breadth of views, combined with the sort of in-depth, and really industry-leading analytics and data that we have access to, which means we really have something quite unique to offer to policy discussions.

Lau: Even talking with some of your colleagues at the OECD, I know that’s very intensely the work that even policymakers, analysts and advisers are actually thinking of on that governmental level. But at some point, the tools are not necessarily there. There’s a dependence on a third, independent party. It might not come from government — it’s certainly not coming from the private interests of the industry — but there’s a middle layer, where, interestingly, Chainalysis is filling that void and being that bridge, as it were. Your official title at Chainalysis is what? And what will you be doing? Your goal is what?

Malcolm: I’m the head of international policy at Chainalysis. I’ll be working with a counterpart who’s leading on U.S. domestic policy, and I’ll be leading on rest-of-the-world policy … really a huge amount of opportunity there, because we’re seeing so much action now — not just in the U.S., but policymakers starting to move, whether it be in the U.K. and obviously in Europe, with some of those details, as well… but right through Asia and even Australia, where we’re seeing a lot more action now, a lot more interest in this space. 

Look, in some ways there’s a sort of a strong continuity with the role I was in at the OECD. And by that, I mean, a lot of the work that we want to do here is around education, because we’re in this very unique position in terms of the data and the analytics that we have access to, first and foremost. It’s about making sure regulators understand what this sector is really about, and not just at the surface level, but really digging into the detail — and you can see that come through. We do a huge amount of research that we publish for the industry, but it’s also picked up by policymakers themselves, in terms of trying to understand whether it be around sort of geographies, where are we seeing the most adoption in different aspects of the industry, different sectors — non-fungible tokens (NFTs), DeFi, for example — or whether it be about some of the work that you’re seeing coming out right at the moment in terms of the outlook on crime in this sector, and what are the different approaches that we’re seeing to criminal activity? How does it fit into the bigger picture of digital assets?

One thing that’s really interesting — and this has really just come out — something we’ve published in the last week is around the fact that, yes, we are seeing an increase in crime year on year from 2020, but nowhere near the level of increase we’re seeing in activity in the digital asset sector more generally.

Lau: And that absolutely is one of the critical things that is facing the industry. We’re going to dive into that a little bit more. 

Are crypto scams on the rise? We talked about you kind of being part of this global trend that we’re seeing with policymakers and professionals in the legacy traditional space and kind of migrating into the industry. This integration is extraordinarily healthy because it means that everybody is starting to speak the same language, and it’s a concerted front that’s increasingly important when it comes to crime on the blockchain, in crypto. It’s a serious issue that a lot of people recognize is undermining growth and triggering a policy response that isn’t always nuanced. That’s what we’ve seen repeatedly. Crime is such a huge issue for the industry. What’s the role that Chainalysis is playing, which industry leaders must play alongside with policymakers here?

Malcolm: So look, Angie. Crime is definitely an issue that the industry is looking to tackle. But I think it’s really important, too, that we put it into perspective. So yes, cryptocurrency-based crime hit a new all-time high in 2021, and we saw illicit addresses receiving just over US$14 billion over the course of the year, and that’s up from US$7.8 billion in 2020. So there’s no question that we do see crime increasing in this space.

Within that picture, though, we really need to keep in mind that cryptocurrency usage as a whole grew faster than ever before (in 2021). And across all cryptocurrencies tracked by Chainalysis, total transaction volume grew to US$15.8 trillion in 2021, which is over a 500% increase on what we saw the year before. Given that sort of roaring adoption, it’s really no surprise that more cybercriminals are using cryptocurrency. But the reality is that as a total proportion of activity in digital assets, crime is actually reducing. 

Lau: And why is it reducing? Why is it diminishing? Is it as a ratio of that growth? Or is it because of proactive procedures? New insights from the industry as a whole?

Malcolm: There’s a variety of reasons why we see criminal activity increasing in total numbers but reducing as a percentage of activity in this space.

One is that we’re seeing different types of criminal activity take place. So, for example, if we just look at what we think of as scamming activity, scamming revenue rose by 82% in 2021 to US$7.7 billion. That’s nearly half of the total of illicit activity we saw in this space, and over US$2.8 billion of that came from rug pulls. Now, that’s something which has really been a new part of criminal activity that we haven’t seen take such a big place up until up until the last 12 months or so.

Now, rug pulls are a relatively new scam. They’re particularly common in the DeFi ecosystem, and that’s where we hear about them a lot. The reality is, though, that about 90% of the total value of what was lost to rug pulls in 2021 can be attributed to one fraudulent centralized exchange. So we hear that a lot in DeFi, and obviously we hear a lot about the boom in DeFi generally, but when you really start to look at the numbers, we realize, in fact, it might be other parts of the sector where the greatest issue might arise. 

Lau: I think a big part of your role, as well, is the intellectual empathy you get, where lawmakers and policymakers are frustrated, recognize some of the obstacles and challenges… just this avalanche of issues that not a lot of things in the toolkit can address. And part of the huge issue of DeFi is the lack of human intervention. It makes DeFi platforms a target for cyber criminals. It also means that if there is some sort of regulatory response, who do I talk to? The whole point of decentralized finance is that it’s decentralized.

How do you envision that this is going to play out? We’re hearing more and more interest and concern from policymakers from around the world to look more closely into DeFi. The question is, where does everybody start? Who’s going to start, and how is it going to start?

Malcolm: It’s a great question, Angie. Look, DeFi is definitely one area that we’ve highlighted where we’re likely to see more regulatory action in the year ahead for 2022. What’s interesting is that some of those discussions around DeFi have already begun. We’ve seen them, for example, start, whether it be in the new AML guidance that the Financial Action Task Force (FATF) came out with last year around virtual assets, where we saw an extension of the rules into those kinds of borders of the DeFi space and also a very clear message to regulators in that guidance, looking to take a stricter approach to DeFi applications and ensuring compliance in the DeFi space with something that needs to be done in terms of monitoring of the implementation of those rules going forward. So, we really saw a discussion start there. There are a lot of contributions on these issues — for example, in the public consultation process — that led into that guidance.

Lau: It’s one of the biggest themes for 2022, and I know we both agree on that: the regulatory component. I do believe it’s going to come to a head this year. Increasingly, as the industry grows, so too regulatory power is becoming more aggressive in its approach.

I want to ask you how you see things playing out. I want you to peek into your regulatory crystal ball. I’m also going to ask you about the crème de la crème right now, which the industry and the retail sector loves: stablecoins. 

Stablecoins have been on regulators’ radars since last year. Congress was urged in the U.S. to subject stablecoin issuers to the same legal obligations as banks. And, increasingly around the world, those conversations, no doubt, are being had at boardroom tables and government agency tables.

What level of regulatory scrutiny can stablecoin issuers expect in 2022, Caroline? Stablecoins — it’s a hot topic.

Malcolm: Absolutely, Angie. You’re absolutely right. There is a trend — at least at the discussion level — to move towards bank or bank-like regulations for stablecoins. Now, I will say that that’s not a statement you can make that’s true globally. Certainly in the U.S., we’ve seen a lot of talk in that direction, particularly with the President’s Working Group paper that we saw come out at the end of 2021.

In Europe, though, we’re seeing a slightly different approach — but again, nothing defined as yet, but certainly some proposals, including under MiCA, in terms of how to best handle stablecoins.

Certainly, around the world, the other factor feeding into the stablecoin discussion is … central bank digital currencies, and where different countries have progressed in terms of whether they themselves envision issuing a digital version of their own currencies, with some seeing stablecoins being able to coexist with that and others seeing those as being exclusive options where there needs to be one or the other. Those discussions will proceed in parallel.

Lau: Once upon a time — it feels like dog-years in our industry, but literally this was maybe a conversation two to three years ago, if that… maybe two years ago, where it was very clear China was on a path — people were just starting to wake up, starting to pay attention. And then there was also excitement that if there was a central bank-backed digital currency, then seemingly it was perceived as governments starting to see the benefits of a digital currency, and isn’t that great for the entire industry? And now … in some cases… stablecoins actually are seen as in direct conflict and a direct challenge from the private sector to what governments are trying to do in the digital space.

Take a look at Thailand, for example. Stablecoins that are tied to the Thai baht are banned in Thailand, whereas, CBDC efforts in Thailand are very, very specific. We’re increasingly seeing that in other countries. Mexico, having expressed CBDC interest and then also banning crypto, and the like. So, now we’ve evolved to this space. If you were speaking to those policymakers, what are the pros and cons to stablecoins that they might not be aware of that they should consider?

Malcolm: I think this idea that these two can coexist is something we’ve already seen. In fact, in monetary policy and in the way that money already operates in our world today, we already have a system of public money and private money, and they serve very different roles. What we’ve really found is that through private money, which is the money that most of us are transacting with on a day to day basis, it allows us a functionality and a usage which simply hasn’t been the role of central banks historically. And making that shift — particularly if you’re looking at some of the models of central bank digital currencies, which are sort of more retail-facing —  that’s a very significant shift in terms of what the role of a central bank might be in our sort of financial system. And so I think that’s certainly one of the one of the issues that central banks are having to grapple with in terms of the architecture and design of their (CBDCs) and how they fit into the monetary and financial system as a whole.

There’s this opportunity for stablecoins to offer functionalities and to evolve in a way that (means) maybe central banks aren’t well placed to provide, in terms of offering products or features to the market, which would require sort of a level of technology management and upkeep. This has never been the role of central banks, historically, and those are some of the factors that we need to think about — but also that some of these things that we’re thinking about today we can draw lessons … from existing systems. As I said, we already exist in a world which operates with both private and public money. Those coexist very happily. They serve very different functions. And so really thinking about that with an open mind, in terms of how these two things might coexist, I think is probably quite important. And ultimately, what are going to be the benefits to consumers, to citizens, to businesses, in terms of having that optionality… that variety of choice offers?

Lau: It’s coexisting, but not a lot of people agree. Looking to your regulatory crystal ball, you’re going to be a busy, busy head of international policy research at Chainalysis — a very busy woman indeed. What are your top predictions on the regulatory front? What do you see coming that you think the industry should brace for so that we can anticipate what’s to come?

Malcolm: Look, Angie, we’ve dug into DeFi and stablecoins. AML implementation is the next one. Everyone gets very focused on the development of the rules themselves, but I think it’s really implementation when the rubber hits the road. FATF has outlined the high level of objectives that countries need to get to, but implementation is really going to see the detail of how they translate that objective into local rules — from an industry perspective, as well as from a government perspective, making sure that that process of implementation is as coherent as possible across jurisdictions. Now, I recognize there will always be some local specificities that there will likely need to be incorporated. But an underlying coherency in those rules, as they’re actually implemented in jurisdictions, will be really, really critical from an industry perspective, in terms of ensuring efficiency and allowing the flexibility and transparency of transactions on blockchains to continue in the way that they have to date. But also from a government perspective, in terms of being able to both promote innovation in this space but also sharing information between different jurisdictions on how these different rules operate — the effectiveness of the rules, but also how the data is actually exchanged.

Making sure those systems can actually talk coherently with one another will be just as important for governments as it will be for industry. So I would say, what AML implementation? We’re already seeing a couple of jurisdictions, including in Asia, with South Korea moving ahead very quickly on implementation of the new FATF rules. And I will say that’ll only spread in 2022. 

The other one, which I think has been a little bit of a sleeping giant, is tax, in fact. So far, a lot of when we talk about tax and crypto, we are often talking about tax treatment. So, how do I actually treat this gain or this loss that I’ve made in this space? Is it income? Is it capital? So on and so forth. What about mining? How about staking? How does that fit from a tax record perspective?

But I think what’s coming even more — and we saw the sort of very early stages of this in the U.S. Infrastructure Investment Bill, and ultimately the act at the end of last year — was this idea about information reporting in the tax space. This is something which I think the industry probably hasn’t paid a huge amount of attention to, to date. It does pick up a lot of the themes that we’ve seen and discussed in AML discussions, in terms of who has responsibility, what information needs to be collected, and how you exchange it. So, in very much the same way that we have, for example, in traditional finance rules like (the U.S.) Foreign Account Tax Compliance Act, or rules set by the OECD, in terms of international information exchange about financial accounts, about taxpayers who are living in different countries and have accounts overseas. We have that in the traditional finance world. I think that’s what we can see coming in the year ahead for 2022. 

Lau: We’ve quickly talked about layer-1 when the industry started, then layer-2 for how it sits on top of blockchain platforms and creates efficiencies and utilities and fundamentals. Let’s just coin a phrase right now: ‘layer-3.’ Is that regulatory layer where we can move with ease and across jurisdictions? A truly multi-jurisdictional, multi-chain compliance layer? One, two, three?

Malcolm: Absolutely.

Lau: Caroline, it’s a pleasure for the one-two-threes and the ABCs of where we’re headed in the regulatory space in 2022. Always a pleasure, and thanks for joining us on Word on the Block.

Malcolm: It’s a real pleasure to be with you, Angie, and your listeners. I hope to join you again soon.

Lau: Absolutely. And thank you, everyone, for joining us on this latest episode of Word on the Block. I’m Editor-in-Chief Angie Lau. Until the next time. 

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