HashKey: Reviewing the Current Status, Trends, and Opportunities of Cryptocurrency Compliance Entry in 2020

Written by: HashKey Capital, article reprinted from Chain News, original title: "Research on Global Digital Asset Compliance Entry Channels (2)"

Overview and Update of Digital Asset Compliance Entry Channels

Last year, we conducted a review of the business landscape of digital asset compliance entry channels. Over the past year, we have observed some new trends and changes in the competitive landscape, prompting further updates. Below are the updates on participants and classification processes (in blue are the updated parts):

In the previous report, we categorized the channels for digital asset compliance entry into four types: wallet payment terminals, compliant exchanges, payment processing companies, and stablecoins. Now, we can add another category of companies, namely financial institutions. The updated classification list is as follows:

New Trends

Over the past year, we have observed the following trends:

Stricter Regulation

On one hand, there is a crackdown on crime, such as the New York State lawsuit against Bitfinex, which later led to a collective lawsuit by investors against Bitfinex, with Poloniex and Bittrex also being named as defendants for providing receiving addresses for USDT generated by Bitfinex. Therefore, businesses providing digital asset entry or trading must avoid relationships with "problematic" channels, or they risk being investigated.

On the other hand, the compliance system is being improved. The VASP regulatory framework established by the FATF (launched in June 2019 and revised in June 2020) is likely to become a globally accepted VASP standard. Compliant exchange businesses are generally adapting to FATF principles, as seen in Hong Kong and Singapore:

1) Hong Kong has been continuously deepening the regulation of virtual asset trading platforms since 2018, with the first exchange license issued;

According to the consultation document from the Financial Services and the Treasury Bureau, after adopting FATF's recommendations, any platform participating in virtual assets, including OTC, wallets, transfer payments, custody, and related financial services (such as digital asset issuance), may also be subject to regulation.

2) The Monetary Authority of Singapore issued the Payment Service Bill in November 2017, which was later officially upgraded to the Payment Service Act in 2019, and introduced PS Notice 2 in 2019, along with a consultation document on the New Omnibus Act released in July 2020. PSN2 is a revision of the PSA Act specifically targeting virtual asset service providers and complies with FATF's VASP requirements.

Stablecoins Cannot Be Ignored; Related Impacts Are Being Taken Seriously by Central Banks

The year 2020 saw rapid development of stablecoins, not only USDT but also compliant stablecoins like USDC growing quickly. Stablecoins provide a convenient and low-friction way to participate, and compliant stablecoins, as entry points, are also subject to strict compliance such as KYC/AML and restrictions based on user location. Global regulators, represented by central banks, are paying significant attention to the development of stablecoins, as seen in reports from the European Central Bank / G7 Group / FSB, focusing on the impact of stablecoins on payment systems, monetary policy, financial stability, and banks.

Increasing Participation of Institutions in Digital Asset Entry Services

This year's institutional services are noteworthy in the market. The term "institution" is quite broad, and we categorize them into three types:

1) Payment institutions represented by PayPal and Square, which directly provide in-app entry but primarily serve U.S. customers.

2) Institutions entering through the Delaware statutory fund model, where fund shares represent digital currency entry, reflecting significant demand from underlying clients, such as Grayscale and Bitwise.

3) Traditional financial institutions, especially banks like SEBA/Sygnum that have obtained licenses in Switzerland, can provide fully compliant on-ramp services to clients.

Various institutions continue to enter this field:

1) On December 10, Asian DBS and the Singapore Exchange SGX established a digital currency exchange that allows trading of digital currencies, securitized digital assets, and provides custody services. As a fully licensed Recognised Market Operator under the MSA, it can also trade stocks, bonds, and private equity funds.

2) On December 9, Bitwise's Bitwise 10 Crypto Index Fund began trading on the largest OTC market provided by the U.S. OTC Markets Group, OTCQX (the highest level of pink sheet trading), similar to Grayscale's six funds, but it has not yet become an SEC reporting company like GBTC and ETHE, so the redemption period remains 12 months instead of 6 months.

3) The Swiss Exchange (SIX) announced plans to launch a digital asset gateway in collaboration with SIX Digital Exchange (SIX's digital asset exchange) and Swiss digital asset custodian Custodigit (SIX is also a major investor), along with communication company Swisscom and bank Sygnum. This will enable banks and their clients to have direct access to digital assets.

Growing Interest in Cryptocurrencies Among Individual and Institutional Investors, with Diverse Entry Channels

We have found that institutional entry channels are also varied, listing some notable cases here:

1) Traditional investor Paul Tudor Jones directly entered the market by purchasing Bitcoin futures through the CME;

2) MicroStrategy disclosed that it purchased Bitcoin through Coinbase Prime;

3) MassMutual, an American mutual life insurance company, purchased $100 million worth of Bitcoin for its General Investment Accounts through New York-based fund manager NYDIG.

4) Square's Cash App saw Bitcoin purchases rise from $180 million in Q3 2019 to $1.63 billion in Q3 2020, an increase of 8.3 times. The estimated MAU of Cash App is around 30-40 million, up from 15 million in Q2 2019, with purchase volume growing much faster than user growth.

Square disclosed the OTC service providers used for Bitcoin purchases on its balance sheet: itbit, Genesis, and Cumberland.

5) PayPal has obtained a Bitlicense with exclusive conditions issued by the New York State Department of Financial Services, consistent with the licenses of many compliant cryptocurrency exchanges like Coinbase. PayPal has partnered with Paxos Trust Company to provide cryptocurrency buying and selling services. Customers can currently purchase cryptocurrencies on PayPal but cannot yet use them for payments and transfers. In 2021, PayPal will allow customers to make payments to merchants using digital currencies through Veemo, with PayPal handling the settlement.

6) Cathie Wood, known as the "Queen of Stocks," has been bullish on Bitcoin since 2017 through her well-known Ark Investment fund, with its flagship fund ARKW gaining exposure to cryptocurrencies by holding GBTC.

Supporting Services for Investors Are Gradually Being Established

Entry is not just about trading; other factors and supporting facilities must be considered, including insurance, storage, accounting, and taxation. Many tools and services have emerged, which will not be elaborated on here. Refer to Square's discussion on methods of participating in Bitcoin.

Updates on Participants

In last year's report, we reviewed the situation of 17 digital asset entry service providers, and we will not repeat that here but will introduce some distinctive service providers we have recently learned about.

Coinify - The Most Compliant Digital Asset Entry Company in Europe

Coinify is a company providing digital asset compliance entry services in Europe, with its business divided into two parts: Payment services for corporate users and Trade services for ordinary investors. Its transaction volume is the largest in Europe among similar companies, covering countries and regions including Europe, the U.S., and Southeast Asia.

Comprehensive Services

Coinify offers six types of services: three Payment services, including merchant payments, virtual currency prepaid cards, and receipt/invoice services; and three Trade services, including converting virtual currencies to fiat, integrated buying and selling services, and wallet-based buying and selling services. Coinify currently supports over twenty fiat currencies and more than ten digital currencies.

Global Compliance

Coinify holds various licenses and is currently licensed to operate in over 70 countries, with plans to continue applying for local licenses in major countries worldwide.

Innovative Partnerships

Coinify has partnered with Swiss online retailer Galaxus and Swiss bank Sygnum to provide platform support for the DCHF stablecoin issued by Sygnum Bank for payments on Galaxus. Each DCHF is backed by a corresponding Swiss franc held as collateral at Sygnum. Currently, this service is only available in certain regions of Switzerland. In addition to banks, Coinify provides solutions for up to 65 payment service providers and offers embedded services for various exchanges and wallets.

Xanpool - An Advanced P2P Model Digital Asset Entry Company

Xanpool uses a P2P model for digital asset compliance entry and exchange. Xanpool has built a network for exchanging fiat and digital currencies, allowing users to choose local fast payment methods for fiat payments, while liquidity providers supply digital currencies. Xanpool's API and key management tools facilitate pricing, digital asset transfers, and other operations, similar to the conditional payment function of Alipay. Xanpool has recently experienced rapid growth, with its user base increasing approximately 17 times since the beginning of the year.

Fiat Payments Utilizing Local Fast Methods

Xanpool's users conduct fiat transfers using local fast payment methods across Southeast Asia: 1) Hong Kong FPS, Alipay HK; 2) Singapore Paynow; 3) Malaysia: DuitNow; 4) Philippines: instaPay, Cebuana; 5) Thailand: Prompt Pay; 6) India: UPI; 7) Indonesia: Go Pay, Mandiri; 8) Vietnam: Viettel Pay. The low entry barrier allows users to get started quickly.

Cross-Border Payment Capability

Xanpool further combines the on-ramp and off-ramp of digital currencies, achieving a quasi-cross-border payment format, as shown in the diagram below:

The initiator of the transfer purchases digital currency from provider A (LP A), LP A transfers the currency to LP B, and LP B, upon receiving the digital currency, uses local fast methods to transfer the local currency to the recipient, completing the entire process.

P2P Model with Network Effects

The P2P model can widely utilize the liquidity and infrastructure of LPs, and the API interface model can scale quickly, with liquidity growth being exponential. More liquidity in the network attracts better LPs. Both fiat and digital currency sides can optimize technology and services through partnerships, enhancing overall network effects with leverage.

Bundle - Africa's Cash App

Bundle is a digital asset compliance entry company in Africa. Bundle's positioning is similar to Square's Cash App, offering a wallet with cryptocurrency and local cash services. Users can buy, sell, and store digital currencies like BNB, BTC, and ETH, as well as deposit and withdraw digital currencies and local currencies like NGN (Nigerian Naira). Transactions within Bundle can be processed through various payment channels, such as bank cards, bank transfers, and mobile payments, and can be securely stored on users' smartphones.

Direct Connection to Bank Accounts

After opening an account with Bundle (KYC required), users receive a local bank account, allowing cash deposits and withdrawals through local Cash Merchants in Nigeria. Bundle's digital currency accounts can connect with the banking system, enabling compliant entry to digital assets.

Prime Trust

U.S. Trust License

Prime Trust is a U.S. digital asset custodian company with a chartered trust license from Nevada.

Diverse Services

Prime Trust offers a variety of services, providing legal custodianship and operational monitoring for exchanges, and collateral fiat trusts for stablecoin issuers. Prime Trust has also begun offering digital asset entry services, referred to as Coin Ramp, which can be embedded for exchanges and wallets, as well as provided as a widget for websites.

CoinRamp can achieve real-time settlement for six major fiat currencies, supporting various payment methods including bank cards, bank transfers, and checks, with bank card payments supporting 163 fiat currencies. The underlying payment processing automatically selects the optimal payment channel. Liquidity service providers offer a Liquidity API, supporting exchange liquidity for BTC, ETH, and USDT.

Convenient and User-Friendly Entry Services

PrimeTrust's entry service only provides an API, with fiat options including ACH, Fedwire, and credit cards, without bearing the risk of cryptocurrency volatility. The API can also be customized based on the website and includes customer identification features, which is a high demand area for clients.

Strong Customer Base

Prime Trust has 300 clients, and CoinRamp will support dozens of clients. The entry services stem from actual client needs and align well with custodial services, making it a natural fit.

Competitive Landscape of Digital Asset Compliance Entry Models

Usability and Stability

Entry channels represent the exchange between fiat and digital currencies for customers. If we disregard the differences in product categories, the entry process is not much different from online shopping, with customers wishing to purchase products on one side and merchants (or users) selling products on the other. Therefore, the foundational capability is to ensure smooth payment methods for customers, timely delivery by merchants, and assurance that products are legitimate (e.g., coins that have undergone KYC/AML), as well as the ability to handle large-scale exchanges (compliance). Since we are still in the early stages, fees are not a critical factor; users cannot compare prices everywhere due to regional regulations and cannot try all channels. Entry and payment have a natural similarity.

Current Prominent Merchant Characteristics

1) A large customer base, such as Square and PayPal;

2) A strong network that can connect to the most diverse liquidity providers;

3) Good technology;

4) A certain level of compliance/license foundation.

Future Competitive Landscape - Institutional Entry, Regional Leaders, Diverse Types

1) Digital currency entry itself will likely become an infrastructure in the future, and as an infrastructure, fees must be moderate. For example, Alipay, as a payment infrastructure, cannot charge excessively high fees and may even need to be free. Earlier, digital asset custody fees were high, but they have decreased over time, with more service types emerging;

2) Competition is not purely a technical contest; competitors are diverse, involving customer types, markets, local licenses, and existing customer bases. Due to the segmentation of licenses and markets, regional leading players will emerge, similar to how there are no global winners in the blockchain industry outside of public chains;

3) Future compliance will be enhanced around banks as the central customer. Generally, any involvement with fiat liquidity will require local payment licenses, such as the state Money Transmitter License in the U.S., EMI and PI in Europe, and digital currency licenses in some developing countries and regions. Banks hold the most customer assets and can only cooperate with compliant channels;

4) Traditional institutions leveraging customer and compliance advantages to enter the market is a trend. Beyond banks/custodians, traditional payment companies like Visa and Mastercard should not be underestimated, as they are moving towards deeper foundational infrastructure. Visa announced a partnership with Circle Internet Financial to integrate the USDC stablecoin into the Visa payment network. Circle has joined Visa's Fast Track program, and if it graduates successfully next year, Visa will be able to issue credit cards with USDC payment functionality, allowing any merchant using this card to accept USDC payments.

This reveals some of Visa's ambitions; if it continues to integrate crypto entry/payment service networks into Visa, crypto could seamlessly connect to traditional payment networks, making Visa a gateway for crypto settlement. Earlier, Visa announced partnerships with numerous blockchain companies like BlockFi and Coinbase to jointly issue credit/debit cards that can be paid with digital currencies. Visa's model may gain more favor from crypto-native enterprises;

5) Due to their natural similarity, pure digital asset compliance entry can extend into the payment industry, as seen with Coinify and Xanpool;

6) We anticipate that 2021 will be an important watershed, as digital asset compliance entry has primarily served crypto-native enterprises or projects in the past, but after 2021, it will mainly serve traditional institutions. The market changes, competitive landscape, and business opportunities in this transition are self-evident.