Good afternoon, readers: Bitcoin hit a fresh all-time high above $35,000 while former Bakkt CEO Kelly Loeffler lost her U.S. Senate seat. Meanwhile, a major Ripple investor filed suit against the fintech and Shapeshift is converting to a decentralized exchange.

Top shelf

Rat poison?
Echoing Warren Buffett’s infamous line that bitcoin is “rat poison squared,” heavyweight investor Bill Miller said that could be true, but “the rat could be cash.” In his Q4 newsletter Miller went on to say inflation is likely in the U.S. due to unprecedented fiscal and monetary stimulus, and that bitcoin could provide a way for companies to avoid devaluing their balance sheets.

State action
A ban on crypto derivatives trading went into effect today in the U.K. The nation’s financial regulator, the Financial Conduct Authority (FCA), said these products are ill-suited for retail consumers due to their outsized risks when introducing the legislation in October, while industry voices think the measure is overwrought and favors institutional investors.

Shifting shape
ShapeShift is going decentralized in a bid to get rid of its know-your-customer (KYC) rules. The Colorado-based non-custodial exchange is now routing orders through decentralized finance (DeFi) applications and phasing out its centralized exchange.

Quick bites

• NEW ORIGIN? Origin is relaunching its yield-generating stablecoin following a November attack that drained OUSD holders of $7 million. (CoinDesk)
• YIELD FRONTIER: David Hoffman makes the case that Ethereum is the last bastion for yield. (CoinDesk - op-ed)
• PRICE APPRECIATION: Ethereum enters top 100 of world’s largest assets, joining bitcoin, gold and silver, as well as companies like Saudi Aramco. (Decrypt)
• RENT SEEKER? Who said you can't spend crypto? Redditor sells free Moon tokens to pay rent. (Cointelegraph)
• PAGE SIX: Who gets Custody of Kim Kardashian’s bitcoin in the divorce? (Decrypt)

Market intel

Korean spreads
The “kimchi premium,” the spread between South Korean’s upbit exchange and Binance, was at 4.15% yesterday, the highest since early 2018. An often-cited figure to explain retail interest in the country, CoinDesk’s Muyao Shen also thinks this premium could explain why bitcoin prices drop during Asia’s trading hours – some traders sell bitcoin at higher prices on South Korea-based crypto exchanges.

At stake

Rippled suits?
In Matt Levine’s much-awaited return to his opinion-heavy Bloomberg newsletter, Money Stuff, the financial columnist wrote about the effects of securities fraud action on business environments. In the U.S., he writes, there’s a growing trend that “everything is securities fraud.” Making a bad video game that causes a gaming studio’s stock to drop: securities fraud. Harboring a culture of harassment: securities fraud. Playing up a news release for something insignificant: securities fraud. 

Though Levine’s headline calls it a “dystopian future,” his conclusion is a bit more positive. A culture where smart lawyers can find restitution for stockholders affected by negative performance is a “general” way to keep publicly traded firms from doing generically bad things, even if they are not affected by these actions in principle. 

“Everything is securities fraud, even things that aren’t actually illegal; anything that gets bad press or moral disapprobation can lead to a securities lawsuit. It is in its way an oddly principles-based form of regulation: You don’t need specific rules against specific types of bad conduct; all you need is evidence that the company did a thing and the stock dropped because of it,” Levine concludes.

There aren’t many publicly traded companies in the crypto industry this trend might apply to, though the attitude – of pursuing legal action for any perceived or real financial loss – still pervades. 

Yesterday, one of Ripple Labs’ biggest financial backers filed suit against the crypto incumbent to redeem its investment. Back in 2019, the multi-billion asset manager Tetragon Financial Group led Ripple’s $200 million Series C. 

And now that the U.S. Securities and Exchange Commission is investigating Ripple for potential securities fraud, Tetragon wants its cash back. Filed in Delaware, Tetragon said it will attempt to “enforce its contractual right to require Ripple to redeem” its preferred stock, Bloomberg reported, and even freeze Ripple’s assets until it pays up. 

Ripple rejected the lawsuit, saying its investor can only redeem its equity for cash “if XRP is deemed to be a security on a go-forward basis,” according to a court filing. 

While Tetragon isn’t claiming securities fraud on behalf of Ripple, it is an effect of an ongoing securities fraud investigation. The SEC claims Ripple raised $1.3 billion over a seven-year period by selling XRP to retail investors. Ripple is the primary holder of XRP, though it has claimed over the years the network is sufficiently decentralized like Ethereum and that it is not the crypto’s creator.

Whether XRP is a security is now up for the courts to decide, but the lawsuit has already led to material outcomes. Grayscale Investments (sister company to CoinDesk) and Bitwise both removed XRP from their crypto index funds, while several exchanges have made moves to delist or suspend XRP trading. 

One might wonder if XRP is deemed to be a security and Ripple found to have violated securities law, if exchanges might have the right to pursue legal action against the firm. Because, as Levine points out, litigiousness is baked into U.S. business culture.

Who won #CryptoTwitter?

• While not many technical details of China’s plans for its central bank digital currency (CBDC) are publicly available, the digital yuan is already raising concerns around privacy, national security and political power.
• The Digital Currency/Electronic Payment (DCEP) system would give the Chinese Communist Party the powerful ability to monitor in real time the minute financial dealings of its citizens.
• The U.S. needs to accelerate its development of tools for dealing with CBDCs on the global stage.

China is leading the world in the development and piloting of a Central Bank Digital Currency (CBDC). With that lead comes increased scrutiny and concerns over the downstream effects a digital yuan might have regarding privacy and political power. 

A new report from the Center for New American Security (CNAS) not only lays out in stark terms the history and state of China’s CBDC system but also reviews what few technical details of it are available and recommends policy steps the U.S. should consider in an escalating CBDC conflict. 

“This CBDC system, which the Chinese government calls Digital Currency/Electronic Payment (DCEP), will likely enable the Chinese Communist Party (CCP) to strengthen its digital authoritarianism domestically and export its influence and standard-setting abroad,” reads the report. 

“By eliminating some of the previous constraints on government data collection of private citizens’ transactions, DCEP represents a significant risk to the long-held standards of financial privacy upheld in free societies.”

Privacy risks of China's digital yuan

The privacy concerns arise largely from the massive amount of insight a CBDC would give Chinese authorities into its users’ financial data and behavior, as well as information about anyone who interacts with those users – including, potentially, American citizens. 

“DCEP would give the Chinese Communist Party something that no government has ever had in history: The ability to monitor in real time the minute financial dealings of its citizens,” said Yaya J. Fanusie, an Adjunct Senior Fellow at CNAS and co-author of the report, in an email to CoinDesk. His research focuses on the national security implications of cryptocurrencies. 

He said that while much of the world transacts digitally today, that transactional data is not accessible wholesale by government authorities because the government has to go through financial institutions to acquire the data. 

The DCEP design deviates from this model, putting the data directly in the hands of the CCP without having to go through intermediaries. Anyone using a digital yuan pretty much concedes his or her financial privacy directly to the Chinese government, according to Fanusie. It’s not yet clear how accessible DCEP would be outside China, but if it is, this has implications for other governments. 

“The U.S. government needs to assess whether DCEP use should be blocked in the United States,” said Fanusie. “But private-sector U.S. tech companies should also be thinking about whether they will allow the DCEP application to be accessible on their platforms, such as app stores.”

The report notes that officials of the People’s Bank of China have said the CBDC will have “controllable anonymity,” meaning the central bank could observe and monitor transactions taking place while the transacting parties would remain private. However, the central bank has also said it would be still able to analyze transactions to monitor “crimes.” 

Taken in conjunction with China’s loose-knit social credit system, information gleaned from digital yuan transactions could be used to wield punitive power against Chinese citizens. Additionally, any metadata collected could give insight into users’ personal and device movements, according to the report, further rounding out a body of significant personal data. 

“PBOC modeling of DCEP shows that each digital currency token held by users would be constructed with a cryptographic algorithm expression, with various data inputs such as information on the owner of the token,” reads the report. “Not all of the data will be available to those transacting in DCEP, but they will all be available to the central bank, according to its early proposed design sketches and most technical reports about DCEP.”

The PBOC will thus become a possessor of a significant data trove to combine with its tools for censuring and surveilling individuals.

The political power of CBDCs

Related to privacy concerns are the ways a lack of privacy coupled with the use of big data can be used to deprive individuals of political power and even change their behavior. 

The parable of the panopticon is one way of looking at this. In it, a central observation tower is placed within a circle of prison cells so guards can see every cell and its occupant, while inmates are unable to see into the tower. Never knowing if they are being watched or not, prisoners assume they are being surveilled and behave accordingly – that is, the way authorities want them to act. 

While certainly simplistic when it comes to the complications of the digital age, it’s a basic model for understanding that information and surveillance are forms of power that can be wielded in the service of a specific set of outcomes.  

In the U.S., the founders created the Fourth Amendment to the Constitution precisely because it was understood that if the government had access to everyone’s private possessions (such as their papers at home), it would lead to government repression, according to Fanusie. 

“This dynamic continues to exist, and places like China which don’t have this standard built into their governing system are more likely to abuse their citizens and hinder their ability to advocate for their interests or redress grievances,” he said. 

The report notes the PBOC is already testing a digital yuan as “a way to disburse government salaries and subsidies.” The centralized monitoring and control of DCEP wallets would make it easier for the government to cut off a person’s ability to transact than if it had to attempt to do so through other third parties. 

Cryptocurrencies have been attractive to some parties as a means to engage in a financial world beyond the reach of the state. Some case studies of the benefits of this are clear in places like Nigeria, where groups protesting police violence were able to receive funds via bitcoin after the government froze their bank accounts, and in Belarus where protestors against the country’s latest illegitimate election were supported by bitcoin grants after being fired from their jobs for protesting. 

CBDCs bring the idea of a digital currency squarely under state control and may seem in conflict with the ethos of cryptocurrencies. But Fanusie said CBDCs probably won’t directly impact cryptocurrencies’ ability to flourish “unless financial authorities technically try to ban cryptocurrencies, which is not feasible.”

CBDCs could be seen as a way for citizens to have the functionality of digital money instead of permissionless cryptocurrencies.

“So, there’s certainly an element of governments wanting to compete with crypto,” said Fanusie. “But one big possibility is that by developing the infrastructure for digital wallets, programmability and microtransactions via CBDCs, governments might actually make cryptocurrency adoption easier.”

Policy recommendations

The report concludes with a set of specific policy recommendations from Fanusie and his co-author, Emily Jin, a research assistant for the Energy, Economics, and Security Program at CNAS. 

These include things such as pursuing a diplomacy campaign urging Chinese government transparency and restraint in using DCEP for punitive measures, monitoring any DCEP data collection on U.S. citizens, making CBDCs a key part of U.S. national security concerns and examining the private sector in the U.S.’ ties to “China’s digital financial authoritarianism.” 

Finally, the report suggests the U.S. lead CBDC standard-setting going forward, conduct more research into the economic impact of CBDCs, and look at economic statecraft possibilities for combatting CBDCs, including evaluating “whether and how the United States can apply sanctions tools to CBDCs.”

CBDCs aren’t a question of if at this point, but rather when. The sooner key considerations such as these are taken into account and seen as an integral part of geopolitics, the sooner countries can consider the risks and benefits they offer. 

“The U.S. should raise this as an important issue in diplomatic channels and also emphasize the privacy component in intergovernmental discussions on CBDC, such as with the Bank for International Settlements, but also the Financial Stability Board, the G7, and G20,” said Fanusie.

The monetary revolution will be digitized … but for the vast majority of earthlings likely not anytime soon, according to central bank digital currency (CBDC) research published Wednesday by the Bank for International Settlements (BIS).

To get there, though, 86% of the central banks surveyed in BIS’ third annual CBDC questionnaire said they were at least considering the pros and cons of issuing digital-first fiat, up from 80% last year. This year’s survey featured 65 central banks.

Even more telling was the share of central banks moving beyond mere table talk. BIS said 60% of central banks are now conducting CBDC experiments or proof of concepts. Just 42% said the same in 2019. 

Read more: What Is a CBDC?

Emerging market central banks are driving CBDCs forward with more gusto and purpose than their counterparts in advanced economies, citing financial inclusion and payments efficiency as top motivating forces. They’re also participating in higher numbers: seven out of eight CBDC projects are in emerging markets.

“A testament to these motives is the launch of a first ‘live’ CBDC in the Bahamas,” BIS wrote. “This front-runner is likely to be joined by others: Central banks collectively representing a fifth of the world’s population are likely to issue a general purpose CBDC in the next three years.”

Although BIS did not provide a country-by-country issuance plan breakdown, that staggering figure could only be representative of China, home to over 18% of the world population and also one of the most advanced CBDC projects. China is already one year into pilot testing its DCEP. 

Still, global CBDC adoption is likely still years away, BIS said. Countries are just not backing their heightened CBDC research with definitive plans to roll a project out. Tellingly, half of the central banks that in 2019 said they were “likely” to issue a CBDC in the short term downgraded their sentiment to “possible” or “unlikely” in the 2020 survey.

Advanced-stage projects are also hedging their go-live windows, BIS said.

Most central banks are more interested in a “retail” CBDC (consumer and day to day use) than a “wholesale” CBDC (systemic payments; transfers between banks). Some countries that once considered both models now focus their research on retail, perhaps seeing more value in digital fiat for the people than digital currency for the banks.

CBDC legality remains a largely unanswered question among the surveyed central banks. Forty-eight percent were not certain they had the authority to issue digital currency and 26% were certain they didn’t. 

Central banks continued to view cryptocurrencies as a largely irrelevant force with limited if any appeal in the 2020 survey. Strong majorities ranked cryptocurrencies as “trivial” for the domestic payments space for the third consecutive year. Notably, over 40% said crypto could have “nice” appeal in the cross-border payments space, a rare bright spot in the otherwise crypto-minimalist data. 

Read more: Geopolitics at Stake in US Response to China’s Digital Yuan: Report

Central banks, and especially those in emerging markets, indicated more concern in the threat posed by stablecoins. Over two-thirds of central banks are studying the issue, BIS said.

But the respondents were nonetheless adamant that private stablecoin arrangements (read: Facebook’s libra/diem) are not a driving force behind their CBDC projects. Competition from stablecoins and cryptocurrencies fail to provide them with a compelling CBDC rationale.

“When it comes to cryptocurrencies, central banks continue to see them with no widespread use as a means of payment,” the report said.