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• <a href="#DeFi">DeFi Protocols Announce Updates, US Bank Introduces Deposit Token Concept</a> • <a href="#Financial">Financial Stability Board Addresses DeFi Risks in New Report</a> • <a href="#French">French Museum to Host NFT Exhibit, New Report Provides 2022 NFT Market Data</a> • <a href="#SEC">SEC Proposes to Expand Scope of Custody Rule to Cover All Crypto Assets</a> • <a href="#DFS">DFS Orders End to BUSD; US, UK Agencies Take Crypto Enforcement Actions</a> • <a href="#Reports">Reports Provide Data and Analysis on 2022 Cryptocurrency Illicit Activities</a>

DeFi Protocols Announce Updates, US Bank Introduces Deposit Token Concept

By <a href="https://www.bakerlaw.com/ChristopherLamb">Christopher Lamb</a>

According to recent reports, Rocket Pool, a decentralized finance (DeFi) protocol used as an Ethereum (ETH) staking service, has reached $1 billion in total value locked (TVL) less than two years after the protocol’s mainnet launch in 2021. Rocket Pool allows users to run their own ETH node with just 16 ETH – half of what is normally required. The other 16 ETH come from a decentralized node operator that only requires users to deposit 0.01 ETH to participate.

In a recent press release, MakerDAO, the DeFi lending protocol and creator of DAI (a decentralized stablecoin), announced that it has successfully onboarded Chainlink Automation as part of its Keeper Network. The Keeper Network provides price and debt ceiling updates through an automated system to promote DAI’s stability by using a network of automated bots. According to the press release, the integration of Chainlink will further decentralize MakerDAO and increase the number of third-party actors tasked with performing essential duties.

A report recently published by a major U.S. bank introduced the concept of “deposit tokens,” which the report defines as “transferable tokens issued on a blockchain by a licensed depository institution which evidence a deposit claim against the issuer.” Among other things, the report argues that bank-issued deposit tokens “are much safer than stablecoins for major institutions looking to transfer value across chains” and increased interest in blockchain emphasizes the need to have “cash equivalents” on the blockchain. According to the report, deposit tokens are different from central bank digital currencies and function similar to traditional deposits at licensed institutions like commercial banks. These deposit tokens would be “supported by the issuer’s regulatory framework, capital and liquidity requirements, contingency funding access as well as ‘robust’ consumer protection policies.”

For more information, please refer to the following links:

<a href="https://cointelegraph.com/news/rocket-pool-s-ethereum-staking-service-reaches-1b-in-tvl">Rocket Pool’s Ethereum staking service reaches $1B in TVL</a>

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<a href="https://www.prnewswire.com/news-releases/makerdao-integrates-chainlink-automation-to-enhance-dais-financial-stability-301743161.html">MakerDAO Integrates Chainlink Automation To Enhance DAI’s Financial Stability</a>

<a href="https://blockworks.co/news/deposit-tokens-stablecoins-defi-jpmorgan?utm_source=Sailthru&amp;utm_medium=email&amp;utm_campaign=Daily%202.10.23&amp;utm_term=Daily%20Newsletter">‘Deposit Tokens’ Could Trade On DeFi Like Stablecoins: JPMorgan</a>

<a href="https://www.oliverwyman.com/content/dam/oliver-wyman/v2/publications/2023/feb/oliver-wyman-jp--morgan-deposit-tokens-report-final.pdf">DEPOSIT TOKENS A foundation for stable digital money</a>

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Financial Stability Board Addresses DeFi Risks in New Report

By <a href="https://www.bakerlaw.com/JoannaFWasick">Joanna F. Wasick</a>

This week, the Financial Stability Board (FSB), an international body that monitors and makes recommendations about the global financial system, published a report on the financial stability risks of decentralized finance (DeFi). The FSB defines DeFi as “an umbrella term commonly used to describe a variety of services in crypto asset markets that aim to replicate some functions of the traditional financial system while seemingly disintermediating their provision and decentralising their governance.”&nbsp;

The report discusses an array of vulnerabilities in DeFi, the “most concerning” of which it identifies as “the different liquidity and maturity profile of liabilities and assets of relevant entities.” Other identified “operational fragilities” in DeFi include “easy-to-manipulate DeFi governance frameworks,” dependence on congested or unreliable blockchains, oracles and cross-chain bridges that can expose users to disruptions and thefts, and coding errors in smart contracts. The report concludes that, in light of its findings, FSB should (1) analyze financial vulnerabilities of the DeFi ecosystem as part of its regular monitoring of the wider crypto asset markets, (2) explore approaches to fill certain data gaps regarding DeFi and (3) study how proposed policy recommendations for international crypto regulation may need to be enhanced in light of DeFi-specific risks.

<a href="https://www.fsb.org/2023/02/the-financial-stability-risks-of-decentralised-finance/">FSB Press Release: The Financial Stability Risks of Decentralised Finance</a>

<a href="https://www.fsb.org/wp-content/uploads/P160223.pdf">FSB: The Financial Stability Risks of Decentralised Finance</a>

French Museum to Host NFT Exhibit, New Report Provides 2022 NFT Market Data

By <a href="https://www.bakerlaw.com/AmosKim">Amos Kim</a><a href="https://www.bakerlaw.com/VeronicaReynolds"></a>

A leading French modern art museum recently announced “an upcoming permanent exhibition targeting the intersection between art and the blockchain represented by nonfungible tokens (NFTs).” The exhibition will feature NFTs from many different artists, including “the next installment of the Punks Legacy Project” by Yuga Labs, a blockchain technology company that is a contributor to ApeCoin. Yuga Labs simultaneously announced that CryptoPunk #110 will be joining the museum’s permanent collection in Paris as “Yuga Labs’ Punks Legacy Project aims to bring awareness to the provenance and cultural relevance of Cryptopunks, one of the first NFT projects ….” The CryptoPunk #110 donation is the second donation from Yuga Labs. CryptoPunk #110 will be unveiled and installed at the Paris museum “this spring as part of an exhibition dedicated to celebrating digital art.”

In other recent news, DappRadar, a global app store for decentralized applications, reported a 59.6 percent “loss in market capitalization in 2022” in NFT collections on the Ethereum blockchain. According to DappRadar, the NFT market began falling from its peak in February 2022 a few months later in May, when the “Terra collapse” occurred, and hit its low of $2.2 billion in November. From that low point in November, “the market finished the year up 68%.” The report notes that “this retraction of the NFT market was not a reflection of NFT’s utility, but rather a result of bad actors and market manipulations.” Other key takeaways from the DappRadar report include the following: (1) The market cap for the 81 collections analyzed by DappRadar showed a decrease of 59.60 percent in USD value; (2) Yuga Labs has established itself as a leading player in the NFT industry, even though most collections faced depreciation at the end of the year; (3) only three NFT collections (Azuki, Pudgy Penguins and Degen Toonz) that were launched in 2021 or early 2022 experienced significant market cap growth; and (4) NFT collections launched after the Terra Luna collapse managed to appreciate their market cap by the end of 2022.

<a href="https://www.prnewswire.com/news-releases/yuga-labs-donates-cryptopunk-110-nft-to-centre-pompidous-permanent-collection-301744093.html">Yuga Labs Donates CryptoPunk #110 NFT to Centre Pompidou’s Permanent Collection</a>

<a href="https://cointelegraph.com/news/france-s-top-modern-art-museum-to-display-cryptopunks-autoglyphs-nfts">France’s top modern art museum to display CryptoPunks, Autoglyphs NFTs</a>

<a href="https://cointelegraph.com/news/ethereum-nft-collections-lost-nearly-60-of-their-market-cap-in-2022-report">Ethereum NFT collections lost nearly 60% of their market cap in 2022: Report</a>

<a href="https://dappradar.com/blog/report-the-decline-of-ethereum-nft-collection-market-caps">NFT Valuation Report: Which Ethereum collections outperformed the market?</a>

SEC Proposes to Expand Scope of Custody Rule to Cover All Crypto Assets

By <a href="https://www.bakerlaw.com/RobertAMusiala">Robert A. Musiala Jr.</a>

This week the U.S. Securities and Exchange Commission (SEC) published a proposed rule under the Investment Advisor’s Act of 1940 to address how investment advisers safeguard client assets. According to an SEC fact sheet, the proposed rule would, among other things, “expand the scope of the current custody rule beyond client funds and securities to include any client assets of which an adviser has custody.” The SEC fact sheet notes that the proposed rule would define “assets” as “funds, securities, or other positions held in a client’s account” and would include all assets that investment advisers custody for their clients. Accordingly, with limited exceptions, advisers would be required to maintain client assets with a qualified custodian, such as a federal or state-chartered bank or savings association, certain trust companies, a registered broker-dealer, a registered futures commission merchant, or certain foreign financial institutions.

The proposed rule discusses “crypto assets” at length. According to the proposed rule, “most crypto assets are likely to be funds or crypto asset securities covered by the current rule” and therefore investment advisers are already required to maintain such “crypto assets” with a qualified custodian. The proposed rule goes on to state that the proposed new definition of “assets” would include “all crypto assets, even in the instances where such assets are neither funds nor securities.” Accordingly, “to comply with the proposed rule, an adviser with custody of client crypto assets would generally need to ensure those assets are maintained with a qualified custodian that has possession or control of the assets at all times in which the adviser has custody.” As a result, under the new proposed rule, an investment adviser with custody of client crypto assets who trades the assets on a crypto asset trading platform that is not a qualified custodian would be in violation of the rule. According to a statement by SEC Chair Gary Gensler, “[b]ased upon how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians.” The proposed rule seeks comments, which should be received on or before the end of the 60-day period from the date the proposed rule is published in the Federal Register.

<a href="https://www.law360.com/fintech/articles/1576412?nl_pk=d839899d-0537-414a-b7cc-d6d00bb8e8ff&amp;utm_source=newsletter&amp;utm_medium=email&amp;utm_campaign=fintech&amp;utm_content=2023-02-16&amp;nlsidx=0&amp;nlaidx=0">SEC Eyes Crypto Assets In New Adviser Custody Proposal</a>

<a href="https://www.sec.gov/rules/proposed/2023/ia-6240.pdf">Proposed Rule: Safeguarding Advisory Client Assets</a>

<a href="https://www.sec.gov/files/ia-6240-fact-sheet-0.pdf">FACT SHEET Proposed Safeguarding Rule</a>

<a href="https://www.sec.gov/news/statement/gensler-statement-custody-021523">Statement on Proposed Rules Regarding Investment Adviser Custody</a>

DFS Orders End to BUSD; US, UK Agencies Take Crypto Enforcement Actions

This week the New York State Department of Financial Services (DFS) published a consumer alert to provide notice that “DFS has ordered Paxos to cease minting Paxos-issued BUSD as a result of several unresolved issues related to Paxos’ oversight of its relationship with Binance in regard to Paxos-issued BUSD.” According to the consumer alert and a blog post by Paxos, “[i]n response, on February 13, 2023, Paxos&nbsp;notified customers&nbsp;of its intent to end its relationship with Binance for BUSD.” The DFS consumer alert noted that “Paxos is required to redeem their Paxos-issued BUSD tokens for U.S. dollars through Paxos at a 1:1 exchange rate pursuant to compliance protocols for customers in good standing” and stated that DFS “is monitoring Paxos closely to verify that the company can facilitate redemptions in an orderly fashion subject to enhanced, risk-based, compliance protocols.”

In other news, this week the federal agency that oversees federal bank deposit insurance published a press release stating that it had issued two letters to crypto industry firms demanding that the firms “cease and desist from making false and misleading statements about … deposit insurance and take immediate corrective action.” Additionally, the agency directed two crypto industry websites “to remove similar false and misleading statements.” The agency published the four letters as part of the press release.

In the U.K., this week the Financial Conduct Authority (FCA) published a press release announcing that it had taken enforcement action against unregistered crypto ATMs that the FCA alleges were operating in the country illegally. The FCA’s action was conducted with assistance from the West Yorkshire Police’s Digital Intelligence and Investigation Unit.

<a href="https://www.dfs.ny.gov/consumers/alerts/Paxos_and_Binance">NY DFS: Notice Regarding Paxos-Issued BUSD</a>

<a href="https://paxos.com/2023/02/13/paxos-will-halt-minting-new-busd-tokens/">Paxos Will Halt Minting New BUSD Tokens</a>

<a href="https://www.coindesk.com/markets/2023/02/14/stablecoin-issuer-paxos-burns-700m-binance-usd-in-27-hours-amid-regulatory-pressure/">Stablecoin Issuer Paxos Burns $700M Binance USD in 27 Hours Amid Regulatory Pressure</a>

<a href="https://www.fdic.gov/news/press-releases/2023/pr23009.html">FDIC Demands Four Entities Cease Making False or Misleading Representations about Deposit Insurance</a>

<a href="https://www.fca.org.uk/news/press-releases/fca-takes-action-against-unregistered-crypto-atm-operators-leeds">FCA takes action against unregistered crypto ATM operators in Leeds</a>

Reports Provide Data and Analysis on 2022 Cryptocurrency Illicit Activities

This week blockchain analytics firm Chainalysis published its 2023 Crypto Crime Report. The report provides detailed analyses on cryptocurrency illicit activities in the areas of Sanctions, Ransomware, Money Laundering, Stolen Funds, Oracle Manipulation Attacks, Darknet Markets, Scams, and Pump and Dump Tokens. Among its many findings, the report notes the following: (1) Illicit cryptocurrency transaction volume “rose for the second consecutive year, hitting an all-time high of $20.6 billion”; (2) “43% of 2022’s illicit transaction volume came from activity associated with sanctioned entities”; (3) “[t]ransaction volumes fell across all of the other, more conventional categories of cryptocurrency-related crime, with the exception of stolen funds, which rose 7% year-over-year”; (4) “[o]verall, the share of all cryptocurrency activity associated with illicit activity has risen for the first time since 2019, from 0.12% in 2021 to 0.24% in 2022”; and (5) “[o]verall, illicit activity in cryptocurrency remains a small share of total volume at less than 1%” while “crime as a share of all crypto activity is still trending downwards.”

Another recent report published by CoinGecko provides additional 2022 data on illicit activity involving cryptocurrencies. Among other findings, the report notes the following: (1) “Cryptocurrency hacks and exploits caused $2.8 billion in losses [in 2022], the highest since 2013”; (2) “47% of these funds were stolen using a diverse range of hacking and exploitation methods” including “bypassing verification processes, market manipulation, ‘crowd looting’, [and] taking advantage of smart contract errors or loopholes”; and (3) the largest hacks in 2022 were the Ronin bridge hack ($625 million), the Wormhole hack ($326 million), the Nomad Bridge hack ($190 million) and the Mango Markets hack ($116 million). In a related development, a report this week noted that the Wormhole hacker recently moved $46 million of stolen crypto funds, according to blockchain transactional data.

<a href="https://go.chainalysis.com/rs/503-FAP-074/images/Crypto_Crime_Report_2023.pdf">Chainalysis: The 2023 Crypto Crime Report</a>

<a href="https://blog.chainalysis.com/reports/2022-biggest-year-ever-for-crypto-hacking/">2022 Biggest Year Ever For Crypto Hacking with $3.8 Billion Stolen, Primarily from DeFi Protocols and by North Korea-linked Attackers</a>

<a href="https://www.coingecko.com/research/publications/crypto-hacks-exploits-by-method">Most Damaging Methods of Crypto Hacks and Exploits in 2022</a>

<a href="https://cointelegraph.com/news/defi-exploits-and-access-control-hacks-cost-crypto-investors-billions-in-2022-report">DeFi exploits and access control hacks cost crypto investors billions in 2022: Report</a>

<a href="https://www.coindesk.com/tech/2023/02/13/wormhole-bridge-exploiter-supplies-46m-to-crypto-lending-platform-maker-buys-wrapped-ether/">Wormhole Bridge Exploiter Supplies $46M to Crypto Lending Platform Maker, Buys Wrapped Ether</a>

<a href="https://cointelegraph.com/news/wormhole-hacker-moves-another-46m-of-stolen-funds">Wormhole hacker moves another $46M of stolen funds</a>

DeFi Protocols Announce Updates; FSB Addresses DeFi Risks; Museum to Host NFT Exhibit; Crypto Enforcement Continues; Crypto Crime Reports Published