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Written evidence submitted by Circle Internet Financial LLC

Non-fungible tokens (NFTs) and the blockchain

CALL FOR EVIDENCE SUMMARY

Circle Internet Financial LLC (“Circle”) appreciates the opportunity to provide this response to the DCMS Committee inquiry into the operation, risks, and benefits of Non-Fungible Tokens (NFTs) and the wider blockchain. Circle commends the Committee for undertaking this timely inquiry as Parliament considers risks and opportunities for NFT investors. The U.K. has the opportunity to be a global leader for digital finance and cryptoassets, so it is important to think strategically about the long-term opportunities for the United Kingdom. Circle would welcome the opportunity to participate in a future hearing and provide oral evidence to expand on this submission.

ABOUT CIRCLE

Circle is a global financial technology firm that provides internet-native payments and treasury infrastructure. We have developed foundational technology centred on payments and banking in the age of digital assets and the internet. Since Circle’s founding, we have prioritised responsible financial services innovation and constructive engagement with regulators and public authorities around the world. Circle has a keen interest in the development of a transparent and well-regulated digital assets market that facilitates capital formation, maintains fair, orderly, and efficient transactions, and protects consumers. Partnership between the public and private sector is critical in developing technology-neutral, principled, activity-based regulation.

Circle is the sole issuer of USD Coin (“USDC”), one of the world’s largest digital currencies, with over $45 billion in circulation as of 3 January 2023; Circle has also recently launched Euro Coin (“EUROC”). Both fully-reserved digital currencies, USDC and EUROC have the benefits of blockchain-based digital assets – fast, inexpensive, transparent, highly secure, global, and interoperable value exchange over the internet – while remaining 1:1 fiat-backed, which removes the downside of extreme volatility that has plagued other cryptocurrencies. USDC is accessible across nine blockchains, is integrated as a settlement option in leading merchant and credit card networks, supports cross-border remittances, and is offered as a payment option by e-commerce platforms.

Additionally, Circle advances the frictionless exchange of financial value through its transaction and treasury services, which enable businesses and financial institutions globally to take advantage of the blockchain-powered global financial system. Circle is licensed to operate as a money transmitter or its equivalent in the United States where such licences are required. In addition, we have obtained a BitLicense from the New York Department of Financial Services (NYDFS) and are registered as a “Money Services Business” with the Financial Crimes Enforcement Network (FinCEN) in the United States.

CALL FOR EVIDENCE QUESTIONS

1. Is the UK’s light-touch NFT regulation sufficient?

The market for non-fungible tokens (NFTs) remains underdeveloped and in its early stages. As such, the UK should strive to balance the protection of end users of NFTs, such as businesses and consumers, and the need for prudent amounts of speculation that can stimulate market activity to allow these nascent markets to grow and mature.

To strike this balance, the UK should consider creating a regulatory framework for NFTs that acknowledges the diversity of the NFT market and of NFTs themselves. A non-fungible token (NFT) is a digital asset that is stored on a public blockchain. An NFT token is a unique asset in digital form that is not interchangeable with any other digital asset. Essentially, every NFT is a 'one-of-a-kind' item. NFTs currently take the form of artwork, music, or in-game assets such as unique avatars, but in the future they may be extended to any form of identifier or property, whether that be membership in a specific group, a subscription to a music service, or another type of product or service.

Given the relatively novel nature of NFT technology and markets, UK legislators and regulators should thoroughly consider the potential harms that exist in the NFT market, including how businesses and consumers may be harmed by speculative activities related to NFTs. At present, there is no comprehensive regulatory framework for NFTs that includes or involves the relevant prudential or conduct regulators in the UK. Additionally, there is currently no authorising legislation in the UK to create such a regulatory framework, or to direct specific regulatory authorities that would create necessary rules and regulations for NFT markets.

Because some NFTs provide their holder ownership rights and may accord value to this ownership, UK lawmakers and regulators should work together to examine the different categories of NFTs and create clear definitional standards to determine if certain NFTs meet the classification of a security or not.

Longer term, with a bespoke regulatory framework, NFTs could be more widely used and developed by a range of businesses and consumers, effectively becoming a “source of truth” for property rights of all non-fungible assets, such as homes, cars, and memberships. The design space for NFTs is largely unexplored, but the concept of verifiable ownership is a novel use of NFTs. While NFTs are still in their nascent phases, and fragmentation across many different blockchains networks exists, the increase in experimentation has already led to compelling use cases that have generated interest. To unlock NFTs’ full potential, regulatory and legal harmonisation will be required, just like with all other digital assets.

2.    What are the potential harms to vulnerable people of NFT speculation?

During periods when market volatility has produced positive returns for NFT speculation, this speculation has created the false perception that such profits are easy to come by. This, in turn, has attracted nefarious actors that look to take advantage of new or vulnerable populations looking to enter NFT markets. For the sake of this discussion, one might describe vulnerable populations as individuals or groups who are generally unfamiliar with the subject matter of NFTs and/or who may not follow generally accepted best-practices related to personal security of digital assets.

These nefarious actors typically exploit vulnerable individuals and groups by:

●        The artificial inflation of price while selling into liquidity created by new vulnerable participants.

●        Selling assets with promises of future profit but simply leaving vulnerable participants empty-handed.

●        Crafting schemes to drain the digital wallets of vulnerable participants through impersonation or other means.

Other risks that are not particularly related to nefarious actors include:

●        Financial Loss: Some people may be at risk of financial loss if they invest in NFTs without understanding the risks involved. NFTs, like other speculative assets, can fluctuate in value and may not always increase in value over time.

●        Exclusion: The high prices of some NFTs may exclude some people from participating in the market, particularly those with limited financial resources.

Circle suggests that these harms are mitigated through consumer protection measures, such as disclosures and requirements by digital wallet providers to guide users to follow certain personal security measures where applicable, and to provide end users with the clear understanding that the value of their assets held as NFTs may fluctuate in value.

3.    Do blockchains offer security to British investors?

Public blockchain technology fundamentally challenges the traditional model of intermediated financial services, and many companies are taking advantage of this period of innovation to gain customers, improve products, and prepare for the future.

Technical complexity and a recalibration of risk assessment are probably the greatest risk of widespread use of cryptoassets in the real economy. Public blockchains are technically complex, and use of cryptoassets likely requires new processes, controls, and training. Consequences for lost funds can be significant: a mistaken payment may not be refunded, and behavioural norms may be undeveloped or unenforceable.[1] Appropriate tools and processes have been developed for use by early adopters of cryptoassets, but the task of establishing best practices to businesses at scale is significant. This risk could be reduced through conduct-focused regulatory measures.

Additionally, risk-sensitive industries such as banking and insurance will need to fully understand and adjust risk ratings for crypto-native business processes. This entails coming to grips with the risks and benefits of public blockchains. On one hand, the risk of total loss due to a bug or error may be greater than in traditional financial infrastructure. On the other hand, the transparency of public blockchains may aid risk ratings in other ways. If the British economy is to fully leverage the transformative power of public blockchains, risk-assessors must adapt to the new technical structure of blockchain-based finance.

For certain businesses, it may be appropriate to pass new legislation or regulations segregating customer funds in accounts that have priority in the event of a financial institution’s insolvency. Providing for greater bankruptcy protections would be an important consumer protection and instil greater confidence in the market.

Circle has always recognised that the proliferation of public blockchain technology is a decades-long project. It has positioned itself as the bridge between the traditional financial system and the world’s leading public blockchains to unlock growth for businesses and investors around the world. Circle takes fiat currencies and puts them on blockchains, which pairs the technological possibilities of blockchains with the stability and trust of fiat currency. The financial services sector should recognise the growth and productivity of blockchain technology and seize the opportunity. Government authorities must likewise modernise and adapt their regulatory models to accommodate this shift.

Additionally, consumer protection authorities should use blockchain-native solutions to combat scams and fraud. Most digital assets are natively digital, open, and auditable, characteristics that offer advantages over traditional systems. This is most apparent in the ongoing fight against money laundering, which has benefited significantly from blockchain intelligence solutions. The same tools can be used to fight fraud and scams. Industry members have cooperated to start addressing the fraud within the industry. Circle recently partnered with TRM Labs and others to launch Chainabuse, a user reporting tool that identifies scammers and fraudsters by on-chain address.[2] When fraud is suspected, users can check the counterparty against a public, searchable database prior to engaging. This adds a layer of user protection using public blockchain technology’s unique identifiers.

Similarly, consumer protection authorities should leverage public community investigations to identify and prevent scams. Digital assets that are natively digital, open, and auditable empower anyone in the world to investigate suspicious activity and publish findings for open source review. For example, the U.S. Department of Justice (DOJ) recently charged three individuals with conspiracy to commit wire fraud, alleging that the defendants illegally traded on insider information. The original tip came from Jordan Fish, a prominent British crypto user who goes by the pseudonym Cobie, and the tip was cited by both the DOJ and Coinbase, one of the individual’s employers, as an important part of the investigation.[3] Similarly, the origin of the first U.S. insider trading case involving NFTs was a tweet from a user who goes by the pseudonym 0xZuwu.[4] The open nature of digital assets has the potential to make digital asset economies safer than traditional, closed systems.

Question 4: What are the potential benefits to individuals and society of NFT speculation?

For the purposes of this discussion, Circle can define speculation as the investment in stocks, property, or other ventures in the hope of gain but with the risk of loss.

While speculation is often negatively perceived for its correlation with heightened periods of volatility in markets, when inexperienced businesses or consumers may take greater market risk, there can be many benefits to speculation that make it a core part of market mechanics and maturation of emerging industries. Some of these benefits include:

●        Wealth Creation: NFTs may increase in value over time, which can benefit those who hold them. This could potentially lead to an increase in wealth for individuals who own NFTs.

●        Inclusion: NFT speculation can provide investment opportunities for individuals, particularly those who may not have access to traditional investment options.

●        Economic Growth & Innovation: Speculation can contribute to economic growth by providing capital for investment and by encouraging risk-taking, competition, and innovation. In the case of NFTs, the use of blockchain technology to create and verify NFTs can potentially lead to innovation in other areas, such as supply chain management, identification, and voting systems.

●        Price Discovery: Speculation can help to discover the fair price of an asset by providing a market for buying and selling. This can help to ensure that prices reflect the true supply and demand for an asset and lay a foundation of stability that allows others to participate.

Circle’s stance is that prudent levels of speculation, done in an environment that regulates for nefarious actors and excessive activity, may pose a net benefit to individuals and society. Ultimately, speculation does have a role to play in the flywheel of innovation, technological advancement, and wealth creation that is part and parcel of the development of emerging markets.

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CONCLUSION

Circle appreciates the opportunity to provide our comments into this important inquiry. We look forward to working constructively with the Committee and Government in the development of new legislation and regulations for the digital and crypto asset sector.  We would welcome the opportunity to engage in future discussions and would be happy to answer any questions the committee may have regarding the evidence submitted.

Yours sincerely

Teana Baker-Taylor

Vice President              , Policy & Regulatory Strategy, U.K. & Europe