Xavier Lavayssiere, XVLV | Stable Value, Unstable Compliance

The name of this talk is stable value and unstable compliance. Uh my name is Xavier Vissiere. I work mostly as a consultant to the public sector on tokenization, central bank digital currencies, and yeah, all these kind of topics. Um stable value. So, uh if we look at a stable coin, uh how it works, we have typically [snorts] Alice that has money and she wants a stable coin.

She will go through a dealer, giving her money to the dealer, that will give it to an issuer, that's the one actually issuing the stable coin, that will deposit it to the financial institution, that will save that money on one side. So, that's the stable part on the financial side, and it works pretty well. We have um this money is stored in safe uh assets, and hopefully we can uh retrieve it at the right speed when people want to get their money back. On the technical side, the issuer is creating the uh token. So, for this uh it uses a smart contract on the on the blockchain that will credit Alice with its stable coin.

Um once Alice has a stable coin, what she can do is to send a message to any of the blockchain where the stable coin is and transfer the asset to Bob. So, in that case, it can be without any uh financial intermediary. So, it's important to to see that the stable coin process itself has in necessarily a lot of intermediaries, but just the transfer can happen without any. If we look at the smart contract a bit more closely, we have always the same pattern, and that's an important aspect about the stability. We have a financial stability, but we have also a technical stability of the basic functions.

Typically, the smart contract will have a token name, a ledger that represents um the different value that um different participant have. And some internal logic, so that's the smart contract part where we have typically function like mint or transfer that we allow the issuer to mint new assets and transfer function that will allow Alice to transfer money to Bob. So all this part is stable, but the compliance part is unstable. So first to understand why we talk about compliance, we have to understand that there is a lot of illegal activity happening on chain now. So it goes from hacks and there have been several hacks over the last decade.

Um of different height. There have been sanctions, so for geopolitical reason, for criminal activity. Like forbidding to use certain addresses or to interact with certain actors. I I feel like sometimes we see this and there is a geopolitical dimension to sanctions and some but there is also like really nasty activity that's using currently a stablecoin. And we know from the latest report that now stablecoin are the the favo way of moving cryptocurrency and moving value for for criminal actors.

And and in terms of nasty things, I'm think thinking for instance of human trafficking, you know, like people that are lured or captured in a different country, moved to another country, they have been in this prison camp. And crypto serves both as a method to acquire money like creating crypto scams, but also as a mean then for these type of center to operate. So there are really uh awful things happening using crypto. So who can apply some compliance and apply some uh controls in this ecosystem. We have the dealer, of course, so the one that gives you the stablecoin can do some checks on on the client.

We have the issuer, also, which can both uh look at uh what kind of dealer it onboards, but also like look at what's happening on chain. We have the wallets. So, of course, if it's a self-hosted wallet, you don't have any option, but if it's a custodian and any financial institution using a blockchain use it through a custodian. Um monitoring uh companies that will monitor on chain and will help uh enforce this compliance. Nodes, also.

So, that's rare on permissionless blockchain, but now we have some nodes on permissionless blockchain that enforce some sanctions. We have also on all the permissioned setup where the validator will contribute to these controls. And also even the bank that has the asset could play a role, but we could have many other actors. Um when we uh have uh compliance, there are three main strategies uh that are being used. First is permission.

So, I'm using the analogy of the medieval medieval strategy. So, permission is like the walls and gates. So, we only allow certain actors to access to the stablecoin. We create block lists, allow lists, or even a transfer control. So, when there is a transfer, we create some controls.

There is monitoring. So, here I'm using the tower analogy where we check what's happening on chain. And there is data that's directly on chain, but there is also travel rule data. Now, most uh actors that are doing payments using crypto, they also have in parallel a network by which they send some additional data on the the people the person sending the money, the person receiving the money. And usually after a certain threshold, it becomes a lot of information even like the address and so on.

And then enforcement, so what do we do if something illegal happen? Uh do we freeze some address? Do we destroy some funds? Or or or bring them back? Or do we seize [clears throat] them for um uh for different reasons.

So, that's some of the option that we have. There's also some This is using smart contract function, but we know now that also at the mempool level there can be some action. Um but this are the methods, but they are fragmented at the moment. And that's the full problem. They are fragmented by jurisdiction.

So, the general rules of what should be applied are recommended by a body called FATF. Beautiful name. But every jurisdiction apply differently. So, in the EU, in US, we have some differences, but also especially some more emerging countries, they don't apply necessarily the same framework, and some don't even care at all, and that creates different ways of doing it. There is also a question of interpretation.

For instance, one thing that's I find interesting is uh the analysis on hops. So, after how many hops you consider that funds that were tainted, that were using a criminal activity, you would consider that now it's it's it's okay. So, there have been different debates, different doctrines. Um for instance, you could have a thousand different transaction, but they are done by the same actor just to uh hide a bit what's happening. And so, you you cannot really consider that the funds have really moved.

So, here we have a lot of discussion on how to interpret this. Um you have also fragmentation by the internal strategy of different actors. So, we have discussed the issuers, the exchanges, the wallets, and even the networks. They apply differently their rules. Uh for instance, when they decide to act, when they consider that something is really illegal and they need to act.

So, some are really proactive. They want to them their network. They want to protect their reputation and every time something happen, they will proactively block the funds. Some are more passive. They wait for court orders.

And some are totally rogue. They don't care at all and they don't apply any rules. Finally, there is the technology and there is a fragmentation on how it's implemented compliance. So, for instance, there is no real standard on how the function regarding compliance are done. We have also various way of analyzing.

There have been some studies showing that companies that provide data analysis on chain have sometimes missed clear red flags or also false flags. So, depending on how the algorithm work, they have different results and there is not enough um knowledge or competition to make sure that it's really the highest quality in the end. And finally, so an interesting case also is the multi-sig delay. So, that's a case for one of the stablecoin issuer. When they block an address or they they ban it, there is a time between the moment that they announce that they want to block it and the message is visible and before it's fully implemented.

And in that delay, of course, bad actors can see that the address will be banned and move the funds. So, that's obviously a problem. And yeah. One example simple is how many bans have been done on USDT USDC. So, that's two dashboards on Dune and you can see that on the first you have USDT that has thousands of address that have been blocked and on USDC it's just a few hundred.

So, does that say that USDT is more proactive in how they implement compliance or does that mean that more bad actors use USDT? I don't know. But and also they have a lot of ban address on Tron. So, that's only for Ethereum. Um you have really new actors that are fully not applying compliance and one particular example is A7 A5.

So, it's a Ruble-based stable coin uh, that's based in Kazakhstan apparently and they um, have already 100 billion in transaction value, 500 million in in total amounts that's um, on the stablecoin. And clearly has a different strategy than other stablecoin issuers. So, that brings us to this table. We can see some of the current stablecoins and their different strategies regarding compliance and regarding especially for instance for MiCA. USDT notoriously chose to not be compliant with the European regulation MiCA.

USDC chose to be. US TS is kind of a gray space at the moment because it's kind of a DeFi project and Dai was definitely really light on compliance. US DS is already one step uh, further but it's still in a this gray space. A7 A5 I mentioned is definitely um, it has been I think even explicitly sanctioned as a smart contract. Um, uh, new actors who are USDG which is a consortium based in Singapore and in Europe and a bank-based stablecoin um, Euro convertible.

So, the consequences of this and that brings me to my conclusion. Uh, first we have seen stablecoin have standardized the transfer functions and have a stable value. So, that's I think a success because it was the purpose of a stablecoin. Uh, there are still some risk um, lingering but the main objective have been achieved. Compliance remains unstable across those operations and implementations.

That leads us to the consequences. The consequences is a lot of legal risk because all the different actors now involved in uh, proceeding with uh, stablecoin transaction cannot be fully sure when they have the transaction they want to be as compliant as possible how uh, they can apply all the different rules, uh, how enforcement from a different country could uh, um, be required to apply and so on. So, that that creates a lot of uncertainty for the intermediaries. So, it's probably a loss economic opportunity for these actors. There are technical failures and these have read really interesting uh, audit reports showing that some DeFi protocol have to be audited and think about if the the stablecoin is blocked, can we still uh, function?

And if you have function that require um, a certain transfer to happen and you don't expect it to be potentially blocked then then you might have a problem and that happened in some uh, DeFi protocol. And of course, more illegal activity because the because there is no uniform way of doing there is a lot of regulatory arbitrage and a lot of uh, um, different illegal activities that persist in stablecoins and which and the market the space in general. I think the problem is entering a worse phase. So, that's my intuition uh, because there is a lot of new actors that are entering, illegal actors understand well the technology, coordination from the public sector is probably hard to obtain. There is awareness about the problem but it takes time.

And so, I'm I'm guessing that this we entering probably the worst phase of all of this. With this, uh, thank you very much for listening and uh, we have 1 minute if you want to have one question otherwise happy to discuss after.