The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.
Let’s see what’s going on this week:
Bitcoin Ordinals: Rock.jpg v.2 — or Something More?
Are NFTs Securities? Federal Court to Take a Closer Look
Coinbase Q4 Earnings and the New ‘Base’ Network
Takeaways from Fed Minutes Meeting
Crypto’s Next Bull Run is Coming From… China?
What’s all this Buzz with Bitcoin Ordinals?
Deep Dive Into Ordinals: Should NFTs Exist On the Bitcoin Blockchain? (link)
First NFT Minted on Litecoin: Ordinals Ported to LTC Blockchain (link)
Satoshi Inscriptions Akin to Stone Tablets of Old
It’s 2023 and NFTs are a new thing — again?
Kind of sounds like groundhog day. But on the Bitcoin blockchain, yes — NFTs are new again, thanks to ordinals.
Bitcoin is known for a lot of things — rat poison squared, a ponzi scheme, and paying for (a now very expensive) pizza to name a few — but the maxis will tell you it’s known for securing sound money with vast amounts of computing power.
Thousands of Bitcoin miners around the world verify each transaction, which are grouped into blocks, and these data blocks are then added to Bitcoin’s decentralized ledger for posterity.
In a way, each BTC is an energy receipt issued by a decentralized computing powerhouse.
Some would say that this energy receipt is too much of a cost for storing value. But in the grander scheme of things, the relative impact is not as large as you might think.
Quantitative carbon emission comparison of various industries. Image credit: University of Cambridge CCAF 2022 Report
But what if Bitcoin mining can be used for more than just securing transactions?
This is where Bitcoin ordinals come into play. Software engineer Casey Rodarmor created a mini-revolution in January after having launched the Bitcoin ordinals protocol.
Without getting too technical, Casey took advantage of the ordinal theory in computer science to inscribe media content onto Bitcoin transactions.
In short, he created Bitcoin NFTs called ordinals. But unlike ‘traditional’ NFTs on Ethereum and other chains that store the actual content (image/video/audio/text) off-chain, such as the IPFS network, Bitcoin ordinals are fully stored on the Bitcoin network.
This has profound implications.
If the Bitcoin network lives forever — or at least for a very long time — the same applies to ordinals as well.
And this may be even more important than you think. Case in point, ebooks as NFTs, or Bitcoin ordinals, could be archived for future generations in their original form, with easy access and transfer of ownership.
For example, controversial censorship or edits to an author’s work — even after their death — wouldn’t be so easy to implement by publishers. Why? The original, unedited version would always be accessible.
In pure textual format, literary works consisting of 400 pages could be made into ordinal blocks of around 2–4 megabytes (MB).
Since Bitcoin ordinals gained traction in January, Bitcoin’s average block size nearly doubled, going from 1.5–2 MB to 3–3.5 MB range.
As a side effect, Taproot adoption has also been skyrocketing. This was a major Bitcoin upgrade in November 2021 that made Bitcoin ordinals possible with extra smart contract capability and reduced transaction fees.
Users have already spent $1.2 million in BTC fees for inscribing ordinals, further incentivizing Bitcoin miners. Although this brand new Bitcoin frontier puts a strain on the chain, layer-2 Lightning Network is there to help, with a capacity that recently notched an all-time high.
Dapper Labs Must Face Class Action Alleging its NBA NFTs Are Securities (link)
New Securities Legal Battle Stirred
We all know of the ongoing tension between US financial regulators and the digital asset space. Recently, this tension has specifically applied to digital assets hosted on proof-of-stake blockchains, as their regulatory status as a security, commodity, or other, has come into question.
The difference between a security and a commodity is quite drastic. If a digital asset is deemed a security, a wide range of restrictions are imposed: how it can be initially offered, who can buy and sell it, how it is traded, legal compliance costs, etc.
In this week’s ‘looming threat of becoming a security’ edition, Dapper Labs is in the crosshairs. The Web3 company is best known for its NBA Top Shots lineup of NFTs called ‘Moments’. As the name suggests, these NFTs immortalize NBA highlights, such as players’ dunks or game-winning shots, in blockchain form.
Dapper Labs mints NBA Top Shots NFTs on its own Flow blockchain as high-quality video reels. Image credit: NBATopShot.com
As licensed digital collectibles attached to such a popular sport, Moments have been a consistently high-performing NFT enterprise, generating $2.4 million in sales in February alone.
So, what’s the problem, isn’t this just like collecting or trading vintage cardboard basketball cards?
The story gets a bit complicated. Dapper Labs first received a class-action lawsuit in May 2021, wherein Momento buyers accused the company of minting the NFTs as unregistered securities.
“Moments are securities because they constitute an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others,”
The reasoning was that Moments’ value relies on the success of Dapper Labs’ Flow blockchain that hosts them. In other words, the value of the proprietary Flow blockchain, powered by its native FLOW token, is itself boosted by the sales of the NFTs it hosts.
In return, last September, Dapper Labs moved to dismiss the lawsuit because plaintiffs can’t “make a federal securities case over basketball cards”.
“Basketball cards are not securities. Pokémon cards are not securities. Baseball cards are not securities. Common sense says so. The law says so. And, courts say so,”
But the New York court dismissed the motion to dismiss the lawsuit this past Wednesday. Apparently, the court is seeking further nuance on whether Moments are commodities, which should be decided in a trial.
“In the most general terms, the Court is asked to assess whether Moments are more like cardboard basketball cards, i.e., commodities, or more like crypto tokens. As the ICO Cases reveal, tokens offered as part of ICOs often bear the hallmarks of a security. Here, it is a close call and the Court’s decision is narrow.”
This trial may become the new Ripple Labs vs. the SEC saga, but for NFTs. On face value, NFTs are collectibles, but they could also be construed as ‘investment contracts’ if there is expectation of profit on secondary markets.
Further, Dapper Labs gets a cut when users make certain transfers. It is then a question of whether Moments NFTs come with a reasonable expectation of profits. When Dapper Labs describes their NFTs as “objects of play”, they are effectively invoking the United Housing Foundation, Inc. v. Forman Supreme Court case.
In that case, the Supreme Court said that an investment is “where one parts with his money in the hope of receiving profits from the efforts of others, and not where he purchases a commodity for personal consumption or living quarters for personal use.”
Coinbase Fails to Rally Despite Improving Numbers (link)
Coinbase Beats Revenue Estimates, but Userbase Declines
Favored by BlackRock and Visa, Coinbase has been building itself up as the ultimate US-based crypto exchange. As the first exchange that went public, Coinbase (COIN) took its institution-embedding very seriously, going as far as selling its blockchain analytics tools to federal law enforcement agencies.
Yet, Coinbase maintains only a fraction of the market share (4.31%) compared to Binance (61.31%). Reliant on crypto flows, Coinbase fared poorly over a one-year period, with COIN shares down by -64%. However, since the start of the year, COIN stock is up +85%.
The latest Coinbase earnings Q4 ’22 report sheds some light on what we can expect from the US’ largest crypto platform. In Q4, Coinbase:
Beat revenue estimates of $590 million with $629 million.
Beat the estimated loss per share of $2.55 (via Refinitiv) with $2.46.
Reported a non-adjusted net loss of -$557 million, a far cry from Q4 ’21 bullrun peak of +840 million.
Overall, Coinbase aligned its year-over-year -75% revenue downturn with its stock price drop, as the crypto cycle turned from bullish to bearish.
Yet, the discount only spurred Cathie Wood’s ARK fund to buy an extra $13.2 million worth of Coinbase shares, accounting for $30 million invested in February.
Although the COIN discount was to be expected, the worrying part is the falling user base. Compared to Q3, Coinbase’s monthly transacting users (MTUs) fell from 8.5 million to 8.3 million in Q4.
But, there are several remedies Coinbase is deploying to get lean and profitable:
Since mid-2022, Coinbase laid off 18% of its workforce, at 1,100, not ruling out additional layoff waves this year.
As transaction revenue declined by 12% in Q4, the exchange is looking for subscription-based services. Staking, Earn and Custody products have generated just over $200 million in Q4.
Most importantly, Coinbase announced a major stepping stone in the crypto space with the launch of its own Base network.
Base testnet went live yesterday. This layer-2 network will use coding from Ethereum’s Optimism L2 scaling solution, with the goal to onboard +1 billion users to decentralized finance.
Base will use the existing ETH token instead of a native one for paying network fees.
Additionally, Base will serve as a bridge to non-Ethereum ecosystems, such as Bitcoin, Solana, and others.
Cryptocurrencies supported on Base. Image credit: Coinbase
Since July 2022, ETH has outperformed BTC, up 61% since that time, compared to BTC’s 29% climb. With ETH pushed further by Base, it could go on to outperform Bitcoin even more than it already has.
Fed’s Goal Post Moving Up?
Fed Minutes Show Members Resolved to Keep Fighting Inflation with Rate Hikes (link)
More Fed Hikes Incoming, but With One Caveat
Another month, another deliberation by the money committee. The dollar’s global reserve status gives the Federal Reserve the de facto world bank status. And the 12 Fed governors are listened to closely as they set the price of money and its creation rate.
Wednesday’s released FOMC minutes pointed to concerns of inflation being stickier than initially thought. With the labor market still remaining “very tight”, the rate of inflation going down might not be enough.
To that effect, FOMC members plan for ongoing interest rate hikes this year to get to the coveted 2% inflation rate.
“The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time,”
Governor Bullard repeated his conviction that the Fed should up its hiking game with 50 bps bumps, increasing the rate to its 5.375% peak sooner from the present 4.5–4.75% range.
Presently, the market consensus for the next hike on March 22nd is 25 bps, with a probability of 76%.
Interestingly, the 2% inflation target could shift in the future. The White House is considering two candidates for the Fed Vice Chair position. One of them is Janice Eberly.
In 2019, she published a paper stating that a 3% inflation target would have led to a faster recovery from the 2008 Great Recession.
LSAPs refers to large-scale asset purchases that contribute to Fed’s policy creation.
If Eberly becomes the next Fed Vice Chair and nudges the new goal post, that would certainly give the central bank a much-needed leeway between soft and hard landing.
Crypto’s Next Bull Run Will Come From… China?
HK Allocates $6.4M to Web3, Seeks to Unlock Potential of “Third Generation Internet” (link)
A Wedge Between the US Regulatory Hammer and a China-Based Oasis
A fresh crypto narrative is in the works.
It may be strange, but the next crypt bull run may come from the most crypto-hostile nation in the world — China.
Last Sunday, Cameron Winklevoss of Gemini exchange first floated the notion.
This was after another exchange boss, Brain Armstrong of Coinbase, said the emerging crypto crackdown in the US (which some have deemed Operation Choke Point 2.0) would lead to a blockchain exodus from the US, and into Hong Kong, the EU, and the UK.
Indeed, on Tuesday, Bloomberg reported that Hong Kong’s crypto hub ambition is ‘quietly backed from Beijing’, the political capital of China.
The HK’s equivalent to the US SEC, the SFC, proposed a new set of rules on Monday that have a “regulate to protect” approach, as opposed to the SEC’s notorious ‘arbitrary sanction by legislative void’ approach.
When new HK rules go into effect, retail investors will have access to licensed crypto exchanges, but with some restrictions, such as derivatives trading.
The China-bull trigger narrative is further boosted by the People’s Bank of China injecting $92 billion to stimulate the economy. Just as we saw in the US during 2020/21, the monetary flooding appears to have boosted digital assets based in China: Conflux, Neo, and Flamingo all entered double-digit gains territory.
Chinese coins mimick the crypto performance following the Fed’s unprecedented stimulatory injections. Image credit: Trading View
But as you can see, the boost was short lived.
Nonetheless, if China indeed nurtures a regulated crypto oasis in Hong Kong, pulling investors from the US, this may be a foreshadowing of China-driven crypto resurgence.
At a time like this, when earnings are falling and hopes for an imminent Fed pivot are fading fast, the market is in a tough spot. History illustrates the challenge: 🧵
The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.
Let’s see what’s going on this week:
CPI Misses Estimates — The Future Outlook
How the SEC Could Soon Have Total Authority Over Crypto Exchanges
Is Wall Street Moving to Absorb Crypto via Silvergate?
Why Paxos Can No Longer Issue BUSD
Why Did BTC Pump to $24k?
CPI Report Breakdown
US Inflation Declines for the 7th Consecutive Month: January CPI at 6.4% (link)
Federal Reserve: Between a Rock and a Hard Place
On Tuesday, the US Bureau of Labor Statistics dropped January’s Consumer Price Index (CPI). The good news is that the disinflationary trend is ongoing, as inflation dropped for the 7th consecutive month, at +6.4% YoY vs. December’s 6.5%.
The not-so-good news is that the drop was still higher than the expected 6.2%. When all inflation indicators are accounted for, all but two came higher than expected.
Obviously, if economists had lowered their expectations in the first place, the numbers would be perceived positively. This friction between incoming data and estimates needs to be as low as possible.
After all, it is the difference between a ‘soft’ and ‘hard’ landing.
If the friction is high, it could lead to a failed fiscal policy. The Fed’s primary driver is still to lower inflation, even at the expense of short-term employment. In that light, there are already some cracks showing in the Fed, as two officials see the need for more aggressive hikes.
Cleveland Fed President Loretta Mester said on Wednesday that “The demand side of the economy is not weakening quite as fast as some thought it was,”. She based that on the unemployment rate falling to 3.4% in January, the lowest in 53 years.
Likewise, St. Louis Fed President James Bullard joined Mester:
“It just seems like a very strong labor market on many dimensions and it seems like there are structural issues with labor supply that are going to keep it strong,”
In January, nonfarm payrolls increased by 517,000 — far above December’s growth of 216,000 — and crushing estimates of 187,000.
How can inflation be sustainably killed, to the coveted 2% range, with people having easy access to jobs? On the other hand, is it even realistic to use rate hikes as the primary weapon against inflation?
Let’s remind ourselves, rate hikes raise borrowing costs for individuals and businesses. In turn, the government’s ability to repay its debt liabilities (bonds) is negatively impacted. That’s because more expensive capital leads to slower economic growth and lower spending at the same time as it reduces inflation.
Consequently, as the government’s tax revenue is lowered, its ability to repay debt is weakened.
At the moment, the bond market priced in a disinflation trend, as 10-year bonds are holding at 3.78% vs. the inflation rate at 6.4%. Why would investors buy bonds other than expecting them to beat inflation?
Even the 6-month treasury is currently 5%, the highest since 2007, but it still doesn’t offset inflation. Surprisingly, even if inflation is beaten in 2023, and the Fed starts cutting rates in 2024, the CBO (Congressional Budget Office) projects 10-year Treasury notes to remain at 3.8%.
With so much debt, the long-term bond yields will have to go up to offset the risk of owning them. Yet it’s difficult to imagine how such a debt can be serviced without massively diluting the value of the dollar.
Of course, the Fed would do so indirectly, by buying more Treasury securities issued by the US Treasury, for example. This would effectively inject more money into the economy for expansionary, inflation-triggering fiscal policies. Then, we are back to square one with high inflation.
In short, the US economy is between a rock and a hard place.
Control Over Crypto Exchanges via Technicality?
SEC Proposes Rules That Would Change Which Crypto Firms Can Custody Customer Assets (link)
The SEC Delivers Crypto Clarity — with Some Caveats
The U.S. Securities and Exchange Commission made a big move on Wednesday.
With a 4–1 vote, the regulatory agency aims to expand federal custody regulations to cryptocurrencies. Simply put, the proposal would extend the existing Custody Rule from securities and commodities to cryptos.
If the proposal goes through, SEC-registered investment advisers (RIAs) would have to place clients’ crypto assets into the hands of dedicated “qualified custodians”.
These include federally or state-chartered banks, broker-dealers, trusts or futures commission merchants. As such, crypto custodians would be subjected to “surprise examinations” and strict record-keeping rules.
On its face, the SEC’s proposal appears to be designed as something that would prevent an FTX-like collapse from taking place again. For example, it would have likely prevented customer assets from being co-mingled with Alameda Research.
More importantly, the proposed rule would offer compensation in the event of a loss, leveling up the legitimacy of the digital asset class.
However, this lack of limited liability is problematic because custodians don’t actually own cryptocurrencies, so it is up to the owner to ensure them. In the case of securities, such a distinction is less relevant because it is the DTCC that holds the titles on securities.
There is also the issue of pushing all cryptos as securities under the SEC’s rug.
“sweeping ‘just about every crypto asset is a security’ statements also seem to be part of a broader strategy of wishing complete jurisdiction over crypto into existence.”
-SEC Commissioner Hester M. Peirce, as the dissenting vote on the proposal.
Altogether, the number of firms that would be qualified as crypto custodians would be greatly reduced. Ironically, this could expose crypto investors to greater fraud risk.
“This approach to custody appears to mask a policy decision to block access to crypto as an asset class. It deviates from the Commission’s long-standing position of neutrality on the merits of investments.”
To play devil’s advocate, is this Gary Gensler’s goal as a former Goldman Sachs banker? The recently SEC-fined ($30M) Kraken CEO, Jesse Powell, certainly thinks so.
Powell questions the very concept of reduced risk with “qualified custodians” because “why is a less diversified business less likely to go bankrupt?”
On the other hand, both Coinbase and Anchorage Digital crypto bank see no threat from the SEC proposal as they are already chartered or have partnerships with chartered banks.
In the end, if a digital asset’s value is outside of the banking ecosystem, how do you control it? Simply, by controlling the fiat roads between the two. Today, these roads are largely crypto exchanges, and their ability to hold and convert fiat-to-crypto.
With this proposal, the SEC would have the power to pick and choose which crypto exchanges (or other entities) have that privilege in the US.
Crypto Bank Silvergate is Now the Second-Most Shorted Stock in the US (link)
Wall Street Seeks Discounted Silvergate
Silvergate has served as the fiat-to-crypto backbone for crypto exchanges. As a chartered bank going beyond traditional banks, the Silvergate Exchange Network (SEN) first enabled exchanges to service their customers 24/7, which gave the bank a prominent position in the crypto ecosystem.
Image credit: Silvergate
Unfortunately, this included FTX.
After FTX went down, bank runs became common, and Silvergate’s coffers drained to the tune of $8.1 billion by January. To keep afloat, the bank even had to borrow $4.3 billion from the Federal Home Loan Bank (FHLB) of San Francisco.
With these stormy headwinds, Silvergate Capital (SI) became the 2nd most shorted US stock last week, having lost 87% of its value year-over-year.
Silvergate (SI) drew the shorter end of the FTX stick since November. Image credit: Trading View
On top of incurring debt, Silvergate also piled on legal scrutiny. December’s class-action lawsuit paints the bank as having “directly aided and abetted FTX’s fraud and breaches of fiduciary duty via first-hand participation in the commingling of funds, improper transfers, and lending out of customer money.”
Yet, Silverage is now an appealing target for a potential takeover. Ken Griffin’s Citadel Securities revealed a 5.5% stake in Silvergate. At the same time, BlackRock, the world’s largest asset manager, recently increased its Silvergate stake to 7.2%.
What do Citadel Securities and BlackRock both have in common?
Citadel Securities had already revealed plans for a Wall Street-backed crypto exchange last September, dubbed EDX Markets.
In turn, BlackRock picked CoinBase for its exchange of choice for institutional investors. Moreover, BlackRock CEO Larry Fink made it clear that the future of next-gen markets lies in tokenized securities.
Combined with the SEC’s recent actions on staking, stablecoins, and qualified custody, a clear picture is forming. One in which digital assets are absorbed into Wall Street.
BUSD’s Expiry Date Set
BUSD Issuer Ordered to Stop Minting New Tokens: Report (link)
Paxos Strongly Disagrees With SEC on BUSD, Willing to “Vigorously Litigate” (link)
Wasn’t Paxos Supposed to Be the Most Regulated Stablecoin Firm?
A serious stablecoin shakeup is underway.
On Monday, Paxos shook the crypto world by announcing it will stop minting new Binance USD (BUSD) stablecoins, taking effect February 21.
Predictably, a -15% surge of BUSD outflows followed, as the stablecoin’s market cap went down from $16.14 billion to $13.71 billion.
Paxos received an order from the New York State Department of Financial Services (NYDFS) to do so because it:
“violated its obligation to conduct tailored, periodic risk assessments and due diligence refreshes of Binance and Paxos-issued BUSD customers to prevent bad actors from using the platform.”
On top of that, the SEC threatened Paxos with a Wells notice. This is a formal letter issued ahead of an imminent enforcement action due to violations of securities laws. Specifically, communication from the SEC suggests BUSD itself is an “unregistered security”.
As BUSD winds down, existing coins will remain fully 1:1 redeemable for USD. More importantly, the world’s largest crypto exchange is left without its own stablecoin. Although it is called Binance USD, it was the Paxos Trust Company that was the issuer and custodian, including holding reserves.
Binance heavily relied on BUSD for its Binance Smart Chain (BSC) ecosystem, holding 90% of all BUSD. BSC currently holds $7B in total value locked (TVL). To pick up the stablecoin slack, Binance already minted $50 million in another stablecoin, True USD (TUSD).
However, Binance CEO “CZ” now thinks that we may see a de-dollarization of the crypto ecosystem. One that mirrors the ongoing de-dollarization in the real world via the BRICS initiative.
“There’s multiple agencies putting applied pressure there. It is just going to shrink the U.S. dollar-based stablecoin market,”
With that said, the NYDFS authorized Paxos to only issue BUSD on the Ethereum blockchain. Therefore, BSC doesn’t fall under the department’s authorization, as BSC-generated BUSD is not issued by Paxos.
This appears to be the critical friction point that resulted in the BUSD shutdown.
The plot further thickens when we see that Circle, a competitive USDC issuer, had previously alerted NYDFS that Binance allegedly failed to fully back some of its tokens.
Of course, Circle/Coinbase’s USDC is at least partially backed by BlackRock.
What’s Happening with Bitcoin?
Bitcoin Above $24K as Crypto Markets Recover From Regulatory Assault (link)
BTC Pump Tea Leaves
On Wednesday afternoon, Bitcoin restored its pre-FTX price by breaching the $24,000 threshold. The next day, BTC price even jumped over the important $25k psychological level, reaching $25.2k.
In technical terms, Bitcoin broke the 200-week moving average, its highest price point since August.
Year-to-date, Bitcoin is up by +42%. Image credit: Coin Metrics
Why would Bitcoin rally as macro uncertainty clings to markets like a toxic cloud?
Bitcoin is still perceived as a risk-on asset, and such assets don’t fare well in the middle of the Fed tightening and recession risk.
Whatever the reasoning, public blockchains track all. And it appears several institutions withdrew at least ~$1.6 billion worth of the USDC stablecoin while only depositing ~$0.2 billion USDC, according to lookonchain analysis.
Representing fiat-to-crypto rails, stablecoin moves typically signal major crypto inflows. Image credit: @lookonchain
This translated to increased Greed sentiment in the crypto market, now at 61.
Of course, as the SEC threatens to turn all crypto into securities, Bitcoin would be the single exception as a commodity, as suggested by Gensler’s own words:
“Many of these crypto financial assets have the key attributes of a security. So some of them are under the SEC. Some, like Bitcoin, and that’s the only one I’m going to say… my predecesors and others have said, they’re a commodity”.
Whatever the key driver is, both options and futures markets are turning bullish. This was manifested through massive short liquidations. On Thursday, Bitcoin shorters lost over $160 million.
Now, it remains to be seen if more $24k breaches will pop up, or if we see red candle fallbacks. One thing is for sure, with unpredictable whale money, relying on technical charts for solid conclusions is more akin to reading tea leaves.
As always, Bitcoin is a signal-receiving network. Therefore, much will depend on the stock market’s performance, which itself continues to react to macro economic signals it receives from the Fed and elsewhere.
Tweets of the Week
#Bitcoin Weekly Chart — RSI
Expansion Phase Historically has begun as we use 50 RSI as support on the weekly.
With all the hoopla over CPI, the NFIB report didn’t get its due this week.
Inflation pressures clear for many small biz as the need to raise wages to attract workers remains firmly in place and if anything ticked up. Not a good sign for JP’s inflation focus areas.
US retail sales increased 3.9% over the last year, the lowest growth rate since May 2020 & below the historical average of 4.8%. After adjusting for inflation, though, the picture is much worse. Real retail sales declined 2.3% over the last year, the 5th consecutive YoY decline.
The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.
Let’s see what’s going on this week:
Operation Choke Point 2.0
‘Britcoin’ CBDC Off to a Stumbling Start
Uniswap: Decentralized Governance Questioned
Asset Managers on the Future of Crypto
Lightning Network Reaches New ATH
Permissionless DeFi Still Needs Permission in the U.S.
Coinbase CEO Says SEC May Be Moving to Ban Crypto Staking in US (link)
Kraken Hit with U.S. Securities Violation, Pays $30 Million Fine (link)
A Movement to Cut Crypto from the U.S. Financial System?
Governments hold many tools to regulate various industries by enforcement rather than having to go through time-consuming and unpredictable legislative runarounds.
Case in point, Obama’s Department of Justice (DOJ) launched Operation Choke Point in 2013 to intercept certain merchants from accessing the banking system.
These were typically payday loan and online poker platforms, as well as firearms dealers, having been identified as ‘high-risk’ for money laundering and fraud. As the governmental pressure stopped banks from processing their transactions, Operation Choke Point was deemed government overreach. It was shut down in 2017.
Now, Bitcoin maximalist, investor, and general partner at Castle Island Ventures — Nic Carter — believes the Biden Adminstration is trying to quietly ban crypto. Carter refers to the development as Operation Choke Point 2.0.
First — why would such a ban development ‘quietly’?
It’s easy to understand the main argument here. It would be a pretty bad political look to openly attack the most innovative technology to reach finance in decades. From Bitcoin as sound money to decentralized finance (DeFi) ecosystems, enormous brain power has been poured into blockchain projects, developing new economic possibilities.
Openly legislating against them would paint the government as regressive and anti-consumer.
Hence, the stealthy Operation Choke Point 2.0 approach.
On January 3rd, the Office of the Comptroller of the Currency (OCC), together with the Federal Reserve and the Federal Deposit Insurance Corporation, issued a milestone joint statement:
“…the agencies believe that issuing or holding as principal crypto-assets that are issued, stored, or transferred on an open, public, and/or decentralized network, or similar system is highly likely to be inconsistent with safe and sound banking practices.”
According to Eli Ndinga of 21Shares research, this approach could cut the legs out from under crypto projects. Although DeFi aims to replace traditional finance eventually, intercepting banking services from exchanges or payment processors would be crippling at this stage of the game.
Ndinga reminded us that we have seen a similar tone before crypto was outright banned in China. In the worst case scenario of such strenuous choking, end-users would find themselves in choppy waters without any principles to hold onto.
Bitcoin advocate Nic Carter thinks that coordinated Choking is already manifesting as both Coinbase and Kraken exchanges are coming under scrutiny.
Coinbase CEO, Brian Armstrong, confirmed such rumors are percolating, involving a ban on crypto staking.
According to Coinbase’s Q3 revenue statement, staking accounted for 11% of total revenue.
This would indeed be terrible because all proof-of-stake blockchains would be prohibited from being secured. PoS networks, from Ethereum and Solana to Aptos and Cardano, all rely on users staking a certain amount of cryptocurrency to validate network transactions.
In exchange, they receive yield rewards just like a bank receives interest rates on loans. Except, stakers support the entire decentralized network, and therefore all participants, rather than a single centralized institution such as a bank.
It appears that the SEC, run by former Goldman Sachs banker Gary Gensler, will be the government’s main Choke weapon. The agency issued a statement this past Tuesday, placing the crypto industry as one of its six top priorities for 2023.
“The scope of any examination includes analysis of an entity’s history, operations, services, products offered, and other risk factors.”
Without any legislative constraint, this could turn into staking bans or classifying thousands of cryptocurrencies as securities. Gary Gensler has already established a well-oiled “regulation by enforcement” machine. Yesterday, he hit Kraken with a $30 million settlement fine for offering “staking-as-a-service”.
But the big technical question is, why would banks fear Operation Choke Point 2.0 aimed at crypto? The answer is — CAMELS:
C — Capital adequacy
A — Asset quality
M — Management quality
E — Earnings
L — Liquidity
S — Sensitivity to market risk
Governmental agencies use the CAMELS rating system to gauge a bank’s health. In turn, they could inject the new crypto narrative to make their rating low. This plays a critical role in the agency’s decision to issue, renew, or even revoke a bank’s license.
As a result, banks — and not just U.S. banks but any banks that work with U.S. banks — could become reticent to deal with any crypto rails.
Does this mean the US government is effectively declaring war on crypto?
India Has 1.4 Billion People and Only 50,000 CBDC Users (link)
Britcoin’s Roadmap Revealed by UK Chancellor: No Hoarding Allowed (link)
Real Money vs. Conditioned Account Access?
The world is undergoing the great Monetary Revolution in more ways than one.
On the one hand, we have non-institutional networks like Bitcoin running on code, without boards or CEOs.
On the other hand, we have central banks racing to deploy their central bank digital currencies (CBDCs).
A visual depiction of current global CBDC development. Image credit: Atlantic Council
The type of blood that flows through the economy — curren(t)cy — has a profound impact on every aspect of life. As we inch closer to the mystical 2030 deadline, we are starting to see what that would look like. On Tuesday, the Bank of England’s Deputy Governor Jon Cunliffe surprised the world with this statement:
“A limit of £10,000 would mean that three quarters of people could receive their pay in digital pounds, while a £20,000 limit would allow almost everyone to receive their pay in digital pounds,”
Yes, this policy limit would effectively prevent people from hoarding digital pounds, ‘Britcoins’.
However, the policy is supposed to be short-lived. The aim is to protect traditional banks from having their accounts drained. Needless to say, this would collapse the UK’s high street made of the ‘Big Four’: Lloyds Banking Group, Barclays, HSBC, and the Royal Bank of Scotland.
Being a digital version of the pound, one could frictionlessly transfer Britcoins from one account to another, 24/7. People already expect it as they are used to dealing with electronic cash. In fact, CBDCs and existing electronic cash are similar in that they represent a claim on the central bank’s balance trickling down to commercial banks.
Cash usage in the UK has declined by 60% in less than two decades, with only 15% of daily transactions using cash. Image credit: Bloomberg, Source: UK Finance
The problem is, the very fact that a limit on ‘Britcoin’ saving can be implemented is not instilling confidence in the general public.
What else can be imposed? Unsurprisingly, everything that the authorities deem as appropriate.
This paints the CBDC picture as one that is based on its developers’ mercy. Imagine playing a game with a virtual economy, in which something is always tweaked to ‘balance it out’.
Traditional thinking suggests players can always opt out of the game if they don’t like it.
But with the CBDC situation, the whole point is to have just one game, for better or worse.
Yet, as money is becoming an entirely new beast, the uptick is abysmal. As of last October, Nigerian eNaira saw 0.5% adoption usage, out of 213 million Nigerians.
India’s pilot CBDC among retailers is seeing only 50,000 users and 5,000 merchants, out of a population of 1.4 billion people.
One thing is for sure though.
By the end of the decade, we will see if money becomes a conditioned access to a central bank’s account, or sovereign cash embodied in the cyber realm. As of early 2023, it’s starting to look like the co-existence of the two has a dim future.
We all know the phrase — ‘the devil is in the details’.
Let’s apply this phrase to an ongoing development with Uniswap, the decentralized exchange (DEX).
First — what does the term ‘decentralized exchange’ actually mean?
First, it means that anyone can access it with a self-custodial wallet without asking for permission. This is unheard of in traditional banking.
Second, it means that Uniswap has a governance token, UNI, with which people can vote on the direction of the platform: listing new cryptocurrencies, restructuring fees, and adding new features.
That sounds great, doesn’t it?
But what if a traditional bank buys a huge amount of UNI tokens? In the case of Uniswap, Andreessen Horowitz (a16z) is not a bank, but a venture capital firm.
It holds over 40 million UNI, having casted 15 million UNI against Uniswap’s latest proposal — to deploy Uniswap V3 on another network, BNB Chain.
Presently, the vote is still unresolved, as only 8.4% of UNI holders participated, having casted an 84.6 million UNI voting weight.
In the first voting round, the proposal passed in favor at 80.28%, from a 20 million UNI voting weight.
Therefore, a16z’s current voting weight is 75% of the first ‘temperature check’ round.
So, why is the prolific VC firm a16z against Uniswap’s expansion?
After all, BNB is the 2nd largest chain with $7.03 billion in total value locked (TVL). This represents much greater growth potential than Uniswap’s previous expansions to Polygon and Arbitrum.
It turns out, a16z has a stake in LayerZero Labs, having raised $135 million last March, bringing the company’s valuation to $1 billion. LayerZero’s interoperability protocol (a bridge between different blockchain networks) seems like it would therefore be the a16z favorite.
The present voting proposal would connect Uniswap to Binance Chain (BNB), which relies on the Wormhole bridge — between Binance Smart Chain (BSC) and the Binance Chain. Of course, Wormhole is a direct competitor to LayerZero bridge.
The voting should be concluded today, but even if a16z mobilizes all of its 41.5 million UNI voting weight, the proposal should pass.
Despite this, the influence of backroom lobbying seems to be reborn in tokenized form.
‘It’s Time for Crypto to Put on Big Boy Pants’: 5 Ways TradFi Investors Are Rethinking Crypto in the Wake of FTX (link)
Asset Managers Agree Crypto is Here to Stay, but Must Change
Angelo Calvello has perfect timing. Just as Operation Choke Point 2.0 is rearing its choking tentacles, he reminds us that the crypto industry relies on investments from pension funds, foundations, endowments, and other pools of discretionary capital.
Perhaps these inflows could neutralize potential choke points? What are the conditions for that to happen?
As the co-founder of Rosetta Analytics, Calvello is a veteran investment manager. He recently asked 15 multi-billion asset managers, outside of the crypto space, what it would take for patient capital to find itself in the blockchain space.
Here are his key findings:
Major crypto bankruptcies, such as FTX, BlockFi, Genesis, Celsius, etc., do not represent the death of crypto. But, while everyone agreed that crypto is here to stay, it will have to take a different form.
That form is not cryptocurrency trading, which is typically perceived as “degenerate gambling”.
Rather, crypto should focus on creating businesses instead of products. One investor summed up the current crypto space as “a giant crypto circle jerk that incentivizes people who contribute very little value creation.”
To put it differently, crypto focus must shift away from building products for other niche crypto enthusiasts. This translates to sustainable and definable Web3 (or other) infrastructure platforms that solve real-world problems — instead of hunting for them.
On the road to that transition, Calvello’s interviewees see major obstacles:
Resistance from legacy financial institutions that rely on centralization.
The mindset of institutional investors. Confined by CFA and MBA curricula, a generational shift would have to take place for a public pension CIO to convert to crypto-oriented investments.
Lastly, they noted the failure of due diligence to notice giant red flags. A Canadian pension fund manager summed it up:
“A lot of people got really lazy, and they didn’t go deep enough.”
Calvello concluded that crypto’s long-term future is transformational and bullish, but only if shifts into scalable business models. On that road, it will have to be vetted and tied to TradFi to establish the necessary trust.
Lightning Network: From BTC as Store of Value, to Daily Currency
Lightning Network Reaches All-time High in Bitcoin Capacity (link)
Bitcoin Scaling Accelerates
Bitcoin scaling has reached another milestone.
Bitcoin’s layer-2 Lightning Network (LN) transforms the world’s most secure blockchain network into a near-instant payment system at near-zero fees.
LN’s capacity to handle Bitcoin transactions in these super-favorable conditions just increased by +61%.
Lightning Network’s capacity is now at 5,530 BTC. Image credit: The Block
What does that mean — practically speaking?
Image yourself going to a bar with your friends for a round of pints. All you have are your bitcoins with your phone as the gateway. The Lightning Network wallet comes into play where you keep a tab open (payment channel) with just a few sats (tiny Bitcoin denominations) deposited to keep it open.
On the other end, the bartender keeps this virtual tab open until you are ready to leave. Then, you just pay the balance and close the tab, the LN payment channel.
And the best part? You don’t have to wait for Bitcoin’s network to settle the bill. Why? Because LN operates off-chain through payment channels. This allows transactions to be almost instant while not costing an arm and a leg in fees.
Only when you close the tab (payment channel) is the final balance settled on Bitcoin’s mainnet. This could be a month’s worth of bar trips, or just for that evening.
Even better, no one can see how much you’ve spent on drinks because LN transactions are private.
You can do this for any merchant that supports LN.
In fact, last week, Strike partnered with the Philippines Pouch.ph to enable ultra-low cross-border remittances. In November, personal remittances to the Philippines sent by Filipinos abroad rose by +5.8%, to 2.93 billion, marking the fastest annual growth.
As a solution to real-world problems emphasized by Calvello’s managers, Bitcoin’s Lightning Network is a solid starting point.
Tweets of the Week
You’ve probably seen this 1921 New York Tribune article before. But have you read it?
Here are some interesting quotes by Henry Ford on the energy-backed currency he envisioned…which #bitcoin is today👇
