The Intersection of Blockchain and AI

https://www.bitcoinmarketjournal.com/blockchain-and-ai/

Ever since Chat-GPT launched to the public I’ve been somewhat obsessed with artificial intelligence and its potential uses. Less than a year since that release we’ve already seen quite a few use cases emerge, with many others on the horizon. Here’s just a small sample of the growing use case list:

  • Generate ideas
  • Translation
  • Content creation
  • Chat bot
  • Customer support
  • Debugging
  • Ecommerce websites
  • Educational applications

We’ve also seen how AI usage is growing in areas such as medicine and finance, with the potential to completely revolutionize both fields.

The current problem being faced by AI companies is the high cost of model training, but as those costs decrease – and I’m sure they will – the number of AI agents is going to become vast. AI agents will outnumber humans online (if they don’t already) and those agents will consume, generate, and exchange an unimaginable amount of information.

The question then is how can we ensure that these AI agents reach their full potential, while also allowing humans to identify AI agents online, and then audit and control the actions they take.

ai figure in front of human

The current state of affairs sees companies like OpenAI covering their massive costs by charging API access to the AI models they create. However, this is not scalable if we expect to have millions, or even billions, of specialized AI agents roaming the online world and transacting with each other. We need a way to enable AI agents to freely transact and complete tasks without direct human interaction for the myriad of tasks they will be expected to complete. And of course we will want to identify, control, and audit their actions.

This last is a problem known in the AI world as AI alignment. AI alignment is defined as the method to ensure artificial intelligence systems achieve desired outcomes. Not just that, but these outcomes should also be in-line with humans’ intended goals, preferences, or ethical principles. Once we can get alignment right it opens up a whole new world for AI agents.

The Solution for Aligned AI Agents

Currently we can’t allow our AI agents to use traditional financial systems because they don’t fit with the identity model used in these systems. This greatly limits the ability of AI to interact within financial systems. It’s also been noted that AI consumes a huge amount of online resources, thus creating additional costs, but is unable to generate revenues in the traditional sense by subscribing to services or clicking on ads. If we can solve this dilemma then AI can not only pay for itself, but it could generate more revenues to become profitable.

This solution requires three things:

  1. A new software model where trusted code execution is guaranteed and is auditable;
  2. A new digital financial system that not only serves humans, but can also serve AI agents;
  3. A cryptographic identity model that includes decentralized communication and reputation protocols.

Currently the best way to achieve these three things is through blockchain protocols and smart contracts.

Combining Blockchain and AI

Blockchain is already providing us with numerous financial services through smart contract interactions. Major blockchain platforms like Ethereum, Solana, Avalanche and others allow for secure, reliable decentralized applications, with an auditable trail of transactions. These networks already see tens of billions of dollars in value locked, along with hundreds of thousands of daily transactions.

Other networks such as Filecoin and Arweave can provide cheap, secure data storage, which will be key for AI models going forward. As the technology continues to improve we should see increased development on all the blockchain platforms, leading to an ever expanding range of available services.

Because these platforms rely on smart contracts, which are themselves self-executing code, it seems a small step to take to use these networks to train, deploy and operate decentralized AI agents that are able to interact with each other through the smart contracts. Certainly this is much easier and financially stable than the current model that requires the use of Web2 REST APIs. Future AI agents could instead operate through smart contracts, paying small fees – in the form of digital tokens – as they go along with their tasks. This not only improves the efficiency of the AI agents, it also increases the usage of the blockchain that the smart contracts reside on, a win-win scenario.

Creating AI agents that can control their own digital wallets would mean they could easily use any smart contract based platform or service, including DeFi protocols and infrastructure services. This alone could open up a whole new universe of use cases and business applications. A wallet-enabled AI agent would be able to pay for its required resources, whether those are computational or data related.

Such an agent could even invest the tokens it holds, through staking or yield farming protocols, or through trading on decentralized exchanges. This would allow for optimization of the financial operations of the agent, while also increasing liquidity in markets. Depending on the function of the agent itself it could theoretically charge other agents for its services. The end result would be a vast network of economically incentivized AI agents, all working together over decentralized protocols, trading data and services while covering their own costs. This is something that’s impossible to even consider using the current traditional financial systems.

Consider the Benefits of Blockchain AI Agents

Even when AI agents are delivering their benefits offchain, if they are doing the work onchain we end up with an immutable record of their activity that’s publically available and transparent. This will allow for the safe deployment of AI agents, with no questions regarding what they might be doing online. This can provide a host of benefits, including the ability to distinguish AI activities and content from human, build identity systems for AI agents, and audit agents actions and created reputation systems for AI agents. We would be able to reward the good actors within this system, punish or remove bad actors, and know with certainty which agents perform best at a given task. Not only will humans know which agents to trust, but other agents will easily determine which agents to trust and rely on based on the publically available onchain history of any given agent.

Of course much work needs to be done to get to this point. While blockchain infrastructure is becoming faster and cheaper, we would need to scale smart contract blockchains to handle all of the transactions AI agents would create. Smart contract programmable wallets are being developed that will help agents in transacting with smart contracts and other agents. One of the key features of these newer wallet types is the ability to integrate account abstraction that would allow human actors to authorize AI agents to spend from a given wallet.

We would also need to build the registries and reputation systems needed to track AI agents, most likely using their public keys as the identifiers for each specific agent. Once that’s underway I would expect to see a number of new business applications and models emerge.

Investor Takeaway

Yes, there is work to be done, but all of these developments, while they may seem out of reach now, are likely just around the corner. And once the floodgates open so many more blockchain/AI interactions will likely become obvious to us, ushering in a new financial system that is more open, more transparent, more efficient, and ultimately more tuned to the needs of humanity.

If you believe, like I do, that a combination of blockchain and AI is inevitable, then it’s likely you can also see how this would impact on the value of various blockchain platforms and protocols. How this activity will generate massive onchain value, lifting the value of the tokens needed to transact within these AI-powered systems. We’ve always looked to mass adoption of blockchain, but none of us expected that this mass adoption might be more AI-based than human-based. Either way, it will drive the value of the underlying blockchains, creating opportunities for those of us that have the imagination to see them.

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Blockchain Believers Portfolio Update Q3 2023

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2023 has seen bitcoin begin a new phase of growth. While Q3 has been a bit of a struggle, increasing adoption and increasing hopes for a U.S. spot bitcoin ETF have sparked renewed optimism.

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Future Winners Portfolio Update Q3 2023

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Our Future Winners portfolio began in 2021, in response to our readers who wanted an all-crypto portfolio. It is newer than our premiere Blockchain Believers Portfolio, so the portfolio is down overall, but with crypto outperforming stocks in 2023, it continues to close the gap.

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Crypto Hodlers Have Nothing to Fear from Friday the 13th

https://www.bitcoinmarketjournal.com/crypto-hodlers-have-nothing-to-fear-from-friday-the-13th/

Happy Friday, the 13th, HODLers!

It might seem odd to wish you a happy day on this, considered the most unlucky of days. However, investors may have several reasons to buck this trend and put a smile on their faces regarding crypto.

We’ll dig into stories, superstitions, and how bitcoin has historically performed on Friday the 13th. Hopefully, this will settle the spirits of those nervous about today’s date.

Was Friday the 13th Always Unlucky?

The oldest known negative reference to 13 is found in the Mesopotamian Code of Hammurabi, a Babylonian code of law that dates to approximately 1760 BC. The laws are numbered, but the number 13 is omitted.

Those who consider 13 unlucky are called triskaidekaphobics. You might not be surprised that horror novelist Stephen King is among the list of famous triskaidekaphobics. So was the 32nd president, Franklin D. Roosevelt.

Friday’s that fall on the 13th possibly got a bad rap based on an event from the 14th century when, on Friday, 13 October 1307, King Philip IV of France ordered the arrest of the Knights Templar, and most of the knights were tortured and killed.

There’s even a name for those scared of Friday the 13th – paraskevidekatriaphobia.

It’s not always the case, however, that 13 is considered unlucky. In France, 13 was traditionally considered a lucky number before the First World War and was used numerically as a good luck symbol on postcards and charms.

friday the 13th sign

Is Friday the 13th Unlucky for Crypto?

Good. Bad. Lucky. Unlucky. What does this all mean for crypto holders?

Honestly, not a lot unless you’re struggling with your portfolio. Friday the 13th has generally been  positive in terms of stocks. Since its inception, the S&P 500 has averaged a gain of 0.1% on Friday the 13th, which doesn’t sound like a lot but is triple the average gain of 0.03% on all trading days.

While it has far less history to draw on, bitcoin has historically shown resilience and positive performance on Friday the 13th, despite the date being considered unlucky due to all the various superstitions and historical events noted above. Data indicates that since 2010, bitcoin has, on average, risen by 1% on this date, with significant surges in the following one and three months. That’s 10x the average gain seen from stock markets on a Friday the 13th.

Looking at the 1-month results is even more telling. Bitcoin, on average, returns 14% a month after Friday the 13th. If we look at the monthly return for the S&P 500 going back to 1900, we find that only three times have we seen monthly returns greater than 14%. And we have to go back to 1938 for the last time, the S&P 500 returned more than 14% in a single month:

  • April 1933 – 29.3%
  • May 1933 – 17.6%
  • June 1938 – 20.5%

While I don’t have the data for three-month returns, I can assure you that the S&P 500 has never been up 66% in three months.

Drilling down further, we can see that some months are better or worse than others (obviously). October has seen the two worst Friday the 13th daily returns for the S&P 500. The worst Friday, the 13th, for stocks, was a loss of 6.1% on Oct. 13, 1989—followed by the 3.8% drop for stocks on Friday, Oct. 13, 1933. Conversely, bitcoin has only seen gains for Friday the 13th in October, though to be fair, there’s only one data point – a 6% gain on Friday October 13, 2017.

Investor Takeaway

We don’t normally consider superstition when measuring our gains. We’re not gamblers, and we don’t count on luck (at least, not entirely).

Good investing is about knowledge, patience, and research. With the correct information and insight, you can invest in crypto without worrying about what day it is.

Fortunately for crypto inventors, the future is hopeful. While there’s not enough data for bitcoin’s historical outperformance to be considered statistically significant, there’s no doubt that bitcoin outperforms stocks given the data we do have. This is entirely in line with other historical measures of bitcoin versus stocks.

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Journey into the World of Tokenized Assets

https://www.bitcoinmarketjournal.com/tokenized-assets/

In the ever-evolving financial landscape, tokenization delivers new opportunities and considerations for investors around the globe. As we navigate through the ongoing downturn in crypto markets, exploring tokenized assets becomes a beacon of potential. It’s a journey through uncharted territories, where commodities, real estate, and financial assets are all intertwined in the digital realm, offering a diversified investing palette.

I’ve written before about the tokenization of real-world assets, so it only made sense for me to delve more deeply into the Federal Reserve paper on tokenization.  I found a narrative that uncovers the intricacies of tokenized commodities, real estate, and financial assets, shedding light on their implications, challenges, and transformative potential for the investment world.

Today’s piece is my journey through this document, an exploration to unravel the implications of tokenization for investors, the opportunities it presents, and the speculative future hinted at by the authors.

The Golden Path of Tokenization

With roughly $2.15 billion in tokenized assets on permissionless blockchains as of May 2023, gold shines brightest, with nearly half being tokenized gold. This makes the golden path of tokenization a metaphor and a tangible reality, locking gold in the digital realm, thus creating a bridge between the tangible and the intangible.

The Fed paper highlights the significant presence of tokenized gold, a market with a capitalization hovering around $1 billion as of May 2023. It’s a domain dominated by Pax Gold (PAXG) and Tether Gold (XAUt), with the two controlling 99% of the market. These digital representations of gold are not merely reflections of reality but are fully redeemable, allowing holders to claim the underlying physical gold, albeit with certain restrictions and fees.

For digital investors, this opens up a realm of possibilities and considerations. The ability to own and trade tokenized gold offers a unique blend of liquidity and stability. However, it’s a journey that requires nerves of steel, careful consideration of the redeemability features, and an understanding of the inherent risks and benefits.

The trajectory of tokenized commodities is a testament to the evolving dynamics of the investment world. It’s a path paved with golden opportunities but also with speculative uncertainties. Will tokenization increasingly improve the investing landscapes, or will the complexities of the digital ecosystem hamper its growth?

Building Wealth, One Token at a Time

Gold isn’t the only tokenized asset class. Tokenized real estate is a growing sector, allowing us to build wealth, one token at a time.

chess board

The paper mentions Real Token Inc. (RealT) as a pioneer in crafting digital representations of legal rights on residential properties. Each property, a unique entity owned by a legally independent LLC, allows investors to own a slice of domestic US real estate and enjoy the benefits of rental income. As of September 2022, RealT had successfully tokenized 970 property units, amassing a value of over $52 million.

This innovative approach to real estate investment is not just a revolutionary concept but a gateway to diversified portfolios. It brings an asset class that is traditionally out of reach into arm’s length.

However, the path has its challenges. The less uniform nature of real estate assets and intricate legal and tax processes pose significant hurdles in real estate tokenization. It’s a journey that weaves between innovation and regulation, where every step forward is a delicate balance between opportunity and constraint.

Financial Assets in the Digital Realm

Thus far, the paper has explored tokenized tangible assets, but it then looks at the tokenization of intangible assets like stocks, bonds, and ETFs. It’s a journey through the digital reflections of these traditional financial instruments, where the essence of stocks and bonds is captured in digital tokens.

The document notes that tokenized stocks and their reference counterparts offer similar economic exposures but a sometimes very different journey for investors, with price variations due to distinct trading hours and intrinsic properties. Notably, the programmability in DeFi applications expands the reach of traditional financial instruments.

For investors, this digital realm offers a spectrum of possibilities and contemplations. The ability to venture into tokenized financial assets opens up new horizons of investment strategies, allowing us to navigate our journey with diverse options for which path to take. However, it’s a journey that requires a discerning eye, carefully considering the evolving market landscapes, and understanding the inherent potentials and uncertainties.

The Notable Benefits of Tokenization

The Fed paper admits that tokenization offers many benefits to investors and markets. It grants access to otherwise inaccessible or costly markets, such as real estate, allowing investors to own fractions of specific assets, contrasting with the broader portfolio ownership in REITs. The inherent programmability of crypto tokens and the utilization of smart contracts enable the embedding additional features in tokenized assets, potentially benefiting the markets of the underlying reference assets by implementing liquidity-saving mechanisms and facilitating better price discovery.

These innovations help to lower entry barriers, inviting a broader spectrum of investors and fostering more competitive and liquid markets. Tokenization also enhances lending mechanisms, using tokens as collateral where traditional methods may be costly or unfeasible, and ensures quicker settlement of transactions compared to their real-world counterparts and traditional securities settlement systems.

Drawing parallels with ETFs, empirical evidence suggests a positive correlation between the liquidity of ETFs and their underlying securities, enhancing information efficiency. A similar dynamic for tokens could imply that increased liquidity in crypto markets may lead to more accurate pricing for the token’s reference assets, thereby improving the liquidity and efficiency of the markets for the reference assets.

tokenize meme
Thanks to Aquanow.io

Potential Implications for Financial Stability

While tokenized markets’ current value is relatively small compared to traditional financial markets, and even as a part of the overall crypto economy, our journey into tokenization could introduce fragilities to crypto asset markets and vulnerabilities to the traditional financial system. Tokenization creates interconnections between the digital and traditional financial systems, potentially transmitting shocks from crypto markets to the markets for the reference assets of crypto tokens, especially when these assets aren’t liquid, like real estate.

One significant concern is the transmission of volatility due to the 24/7 trading of crypto assets compared to the limited trading hours of most reference asset markets. This mismatch could lead to unpredictable implications during stress events, such as fire sales of tokenized assets, affecting the solvency of institutions holding substantial shares of the tokenized asset.

Tokenized assets with redemption options, like collateralized stablecoins, could suffer from runs on the issuer due to uncertainties surrounding the tokens’ collateralization levels. This is particularly true when the issuer lacks transparency. The growth of tokenizations also exposes traditional financial institutions to crypto asset markets by directly owning tokenized assets or using tokens as collateral for other financial instruments.

Ondo Finance’s journey into tokenizing U.S. government money market funds on the public blockchain Ethereum exemplifies the potential wider range of uses and interconnections created by tokenization, impacting traditional financial markets. Tokenization can disguise riskier or illiquid reference assets as safe and easily tradable, encouraging higher leverage and risk-taking, which could trigger systemic events in the case of a sudden reversal of these positions.

Investor Takeaway

Tokenized assets are a voyage unveiling the revolutionary potential of blockchains in creating a diverse and inclusive set of investment opportunities. From the golden allure of commodities to the solid potential of real estate and the intricate trails of financial assets, this paper’s exploration created a map of possibilities and considerations.

exploration board

This journey through tokenization is not just a narrative of digital reflections but rather an exploration of the evolving landscapes of investment possibilities. We are creating a realm where the tangible and the intangible converge to create a blend of opportunities and challenges.

While the paper’s authors strike a cautious note, I believe that we should look at tokenization as a journey to envision the future, embrace the transformative potential, and expand our investment strategies in the diversity of new financial spheres.

Let’s embrace the revolutionary strides of tokenization with open minds and discerning eyes. Let’s engage in thoughtful discussions on the future landscapes of investment.

Let’s navigate the future landscapes with enlightened minds seeking to build wealth through the revolution of tokenized assets. Let’s be the pioneers of the new frontier, exploring and building wealth one token at a time.

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Blockchain Believers Q2 2023 Portfolio Update

https://www.bitcoinmarketjournal.com/blockchain-believers-q2-2023/

Blockchain Believers have consistently come out ahead of traditional investors, and the long-term performance of our crypto investing portfolio has been remarkable.

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Future Winners Q2 2023 Portfolio Update

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Our Future Winners portfolio began in 2021, in response to our readers who wanted an all-crypto portfolio.

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BlackRock’s Bitcoin ETF: A Game Changer for Crypto

https://www.bitcoinmarketjournal.com/blackrocks-bitcoin-etf-a-game-changer-for-crypto/

What a spot bitcoin ETF could mean for your crypto investments.

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The Securities Clarity Act: We Need This!

https://www.bitcoinmarketjournal.com/the-securities-clarity-act-we-need-this/

Regulatory clarity in the crypto industry in U.S. has taken front stage for much of 2023, as jurisdictions across the globe put frameworks in place to regulate the nascent industry, while the U.S. lags behind.

Last month, the U.S. House Financial Services Committee issued a bill aimed at regulating the industry; however, not much progress has been made on the bill. (Remember, this is the same bill that failed to gain bipartisan support back in September 2022.)

Last week, House Majority Whip Tom Emmer (R-MN) and Representative Darren Soto (D-FL) announced the introduction of their bipartisan Securities Clarity Act to clear up one of the main sticking points in cryptocurrency regulation: the question of whether cryptocurrencies are classified as securities.

tom emmer twitter post
Image via Twitter.

It’s an important question to answer, since much of the uncertainty surrounding cryptocurrencies in the U.S. has stemmed from the actions taken by the Securities and Exchange Commission over the past years.

Some Background

The bill is intended to provide clarity in the regulatory classification of digital assets, providing market certainty for innovators and clear jurisdictional boundaries for regulators.

This is key, since one of the chief complaints in the U.S. is that blockchain innovation is being stifled by a lack of clarity around the classification of digital assets.

Much of that uncertainty is being created by the SEC. The Commission has been increasingly active in bringing actions against a number of crypto industry businesses; however, there has been a lack of guidelines from the SEC, leading to uncertainty in the industry.

In some cases, it seems the SEC has implicitly approved of a crypto business model, yet it still brings action against the project, again without providing any details or guidelines to the project to inform them on how they might rectify any alleged violations.

The most visible action has been the serving of a Wells Notice to crypto exchange Coinbase earlier this year. Even before receiving the Wells Notice, Coinbase was seeking clarity from the SEC.

According to statements from Coinbase CLO Paul Grewal, the company has repeatedly approached the SEC over the past nine months to seek clarity on its business activities, but the SEC has repeatedly failed to provide a straight answer on which digital assets the Commission considers to be securities.

coinbase

The current environment in which enforcement comes before regulation needs to change. Currently there is little guidance for crypto companies, and despite the SEC saying they will work with those projects that register properly, currently there is no process in place to complete such a registration. The Securities Clarity Act seeks to resolve that Catch-22.

The Securities Clarity Act Explained

The Securities Clarity Act is a short bill, just 5 pages long. That’s because it seeks to address one failing of current securities law in regard to digital assets. According to the bill, “existing securities law does not distinguish between an asset and the securities contract it may or may not be part of.”

Congressman Emmer introduced this same bill previously in September 2020, when he was serving as the Ranking Member of the House Financial Services Committee’s Task Force on Financial Technology. In addition, Congressman Emmer became co-chair of the Congressional Blockchain Caucus in 2018.

The Securities Clarity Act, if drafted into law, will provide clarity for digital assets by setting a distinction between the digital asset (cryptocurrencies) and the securities contract that it may or may not be part of.

The bill also seeks to clarify that an investment contract asset is separate from the investment contract under which it was sold.

Simply stated, a crypto project can have a securities contract, but it is possible that the token of this contract is not classified as a security.

We are all aware that many cryptocurrencies are issued as part of a securities contract, however once the project develops and becomes decentralized, these tokens might not be classified as securities any longer. Instead, they might be considered as a commodity or as property.

Currently, without a defined distinction between the cryptocurrency and the securities contract it was issued under, projects that need to issue tokens to fund development in early stages find it impossible for these tokens to move out of the securities framework, which is preventing the tokens from being used for their intended utility.

“So long as we lack a clear definition under the law for what is a commodity and what is a security, American innovation will suffer.”

– House Representative Thomas Emmer

The Securities Clarity Act will amend the 1933 Securities Act to separate “investment contracts” from the underlying assets sold pursuant to the investment contract.

In essence, the bill says that assets sold as part of an investment contract do not become securities merely by being sold as part of that investment contract.

Also key to understanding of securities law and the definition of securities is the Howey Test. (See our Guide to SEC Regulation on Tokens, Explained with Cat Photos.)

The Howey Test Explained

The Howey Test was created in 1946 by the U.S. Supreme Court to determine if an asset is a security, and thus under the purview of the Securities and Exchange Commission. It has four parts, all of which must be true for an asset to be classified as a security:

  1. There is an investment of money. This means you give money or something else of value to someone else.
  2. There is a common enterprise. This means you and other investors are pooling your money together for a shared goal.
  3. There is an expectation of profit. This means you hope to make more money than you invested.
  4. The profit is derived from the efforts of others. This means you rely on someone else’s work or skill to make money, not your own.

By placing an asset into the framework of the Howey Test, it is possible to determine whether or not it should be classified as a security.

However, as you’ll see in the video below, even Gary Gensler, the chairman of the SEC, has difficulty in answering a question about whether Ethereum is a security.

Investor Takeaway

Getting clarity on the classification of digital assets is key to opening up the blockchain economy in the U.S. Business and consumers both need this clarity to allow them to invest in the space without fearing prosecution.

The Securities Clarity Act would provide that certainty for businesses, investors, and consumers by legally establishing the difference between an investment contract and the digital assets that are sold under these contracts.

This will allow companies to create great products and services, while also maintaining consumer protections. The bill is one of the smartest approaches brought forward for providing clarity regarding the application of securities law to digital assets.

If the U.S. wants to remain a leader in the blockchain space, and reap the economic benefits of that leadership, then such legislation is a requirement. The sooner we can define digital assets, the sooner we will be able to create a strong digital asset market.

Without it, we will rapidly fall even further behind the European Union and Hong Kong, both of which have been working diligently to provide the clarity that U.S. investors and businesses have been asking for over the past several years of regulatory limbo.

As stated on Emmer’s website, “The Securities Clarity Act offers a key distinction that will enable crypto projects to reach their full potential in a compliant way, enabling the United States to compete globally in this next iteration of the internet.”

We agree.

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Which U.S. States Are Creating New Crypto Regulations?

https://www.bitcoinmarketjournal.com/which-u-s-states-are-creating-new-crypto-regulations/

Decide for yourself where you want to live.

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Stablecoin Regulation Incoming!

https://www.bitcoinmarketjournal.com/stablecoin-regulation-incoming/

March has been a tumultuous month for crypto and the traditional banking system. This has caused a re-examination of regulatory frameworks for banks and re-ignited regulatory discussions regarding cryptocurrencies… More specifically, stablecoins.

We’ve long known regulation is coming for the crypto market. Several events over the past year have highlighted the need for such regulation to keep markets and assets safe for investors. Those include the failure of Terra’s stablecoin, the subsequent failure of several lending platforms, and the October failure of the FTX exchange.

Those combined events put the spotlight back on crypto regulation in a major way. While no real progress has been made, there has been plenty of discussion and speculation over the past few months. One theme has emerged from these discussions: stablecoins are likely to be the first crypto assets to be regulated.

document and gavel
Is regulation finally coming for stablecoins?

With that in mind, let’s dig into the events that have brought us here, the role and classification of stablecoins, and some potential directions regulators could take in creating a framework for the $125 billion stablecoin industry, which underpins much of the crypto ecosystem.

A Crackdown on Stablecoins

Even before the failure of Silvergate, SVB, and Signature Bank, there were already warning shots being fired at stablecoins. In February, the Security and Exchange Commission (SEC) went after Binance’s stablecoin BUSD and claimed it was a security. The agency told Paxos Trust Company, which also issues its own stablecoin PAX Dollars (PAXD), that BUSD should have been registered as a security. Paxos disagreed, and the two entities are currently in talks.

The crux of the SEC’s assertion is BUSD offers its holders advantages like lowered fees on the Binance exchange. This gives users an incentive to buy and hold tokens, and this could hold the key to its classification as a security.

At the same time, the New York Department of Financial Services ordered Paxos to stop minting BUSD, claiming Paxos violated its obligations for “tailored, periodic risk assessments” and due diligence checks on Binance.

These are the SEC’s first actions against stablecoins, although head Gary Gensler has long been of the opinion that some stablecoins could be securities.

Further Troubles = Increased Scrutiny

Stablecoins have grown to an industry worth more than $125 billion in under five years. It’s dominated by three main players: Circle’s USDC, Tether’s USDT, and Binance’s BUSD.

Tether was the first to market. This early release has produced a significant first-mover advantage for USDT, which has a market cap of $77 billion. However, the project has come under fire for questionable management, its lack of full transparency, and its frequent run-ins with regulators.

Circle’s USDC is the second largest stablecoin with a market cap of over $35 billion. Circle has taken a different route, trumpeting the transparency and regulatory compliance of its USDC stablecoin. In fact, users can easily see the majority of the stablecoin’s reserves, as $29 billion is sitting in a Treasury bill fund run by Blackrock. It also posts monthly attestation reports conducted by Deloitte right on its website.

Then there’s BUSD, with an $8 billion market cap. Given Paxos has stopped minting BUSD, there doesn’t seem to be much hope for its continued existence, at least in the US. This leaves Tether and Circle as the top stablecoin issuers.

However, the events of March in traditional banking have created some volatility in what are supposed to be stable assets, catching the attention of regulators.

Early in March, Silvergate Capital failed due to its exposure to the crypto markets. As one of the few U.S. banks willing to take on crypto depositors, this was a blow to the industry, but the worst was yet to come.

svb webpage
Too many bank failures.

The following week, Silicon Valley Bank failed, though the failure had little to do with crypto. Instead, it was brought on by Fed policy, as the rapid increases in interest rates to contain inflation caused the value of Treasuries to plummet. SVB held a large amount of these Treasuries, and raising capital would have meant steep losses for the bank. Large investors found out and there was a sudden run on bank deposits, causing SVB to fall into FDIC receivership.

Once SVB fell, Circle was found to have $3.3 billion deposited at SVB. Crypto investors panicked and feared Circle would be unable to access this capital and redeem USDC. Traders and investors fled the stablecoin over the next three days, causing it to lose its peg against USD. At one point, it was trading at $0.88.

At the same time, much of this capital was being directed at USDT. That stablecoin also broke its peg but to the upside, briefly trading almost as high as $1.03. This created a great arbitrage play for those who were prepared (sell USDC, buy USDT, pocket the difference).

All these events told regulators that stablecoins need regulation. It’s ironic that came to light from the failure of highly-regulated banks, but there you have it.

How Do We Classify Stablecoins?

One of the key questions in the regulation of stablecoins is how to classify them. Four possibilities are under consideration, as stablecoins could be regulated as banks, commodities, e-money institutions, or money market funds (securities).

Given the lack of regulatory clarity, it’s ironic that each of these possibilities already has adequate regulations in place.

viewing charts and graphs
Can stablecoins offer yield?

One thing is certain: we need clear regulations around stablecoin reserves. Stablecoin issuers must be held accountable to obligations just like other issuers of monetary liabilities.

As mentioned above, it seems odd to consider unregulated stablecoins as a threat to the stability of our financial systems when it’s clear the highly-regulated banking industry poses its own threats. Stablecoins have maintained their stability. Even the recent de-pegging of USDC was short-lived and quickly rectified. Stablecoins passed the stress test.

However, the sudden loss of confidence in USDC highlights its vulnerabilities and the need for adequate regulation to avoid a recurrence. Also consider that USDC is among the most transparent and trustworthy stablecoin. Just look back to the failure of Terra’s UST and we can see the worst-case scenario when stablecoins are unregulated.

According to Representative French Hill (R-Ark.), who chairs the House Subcommittee on Digital Assets, Financial Technology, and Inclusion, “I think we need legislation to provide clarity to digital assets on how they’re categorized for that functional regulation. However, I think it’s more complicated than just the composition of what is the nature of the stable part of the stablecoin collateral. The events of the last couple of weeks have only demonstrated the urgency of creating a crypto regulatory framework.”

The classification of stablecoins will likely be key to how their regulation develops, with different entities having differing views. Let’s look more closely at how various regulators currently view stablecoins.

The SEC

SEC chairman Gary Gensler has been clear in his stance that most cryptocurrencies, including most stablecoins, should be considered securities.

In the case of stablecoins, the fact that they’re backed by assets other than the pegged currency makes them look like money market funds. Money market funds are regulated by the SEC under the Investment Company Act of 1940.

Of course, it benefits the SEC to have the fledgling crypto market fall under its sway. As the size of the crypto market grows, so would the SEC’s power.

sec building

Some are stringently against the SEC regulating stablecoins. Jeremy Allaire, the CEO of Circle, said in a Bloomberg interview in February, “I don’t think the SEC is the regulator for stablecoins.”

Instead, he believes that stablecoins, at least in the case of USDC, should fall under the purview of prudential banking regulations. He said, “There is a reason why everywhere in the world, including the U.S., the government is specifically saying payment stablecoins are a payment system and banking regulator activity.”

The CFTC

Not to be outdone by the SEC, the Commodities Futures Trading Commission (CFTC) has frequently gone on record to claim that digital assets (including stablecoins) are commodities that should fall under the umbrella of the CFTC.

Indeed, the agency was the first to bring action against a stablecoin issuer, fining the operator of Tether $41 million in 2021 for violations of the Commodity Exchange Act (CEA) and other CFTC regulations.

More recently, at a hearing before the Senate Agricultural Committee in early March, CFTC Chair Rostin Behnam said stablecoins are “going to be commodities in my view. Colleagues might have a different opinion, but we’ve done the legal analysis.” He went on to speak specifically about USDC and said, “Based on the cases we have brought in the past around stablecoins, I think there is a strong legal argument that USDC and other similar stablecoins would be commodities.”

cftc
Securities or commodities…or something else?

There’s clearly some turf war between the SEC and the CFTC, which will only be decided through legislation that determines which agency is responsible for policing stablecoins and other digital assets.

One potential solution could come from the 2022 Lummis-Gillibrand Responsible Financial Innovation Act in the Senate. That legislation would give the Commodity Futures Trading Commission (CFTC) the lead role in regulating spot crypto markets, settling the turf war with the SEC.

The Federal Reserve

Banking regulation falls under the Federal Reserve and several other entities. The Fed, which some claim is to blame for the failure of SVB vis-à-vis its ongoing monetary policy, has been quite vocal about crypto and stablecoins in 2023.

On January 3, 2023, the Fed, in conjunction with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, issued a statement warning of “key risks associated with crypto-assets and crypto-asset sector participants that banking organizations should be aware of.”

This included (somewhat prophetically) a warning against the “susceptibility of stablecoins to run risk, creating potential deposit outflows for banking organizations that hold stablecoin reserves.”

More recently, following the failure of Silvergate Capital, Michael Barr — the Federal Reserve’s vice chair for supervision — weighed in on the Fed’s view on stablecoins.

“There’s a critical role for Congress to play right now in establishing a framework for stablecoins, because stablecoins in particular pose the potential for systemic risk if they’re not regulated appropriately,” he said. “They are a form of private money that borrows the trust of the central bank.”

paper money
Backed by the full faith and credit of the U.S. government.

That idea of trust in the central bank is a keystone to the Fed’s drive to regulate stablecoins. Barr made that clear in his speech when he said, “Any entity issuing money denominated in the U.S. dollar and drawing on the trust of the Federal Reserve needs to be subject to federal prudential regulation and supervision. I am not saying anything new here. This has been our consistent approach.”

Because stablecoins lack liquidity and Fed supervision as a backstop, they are the perfect mismatch in value and liquidity that leads to bank runs, according to Barr. Wider adoption of stablecoins exacerbates these risks, and the Fed believes it can regulate the stablecoin market without stifling innovation.

Perhaps the SEC and CFTC will both lose out to the Fed and banking regulators in the stablecoin regulation war.

The Stablecoin TRUST Act

The Stablecoin Transparency of Reserves and Uniform Safe Transactions (TRUST) Act is currently the best framework that is in Congress, although it has failed to gain broad bipartisan acceptance. The Act was introduced by former Senator Pat Toomey (R-PA) in December 2022 just before his retirement.

It is designed to provide a regulatory framework for payment stablecoins, and it could serve as the framework for further crypto regulation if passed into law. Here are some of the key takeaways from the bill as presented by the Senate Banking Committee:

  • “Encourages competition by authorizing several types of regulated entities to issue payment stablecoins.
  • Enhances financial stability by requiring that all payment stablecoins are fully backed by high-quality liquid assets.
  • Establishes transparency by subjecting all payment stablecoin issuers to standardized disclosure requirements and attestations by registered accounting firms.
  • Provides much-needed clarity that, at a minimum, stablecoins that do not offer interest are not securities.
  • Protects consumers by clarifying that payment stablecoin holders would have priority in the event of an issuer’s insolvency.
  • Authorizes the Office of the Comptroller of the Currency, the primary federal regulator of national banks, to establish a new federal license designed specifically for payment stablecoin issuers.”

These takeaways cover many of the issues with regulating stablecoins. It authorizes an agency to establish a federal license for stablecoin issuers, indicates how transparency and financial stability will be regulated, and clarifies that the SEC doesn’t have any regulatory oversight for stablecoins that don’t bear interest.

In terms of acceptable reserve collateral, it would be limited to U.S. currency, Treasury bills with maturity of 90 days or less, and repurchase agreements with maturity of seven days or less that are backed by Treasury bills. It also allows Federal Reserve banks to provide services to stablecoin issuers, thus addressing any capital reserve and liquidity concerns.

It also examines the issue of stablecoin issuers borrowing the trust of the Federal Reserve by requiring a statement from stablecoin issuers that the assets are not FDIC insured or backed by the full faith and credit of the U.S.

Such legislation, while it may not be perfect, would help to establish a framework for the stablecoin industry to operate under. It would allow for greater integration with existing financial systems, protect consumers, and help to mainstream crypto assets for consumers and institutions.

Investor Takeaway

We’ve all known crypto regulation is coming, and recent events have only highlighted the need for such regulation. Stablecoins are easy ways for the U.S. government to begin regulation efforts, and crypto markets are likely to benefit from regulation thanks to improved protections, security, and liquidity.

However, some of the changes could impact your holdings. Certain stablecoins, like algorithmic stablecoins or those that provide incentives to holders, could be exempted from regulation or could fall under an entirely different regulatory framework from “plain vanilla” stablecoins.

Given its focus on transparency and regulatory adherence thus far, Circle’s USDC could come out on top once regulations emerge, though nothing is certain. Even with regulation, I believe it will be difficult, if not impossible, for regulators to eliminate competing stablecoins, though they could certainly block their use in the U.S. and make them less desirable for a large swath of the crypto community.

The best course is to stay informed of coming changes. They certainly won’t happen overnight. Once we have more clarity, we’ll have a better knowledge base for making financial decisions that include stablecoins in our portfolios.

The post Stablecoin Regulation Incoming! appeared first on Bitcoin Market Journal.

Tokenization of Real-World Assets: The Complete List

https://www.bitcoinmarketjournal.com/tokenization-of-real-world-assets-the-complete-list/

What is the fundamental goal of blockchain technology?

Until now, it has mainly been used to speculate on the price of crypto tokens and create decentralized finance protocols that allow other types of profit incentives, but is that really all crypto can do?

A better description of the blockchain is to create a global economy that is more transparent and efficient while also being accessible to everyone.

We’re not at that point yet, but by beginning to create more real-world use cases, we can begin unlocking the true potential blockchain has for everyone.

It’s these real-world use cases that will truly benefit the average person and speed overall adoption of blockchain technology.

rwa-real-estate
Real estate is a real-world asset that’s being tokenized.

To push blockchain technology into mainstream usage, we need to find effective ways to tokenize real-world assets (RWAs). This shift from physical to digital is an opportunity that could be life-changing for billions of people worldwide.

Why We Need Real-World Assets On-Chain

Money makes the world go round. Financial systems have a history dating back some 5,000 years to the Babylonian empire, where clay tablets were used to track debts and payments.

We’ve come a long way since then, with finance today being largely electronic. However, the current financial system is still bogged down with the need to reconcile ledgers and audit financial flows. This results in an inefficient system that adds costs and increases settlement times.

history of money
Image via Oliver Wyman Forum

A better way is emerging through decentralized finance. The next step is to begin moving real-world assets onto these new blockchain rails. Tokenizing real-world assets will provide a number of advantages like:

Increased efficiency: The blockchain ledger is a single source of truth, which reduces the friction inherent in current financial transactions. Atomic settlement means settlement happens almost instantaneously, greatly increasing efficiency.

Reduced costs: Current systems are bloated with the need for intermediaries, which often only serve to drive up costs without providing a great deal of value. Using smart contracts for many of our financial systems eliminates the need for third parties, greatly reducing transaction costs. For example, early tests in blockchain-based bonds have shown a 90% reduction in the cost of bond issuance and a 40% reduction in fundraising costs.

Increased transparency: Public blockchains can be audited in real time, opening up the ability to verify the quality of asset collateral and systemic risk exposure. Recordkeeping disputes are easily resolved thanks to public dashboards that show all on-chain activity.

Built-in compliance: Smart contracts not only have the ability to reduce the need for intermediaries. They can also be used to ensure compliance to regulatory oversights. This can be done in such a way that personal privacy is always protected.

rwa-music
Music royalties are real-world assets being tokenized.

Liquid Markets: Many traditional financial markets are illiquid. Think art, real estate, even stocks to some extent. Tokenizing assets increases accessibility to trillions of dollars of largely inaccessible assets.

Innovation: When you put assets and application logic on a common settlement layer, you can create new financial products, from fractionalized real estate funds to liquid revenue-sharing agreements. Tokenization increases the ability to build products previously thought impractical or even impossible.

What RWAs Could Be Tokenized?

There are many real-world assets that could potentially be moved onto a blockchain for increased efficiency, transparency, and accessibility. Some of these are already being tested on-chain:

Physical gold: Blockchain technology is already being used to manage the ownership and transfer of physical gold, allowing investors to hold gold securely and transparently. There are already a number of gold-backed cryptocurrencies like Paxos Gold, but true digitization of gold has not been achieved. The London Bullion Market Association has a good analysis of the current state of gold and the blockchain for those interested in learning more.

Real estate: Land titles, deeds, and other property ownership records can be recorded on a blockchain to simplify the process of buying, selling, and transferring real estate. This is one area that’s been seeing a good deal of activity already, with projects like Lofty.ai (residential) and SliceSpace (commercial) blazing the trail towards fractionalized real estate ownership.

Intellectual property: Copyrights, patents, and trademarks can be recorded on a blockchain to ensure ownership and rights are properly documented and protected. Smart IP registries could track the entire lifecycle of any registered IP right. It could also resolve the practicalities of collating, storing, and providing such evidence. It would also make for smoother IP right audits. This could simplify due diligence exercises that are necessary for IP transactions, for example, in mergers and acquisitions. Blockchain could track royalties for music streaming or content downloads to ensure artists receive fair compensation for their work.

WIPO
Image via World Intellectual Property Organization whitepaper.

Supply chain management: Blockchain technology can be used to track the movement of goods through the supply chain, enabling better traceability and accountability for businesses and consumers.

One good example is medical products (including pharmaceuticals, medical devices, and supplies) to ensure quality and prevent counterfeiting. Another is agricultural products, where blockchain ledgers could allow farmers and consumers to track the journey of food products from farm to table.

Many major corporations already use blockchain in supply chain management including Amazon, Microsoft, IBM, Walmart, and Ford Motors. As adoption of blockchain technology increases, the number of companies using it for their supply chains can only grow.

supply chain
Image via Amazon

Identity management: Personal identity information like birth certificates, passports, and social security numbers can be stored on a blockchain to reduce identity theft and streamline identity verification processes. In addition, it enhances data security, reduces costs, and creates an auditable record trail.

Blockchain identity management can be applied to a growing number of use cases across a variety of industries and sectors including healthcare, financial services, supply chain, Web3, and retail.

While China’s efforts to create a national digital ID have been closely watched, there are a number of Western companies also creating digital ID systems like IBM and Microsoft. There are also many startups working to create digital IDs.

ID
Image via Dock.io

Financial instruments: Stocks, bonds, and other financial instruments can be issued and traded on a blockchain, creating a more efficient and transparent financial system. We already see this in the derivatives markets, but tokenizing actual stocks and bonds would significantly reduce costs, improve efficiencies, and remove unnecessary third parties from financial markets.

This area could be ready to explode soon, with the very first tradeable stocks and bonds launching on the Polygon blockchain in February 2023 via the regulated European exchange Swarm. The exchange is starting out with Tesla and Apple, as well as two U.S. Treasury-based ETFs. Additional stocks and bonds will be added based on demand.

Art and collectibles: Ownership and provenance of art and collectibles can be recorded on a blockchain to prevent fraud and ensure authenticity. Note that these are not NFTs, but tokenized versions of actual physical art and collectibles.

Tokenized art and collectibles also help solve the problem of liquidity in these markets through the use of fractional ownership, which can dramatically increase the investor base in the market. The digitization of art has begun via companies such as Securitize, TokenD, and Sygnum. Access to art can help diversify any investment portfolio.

art
Image via Securitize

Carbon credits: Carbon credits, which are used to offset greenhouse gas emissions, can be tracked and traded on a blockchain to create a more efficient and transparent market. Under the current system, carbon credits are (for the most part) only accessible to those with access to brokers or traders and purchased by corporations. This has resulted in a fragmented, inefficient, and illiquid market.

One of the leaders in tokenized carbon credits is Toucan.earth, which has created the TCO2 token. It allows any carbon credit holder to tokenize that carbon credit. Toucan.earth connects holders to the Carbon Bridge, which allows owners of carbon credits from verified sources to link each one to a TCO2 token. These are stored in a smart contract on a blockchain database called the Open Climate Registry. Other carbon credit projects looking to tokenize include Klima DAO and SavePlanetEarth.

Insurance policies: Insurance policies can be stored on a blockchain to simplify claims processing and reduce fraud. With blockchain technology, insurance companies can create smart contracts to track insurance claims, automate outdated paperwork processes, and safeguard sensitive information.

Unlike physical contracts, smart contracts can track insurance claims and hold both parties accountable. Smart contracts can also help automate outdated processes, save billions of paperwork hours each year, and reduce human error because all forms and data are safely stored on-chain. Blockchain technologies have already been embraced by the traditional insurer Nationwide and Web3 companies like Etherisc and Lemonade.

Loyalty points: Loyalty programs for retailers and service providers can be built on a blockchain, making it easier for customers to redeem points and for businesses to manage their programs. Bitcoin Market Journal is a pioneer in this space, having recently released its own loyalty-based token for Premium subscribers. One of the leaders in the blockchain loyalty points space is Bakkt, which builds loyalty programs for its client base. Other high-profile crypto loyalty programs include those at Singapore Airlines and Venmo.

Gaming assets: Virtual items and currencies used in online games can be managed and traded on a blockchain, allowing players to truly own their in-game assets. In 2021, the Blockchain Game Association (BGA) surveyed over 200 gamers worldwide and found that most of them (85%) considered asset ownership the most significant advantage of blockchain gaming. Platform games like Axie Infinity pioneered this space, but it’s growing significantly as top gaming houses are building out games based on blockchain technology.

Then, there are platforms like Enjin.io that are providing game developers an easy way to add NFT assets to their games. Eventually, the space could see interoperability, where assets can be easily moved from one game to another. See our guide to blockchain gaming for investors to learn more about what’s happening in the space.

NFT

Some additional potential uses of blockchain technology with real-world assets include:

Energy trading: Energy providers can use blockchain technology to create a more efficient and transparent energy trading platform, allowing individuals and businesses to trade energy directly with each other.

Water rights: Blockchain technology can be used to track water rights and usage, enabling efficient allocation and distribution of water resources.

Sports contracts: Professional sports contracts can be recorded on a blockchain, ensuring athletes and teams have accurate records of their contracts and that payments are made according to agreed terms. Like other assets, these contracts can be fractionalized and sold off by players if they want immediate liquid cash.

Charity donations: Charitable donations can be tracked on a blockchain, ensuring funds are used for their intended purposes and increasing transparency for donors.

Online advertising: Blockchain technology can be used to create more transparent and efficient online advertising systems, allowing advertisers to track and verify ad impressions and clicks.

Legal contracts: Legal contracts can be stored on a blockchain, allowing parties to easily verify the terms of agreements and ensuring contracts are executed as intended.

Investor Takeaway

This list may just be scratching the surface.

In the coming decade, it’s possible nearly everything of value will be placed on-chain thanks to the trust, security, transparency, and efficiencies blockchain provides.

Tokenization of real-world assets has one massive benefit: accessibility. If you’ve been interested in investing in art, carbon credits, or even stocks, and you’ve found there are too many hurdles, tokenization of these assets can help overcome many of them via increased liquidity and simplicity.

If you’re an investor, this is an exciting time. In our view, asset tokenization will only continue to grow, and those who understand the benefits at the start are most likely to reap the rewards.

The post Tokenization of Real-World Assets: The Complete List appeared first on Bitcoin Market Journal.

How Coinbase Plans to Bring One Billion Users to Web3

https://www.bitcoinmarketjournal.com/how-coinbase-plans-to-bring-one-billion-users-to-web3/

Since its inception in 2012, Coinbase has had the goal of being the crypto platform that’s most trusted and the easiest to use.

It has certainly accomplished this in terms of its crypto exchange service and, more recently, its subscription business (which is growing at a 34% rate; see our CEX Sector Report for more details).

Now, the company is making its move into the developer space, and the implications are nothing less than epic.

On February 23, Coinbase announced the launch of a new testnet called Base, which is an Ethereum Layer-2 network powered by Optimism and developed using the OP Stack. This will allow Base to be decentralized, permissionless, and open to anyone looking to create decentralized apps that can reach the full set of Coinbase products, tools, and users.

base
Image via Coinbase Blog

The move is epic as it combines one of the largest global crypto exchanges with the largest smart contract blockchain. The reach will be huge. In the words of Coinbase:

“Our goal with Base is to make onchain the next online, and onboard 1B+ users into the cryptoeconomy.”

Considering Coinbase currently has 110 million registered users, a leap to 1 billion has to be considered epic.

Let’s look at how Base works, why they created it, and the implications for Coinbase (COIN) investors.

The Goal of Base and Why Coinbase Chose Optimism

Base was created with a goal of bringing many more users into the crypto ecosystem. It’s meant to be the home of all future on-chain products created for Coinbase.

By choosing Ethereum and Optimism, Coinbase has ensured it will remain a decentralized, permissionless, and open ecosystem that anyone can use to build dApps and solutions.

Coinbase says this will foster ease of use and make the transition to Web3 easier, and that’s true. It will also benefit Coinbase as it brings in the collective experience of millions of developers who can create an ecosystem around Coinbase.

coinbase_OP
The BASEd and Optimistic NFT, commemorating the historic collaboration between Base and Optimism. Image via Base Mirror Newsletter

Coinbase could have created its own blockchain as Binance did with Binance Smart Chain. Instead, the company partnered with Optimism and used Ethereum as the Layer 1, meaning it can leverage the existing Ethereum developer base.

Collaboration and decentralization gives Coinbase far greater reach and trust in developing this Layer-2 solution. This should ensure the long-term adoption and growth of Base. In the words of Coinbase,

“We believe this decentralized effort will create the foundation for a much more vibrant developer ecosystem than what would be possible by a single chain alone.”

What’s not been publicized is Coinbase has been working with OP Labs (the first core dev for the OP Stack) and the core Ethereum development team since May of last year.

That collaboration has accelerated work on Ethereum’s EIP 4844, which will decrease fees for Layer 2 networks by 10-100x. It also takes the network one step closer to full sharding (another 10-100x cost reduction), and ensures the new data storage requirements are manageable for stakers.

During the collaboration with OP Labs, the two companies found common ground. Using the OP Stack, they could deliver massive benefits to users, developers, and the broader crypto ecosystem by providing interoperability and composability between the two companies.

The vision they share is a mesh of rollups that will eventually form a Superchain which jointly scales Ethereum. Such a Superchain is expected to be far more beneficial to the crypto ecosystem than a single chain could ever be.

The Benefits of Base

There are several ways in which Base will benefit not only Coinbase, but also Ethereum and the overall developer and user communities.

choice

1. The choice of Ethereum as the blockchain rather than building a new blockchain for Base is a huge vote of confidence in Ethereum and its ecosystem. This sets a massive precedent that others firms like banks and fintech companies will likely follow. Ethereum could become the de facto Layer-1 solution used globally for all Layer-2 activities.

2. Despite Coinbase being centralized, Base is the best decentralized way for the company to launch a chain. There’s no token; it’s all open source. A huge win for the crypto maximalists, as Base is more DeFi and less CeFi.

3. Base is a trustless money system built on transparent, open, DeFi protocols. This could help appease regulators by showing how code can be used to protect retail investors in the space.

4. With Coinbase having 110 million verified users, the success of Base could see an explosion in DeFi and crypto native users in the coming years.

5. Coinbase now has an incentive to help develop Ethereum’s infrastructure. This brings massive resources to Ethereum development. It will also supercharge Layer 2 development, accelerating innovation in the space.

6. The fact that Coinbase was able to get this through its legal and compliance teams in the U.S., where regulators seem to be constantly battling any innovation in the crypto space, indicates confidence that Base will not be shut down by the S.E.C. Even if it tries, few companies are as well prepared to battle regulators in the U.S. as Coinbase.

build on base
Coinbase’s gateway to DeFi. Image via Twitter

Not Without Problems

While the initial hype surrounding Base was overwhelmingly positive, the project has already run into problems. Just hours after Base was announced, social media saw a flood of user complaints about the functionality of the network.

Those first hours saw the majority of transactions reverted (i.e., reversed), and with the Base bridge being unverified, no one was able to figure out why this might be happening.

“The bridge contracts bump up gas usage under load, which wallets weren’t properly estimating,” Coinbase software engineer Roberto Bayardo explained on Twitter some hours after the launch. “Hardcoded a higher gas limit.”

It seems Coinbase wallets were inaccurately estimating the amount of Ethereum fees (gas) needed to complete a transaction. This meant users weren’t allowing enough gas for their transactions, and Base was reverting the transactions rather than processing them.

Speculation is that Coinbase didn’t anticipate the huge flood of users coming to try out the new Base bridge.

Given the history of Coinbase, which has halted transactions due to overcapacity multiple times in the past, this probably shouldn’t be too surprising. You’d think they’d be used to these growing pains by now.

Investor Opportunities in Base

One of the major commitments in building Base is it will remain open-sourced, decentralized, and permissionless, and that Base will not have its own native token, so how can we (as investors) benefit from Base?

Currently, there are three primary entities that could see a benefit from the launch of Base, though to be sure, any real gains likely won’t come until Base is launched on its mainnet. These three are:

  1. Ethereum (ETH)
  2. Optimism (OP)
  3. Coinbase (NASDAQ: COIN)

Ethereum

Ethereum is already the largest smart contract blockchain by far. With roughly 500,000 daily active addresses and a market cap just shy of $200 billion, it would take quite a shift for one project to heavily influence the price of ETH.

Yet, Base could be that project.

If Coinbase can meet its goal of one billion users, usage of Ethereum and ETH could grow 100-fold or more. That will take some time, but it’s worth baking into your forecast if you’re a long-term ETH hodler.

Optimism

The OP token saw a quick jump of 8% following the announcement of Base, taking it briefly above the $3 level. However, this proved to be too much resistance, and the price dropped back over the coming days.

Still, OP has seen a 230% gain in recent months, mostly on the back of bullishness surrounding the Ethereum Merge event.

Increased usage of Ethereum and Optimism, once Base hits mainnet, could be just the catalyst to see OP reach new all-time highs. At the very least, we expect a pump of the token when Base announces its mainnet date.

Long-term, the token may benefit from massive increased usage of Base if Coinbase can deliver on its promise of making on-chain the new online.

Coinbase

Like everything in crypto, Coinbase has seen its stock plunge during the crypto winter, with its price falling from an all-time high of $368.90 to its recent price of $64.15. That said, price has rallied by more than 10% in the wake of the Base announcement, promising better days to come if Base delivers on its promise.

Tom Dunleavy, a former senior analyst at Messari, put forth some interesting numbers in a Twitter explainer thread following the announcement of Base. He hypothesized that Coinbase could double its revenue and profits solely on the back of Base.

dunleavy
Image via Twitter

His hypothesis goes like this:

  1. Coinbase has 110 million verified users.
  2. Roughly 10% of these (let’s call it ten million) are active users, not just those who have an account for holding crypto assets.
  3. Assume 50% of them are interested in crypto-native applications. That gives Base a five million strong user base from day one.
  4. Users will need wallets. Assume that half the user base will choose Coinbase wallets simply for ease of use. That gives us 2.5 million Coinbase wallet users.
  5. All these users will need to swap assets. They could do this through Uniswap (which will likely be integrated with Base on day one), or they could use the native swap feature in the Coinbase wallet.
  6. According to data from Dune Analytics on MetaMask swaps, during a bear market, it does $200K-$500K a day in swap revenue across 4K-5K DAUS. During a bull market, it does $500K-$2M a day across 6K-7K DAUs.
  7. If only 1% of the total users do their swaps through the Coinbase wallet, we get 10x the DAUs of MetaMask. Assuming the same take as MetaMask we get $60-600 million per month in swap revenue, which is pure profit.
  8. Through Base and Coinbase wallet-native swaps, Coinbase could be adding roughly $0.7B (bear market) – $7B (bull market) annually to its bottom line in profit. Coinbase annual revenue was $3.15B in 2022 and $7.36B in 2021.

While Dunleavy’s numbers could be (ahem) optimistic (five million Base users and 2.5 million wallet users on Day one seems quite high), there’s still an opportunity for Coinbase to grow its revenues and earnings quite aggressively just from swaps, and as the user base grows over time, so will these numbers.

Also, as Base grows towards its goal of one billion users, it’s likely safe to assume the majority of these will favor convenience and ease of use, so they should favor the Coinbase wallet and native swaps. That means swap revenues could accelerate dramatically in the coming three-five year timeframe.

As an example, look at how services and subscription revenue at Coinbase grew in 2021 and 2022, even during a bear market.

subscription
Image via Coinbase Shareholder Letter

A similar trajectory in Base swap fees would give Coinbase a pretty massive injection of easy revenues and profits.

Investor Takeaway

Coinbase is the largest U.S. crypto exchange, while Ethereum is the largest smart contract blockchain.

As they pair up to bring one billion users into the Web3 ecosystem, it’s probably fair to say this bears watching if you’re an investor.

If Coinbase can deliver on its promise to “make onchain the next online, and onboard 1B+ users into the cryptoeconomy,” this could easily be an “iPhone moment” for the crypto ecosystem.

Coinbase currently has a market cap of just over $15 billion, so imagine if it could grow to the size of Apple with a market cap in excess of $2 trillion.

Of course, ETH and OP stand to benefit massively from such adoption as well. Optimism has already seen a 230% increase in two months on the back of the Ethereum Merge. Imagine how the value of the OP token could increase if Base is successful.

If Ethereum becomes the de facto Layer-1 solution used globally for all Layer 2 activities, combined with massive user adoption, we could see the flippening sooner rather than later.

Oh, and if you like collecting NFTs, there’s a free NFT giveaway (you will need 0.000777 ETH for minting fees) promoting Base, Introduced. Click the link to go mint your free NFT.

The post How Coinbase Plans to Bring One Billion Users to Web3 appeared first on Bitcoin Market Journal.