April 8, 2022

Exploring the transformation of value in the digital age

By Michael J. Casey, Chief Content Officer

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With Sen. Pat Toomey (R-Pa.) releasing a proposal for comprehensive stablecoin regulation this week, a group of lawmakers proposing an ECASH Act last week to create a cash-like digital dollar and Senators Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) teaming up to propose a legislative overhaul that covers all crypto, the policymaking process is heating up in Washington. It matters more than ever that we find the right balance between regulation and innovation. That's the motivation for this week's column, which looks at what lessons to draw and not draw from comparisons between the complexity of innovation in decentralized finance (DeFi) and the financial engineering that preceded the banking crisis of 2008.

In this week's podcast, my co-host Sheila Warren and I talk to Simone Maini, the CEO of blockchain analytics firm Elliptic, about finding a balance between privacy and transparency in monitoring crypto transactions. Maini argues that tracking blockchain transactions can foster more crypto-friendly regulation because it can help policymakers see that the stereotypes about its criminal usage are just that.

Have a listen after reading the newsletter.

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No, DeFi is Not a Repeat of the 2008 Crisis

Yunha LeeCoinDesk

Charlie Warzel's generally quite readable "Galaxy Brain" newsletter carried a provocative headline this week: "Is Crypto Re-Creating the 2008 Financial Crisis?"

Not surprisingly, it turned out to be a rhetorical question. The Atlantic writer's newsletter carried an interview with American University law professor Hilary J. Allen in which she discussed her recent paper arguing that decentralized finance is repeating the mistakes of "shadow banking" that preceded the financial turmoil of the late 2000s.

Allen's thesis is that the high degree of complexity around DeFi's innovative new models for borrowing, lending, insurance and payments will leave the same lack of clarity around looming risks that credit default swaps (CDS) and collateralized debt obligations (CDOs) fostered during the pre-crisis housing bubble. "Complexity-induced opacity increases the chance that such risks will be underestimated in good times (causing bubbles), and overestimated in bad times (making panics worse)," she writes.

Allen is urging the U.S. government to step in to regulate the sector before it becomes more integrated into the mainstream financial system. She argues that decentralized applications (dapps) should be licensed and their founders and developers subject to enforcement actions if they are non-compliant.

That won't sit well with many in the crypto community, where the idea that open-source coders can be charged with wrongdoing is seen as chilling to innovation.

First, let me acknowledge there's some truth in Allen's DeFi observations and that some of the parallels she draws to the financial crisis are legitimate and important.

It's true the average person can't hope to understand DeFi. Much like how Wall Street's financial engineers exploited the black box of CDS and CDOs to the eventual detriment of bank customers, that complexity also gives DeFi project founders asymmetric advantages. It's why "rug pulls" and other abuses of overly trusting investors are common.

Other valid observations from Allen: There's an awful lot of 2008 bubble-like behavior in DeFi now, and there's a lot more centralization with trusted intermediaries than "decentralization" enthusiasts acknowledge.

But there's a fundamental flaw in Allen's perspective, one that could lead to a major policy error.

Read the rest of this column here.

Off the Chart

Prices go up, fees go down

Something quite striking has happened in the Bitcoin market these past six months: Transaction fees are at or near all-time lows, despite the fact that the market has had a series of runs higher in that time, including to a record high in November. In the past, increased prices have led to higher activity on the Bitcoin network, which leads to increased competition for block space on the blockchain and, by extension, to higher fees. Why not this time?

Alex Thorn, an analyst at Galaxy Digital, offered three explanations in a report this week: increased adoption of segregated witness (SegWit), a protocol upgrade from 2017 that made data more efficient in each transaction and so freed up storage space in each block; the increasing use of batched transactions; and the growth of the Lightning Network, which processes transactions off chain.

Thorn also provided this illustrative chart of how anomalous this situation is.

As we'll discuss below, at least one prominent bitcoiner doesn't think this is good news. The strategist and podcast known only by the pseudonym Hasu said it spells doom for Bitcoin long term because miners won't be incentivized to secure the network. I disagree: Lower transaction fees are by definition good for the ecosystem because it means everyone is transacting more efficiently. Lower costs will make all the more use cases viable, which surely will mean that demand for bitcoin will rise, which will drive the price higher and appropriately reward miners.

The Conversation

What's good is bad?

When Galaxy's Alex Thorn cheerily tweeted out his observation of the declining fee trend, along with the chart that he described as "awesome," he probably didn't expect to get to slammed with the accusation that he is "brain-washing people with ridiculous positive spins," least of all from a prominent bitcoiner.

But that's what the influential analyst Hasu did, with a subtweet of Thorn and a message to his 155,000 followers that low fees "means Bitcoin is f**ked long-term." And that prompted a flurry of responses.

Bitcoin core developer Dhruv Mehta asked, "Isn't that literally the creation of room to onboard more of the world population onto bitcoin?"
After the trader known as @CanteringClark asked for the "TLDR," Hasu responded with: "block subsidy secures bitcoin; block subsidy goes away; people hope fees will rise to replace subsidy, in the face of all available evidence; and it's not happening."
Commentator Luke Mikic mocked Hasu for "misleading people" and suggested his follower count "doesn't correlate with knowledge of the #bitcoin protocol here."
For his part, Thorn responded politely. He agreed with Hasu that the security budget was a problem long term. But he maintained that this report was about "efficiency gains and how scaling via compression is having real impact in the near term." He added, "I certainly wouldn't call it "brain-washing."

Tezos – Designed to evolve. Built to Empower.

On April 1, Tezos will complete its ninth upgrade. The upgrade, Ithaca 2, will see a new consensus mechanism called Tenderbake deployed that will improve finality and position the Tezos network for greater scalability and the implementation of roll-ups at the protocol level.

Learn more about the original Proof-of-Stake protocol at Tezos.com

Relevant Reads

Miami Lightning

Bitcoin 2022 kicked off in Miami this week with hordes of crypto folk descending on the sun-baked Floridian city. As of Friday, a flow of announcements seemed to carry a common theme: The Lightning Network for payments is undergoing something of a mainstreaming moment in apps and wallets.

Robinhood used the conference to announce the rollout of its new crypto wallet and in so doing said it planned to integrate the Lightning Network. Danny Nelson reported.
Block's Cash App, which integrated Lightning in January, extended that service into a special feature by which employees can opt to get a percentage of their paycheck invested in bitcoin. George Kaloudis reported.
Jack Mallers, the CEO of Lightning-based payments app Strike and the star of last year's historic Bitcoin Miami announcement that El Salvador would adopt bitcoin as legal tender, announced a Shopify integration. As Danny Nelson reported, he also waxed philosophical on the need to return the Bitcoin network to its roots in payments.
But if Mallers got his second-round performance, it wasn't to be for El Salvador's President Nayib Bukele, who last year joined Mallers on stage via a remote connection. As Andrés Engler reported, Bukele called off his appearance at this year's event due to "unforeseen circumstances" that require his full attention at home. He had previously teased he would make an important announcement.