June 24, 2022

Exploring the transformation of value in the digital age

By Michael J. Casey, Chief Content Officer

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With the fallout widening from last month's collapse of the algorithmic stablecoin UST and its related LUNA token, it's time for the crypto community and regulators to jointly work out a way forward that helps bring stability and boosts investor confidence in this industry. Just what that regulatory bargain should look like is the topic of this week's column.

With my co-host Sheila Warren and our producer Michele Musso out for a couple of weeks, the "Money Reimagined" podcast is taking a break from live recordings. Instead, we're featuring highlights from CoinDesk's Consensus festival, which was held in Austin, Texas, June 9-12. This week we bring you a lively discussion from a June 9 session titled "Open Money: Redesigning the System with Humans and the Planet in Mind." It featured Transparent Systems President Patrick Murck, Knox Networks co-founder Natalia Thakur and Valour Chief Strategy Officer Diana Biggs. The moderator: our very own Sheila Warren.

Have a listen after reading the newsletter.

Launched in September 2017, KuCoin is a global cryptocurrency exchange with its operational headquarters in Seychelles. As a user-oriented platform with focus on inclusiveness and community action reach, it offers over 700 digital assets, and currently provides spot trading, margin trading, P2P fiat trading, futures trading, staking, and lending to its 18 million users in 207 countries and regions.

In 2022, KuCoin raised over $150 million in investments through a pre-Series B round, bringing total investments to $170 million with Round A combined, at a total valuation of $10 billion. KuCoin is currently one of the top 5 crypto exchanges according to CoinMarketCap. Forbes also named KuCoin one of the Best Crypto Exchanges in 2021. In 2022, The Ascent named KuCoin the Best Crypto App for enthusiasts.

There Are Open-Minded People in Government. Work With Them

If you still think cryptocurrency can thrive best within the ambiguous, ill-defined, geographically varied and relatively lax regulatory system, you haven't been paying attention.

With the spectacular failures of TerraForm Labs' LUNA/UST and Celsius, the systemic fallout from the liquidity challenges at Three Arrows Capital and the erasure of almost $2 trillion in value from crypto markets, it should now be clear to all that this industry needs better, clearer and consistent rules.

Whatever comes next must be good for the industry as a whole – the developers, the businesses and most importantly, the users. We need regulation that makes the entire ecosystem more stable and secure, yet which also enables innovators to develop projects that realize the true benefits of decentralization and that give users greater autonomy and sovereignty.

The good news is that, despite the understandable alarm that recent events have sowed among some policymakers, a growing cadre of regulators recognizes the positive potential of cryptocurrencies, digital assets and blockchain technology and genuinely wants to be constructive.

We heard that sentiment at CoinDesk's Consensus 2022 festival this month. It came from the likes of Commodity Futures Trading Commission Chair Rustin Benham, Deputy Treasury Secretary Wally Adeyemo, White House Director of Cybersecurity and Secure Digital Innovation Carol House and Federal Reserve Chief Innovation Officer Sunaya Tuteja, as well as from the three senators and one congressman who joined a bipartisan panel of lawmakers.

Also, last week, the Bretton Woods Committee, a nonprofit organization comprising many former regulators and current leaders of the Wall Street and business establishment, unveiled a surprisingly constructive report that we highlighted on our "Money Reimagined" podcast. It was encouraging to find the committee recognizing the benefits of privacy, financial inclusion and international efficiency that permissionless, decentralized and token-based protocols have to offer.

This might be hard to accept for many in the crypto community who've seen the government as the enemy, but hearing these people's open-minded perspectives has put them in a far more positive light than various crypto leaders whose dubious behavior has caused great pain for so many over the past few months.

No knee-jerking, please

Those positive signals notwithstanding, there is real hostility toward this industry in some government quarters. If these skeptics gain the upper hand – especially if public opinion gets behind them – there's a real risk of a knee-jerk policy response to the latest fallout. One unwelcome upshot might be that regulators end up forcing more centralization on an industry when the best way forward is to build workable decentralized systems that can't be exploited by self-interested players.

Too much centralization in crypto is, in some respects, the core problem right now. (Consider Celsius' freeze on withdrawals – it would simply not be possible if, under a more decentralized model, the provider did not have custody of its users' assets.)

But regulators, working off the old pre-crypto playbook for keeping financial entities in line, instinctively want someone or some entity to be held accountable. That means they can end up favoring the formation of centralized, trusted third parties, the very source of risk, corruption, cost and dependency that cryptocurrency developers have historically sought to replace. If that happens, it would set the industry up for the same "too big to fail" problems that led to the Wall Street collapse of 2008.

Yet crypto users really do need greater protection from businesses and developers who, with their information asymmetry advantages, are in a position to exploit their customers. Regulation should lean into solving that problem in a way that brings transparency and trust to decentralized models and which limits the ability of centralized parties to take outsized risks with their clients' funds.

Centralized entities such as Celsius could be required, as brokerages often are, to create segregated accounts that ringfence clients' assets – especially crypto collateral posted for loans – from risks taken on by the firm. That will, of course, tie these firms' hands, giving them less leverage with which to take big bets, which will result in lower yields on clients' investments. But such is the trade-off for the safer conditions that come from regulation.

This could also mean yield-maximizing opportunities shift to noncustodial decentralized finance (DeFi) models in which users retain control over their private keys.

Yet, after the Terra debacle and a host of hacks and "rug pulls" by founders, users also need protection from flawed projects in DeFi. Here, the way forward may lie in a decentralized version of industry-based self-regulatory organizations (SROs). Token holders with governance voting rights could forge these bodies, preferably with an interoperable purview across different platforms, to agree on software and security standards and, most importantly, on frequent audits of the code.

A DeFi SRO could also borrow from a tool the Federal Reserve applied to banks in the aftermath of the 2008 financial crisis: stress tests. Simulations of stressful market conditions and of different types of speculative and technical attacks might have revealed the flaws in the Terra ecosystem before it was too late.

Lean into blockchain transparency

Whether these rules and transparency standards are administered by government agencies or by token-holder bodies, they should be taking advantage of a hugely underutilized aspect of blockchain technology: its capacity to enhance transparency around reporting.

In a tweet this week, investor and commentator Maya Zehavi suggested the industry needed its own "on-chain Dodd-Frank or Mifid2," a reference to the seminal postcrisis financial legislation that was introduced in the U.S. and Europe, respectively, to boost transparency around financial systems.

Her idea is that to reduce the systemic risk exposed by failures such as Three Arrows Capital, users could have access to reliable, blockchain-based data on outstanding trading positions so as to "gauge the overall leverage in [the] centralized platforms" that interact with those blockchains.

The bottom line is that while crypto needs regulation, it must be designed in ways that leverage the strengths of the technology and which are consistent with its core design principles. Whether it's the 89-year-old U.S. securities law that can't be reconciled with the commoditylike features of blockchain tokens, or the 51-year-old Bank Secrecy Act, which gave rise to draconian anti-money laundering and know-your-customer rules, many financial laws are simply incompatible with entirely new, open-design system of finance that crypto proposes.

Let's stop trying to jam square pegs into round holes.

Off the Charts: The Mining World, Way Back...

On Thursday, the journal Nature published an article by six Chinese scientists that mapped the entire Bitcoin mining network. It resulted in some cool visualizations, two of which I've included below. They demonstrate both the remarkably widespread geographical spread of mining operators and the concentration of hashing power within regions whose power supply, cost and other factors make them economically favorable.

The problem: The data behind this potentially valuable survey came from 2018-2019, one year before the anti-cryptocurrency crackdown by Chinese authorities led to a mass exodus of miners from their country. Nonetheless, the images offer a great snapshot of how this ever-changing, dynamic industry has mushroomed globally since Satoshi Nakamoto and Hal Finney ran the only two nodes in the network 13 years ago.

But then the authors came up with a different perspective. They divided the world into 7,205 hexagonal grids and measured the amount of hashing power in each. From that, they came up with a ranking system.

They identified 18 Tier 1 grids that each accounted for 1% or more of the Bitcoin network's total hashing power, 97 Tier 2 grids with less than 1% and more than 0.1% of hashing power, 162 Tier 3 grids with less than 0.1% and more than 0.01% of the network, 211 Tier 4 grids in the 0.01%-0.001% range and 445 Tier 5 grids with mining operations that account for less than 0.001% of hashing power. There were 6,272 grids with no operations at all.

The authors also noted that 61.8% of hashing power was managed within the 18 Tier 1 grids, which, in the image above, are represented by the darkest tone of brown, in contrast with the lightest tone, which applies to the vast number of Tier 6 grids. Now you can see China's dominance at that time more clearly.

It would be good to see what this map looks like now that so many miners have migrated from China to places like Texas and Kazakhstan.

The Conversation: 'Bitcoin' Versus 'Crypto'

The failure of various crypto projects appears to have emboldened the Bitcoin maximalist crowd.

For them, the meltdown of UST and Terra's LUNA, along with the losses incurred by institutions invested in it, is proof that there's really only one viable token, and that's bitcoin. Their schadenfreude appears to be turning its focus on the term "crypto," which is used by many of us to describe the wider universe of cryptocurrencies, digital assets and blockchains but which, for some maxis, is a pop term that seeks to legitimize any token accept bitcoin. (They use a particularly unflattering term.)

Their confidence in this position shined through in the responses to a question posed by German commentator Jürgen Geuter, who goes by @tante on Twitter. Geuter asked his "#Bitcoin" and "#crypto" followers to explain why some people say "Bitcoin is not crypto."

What followed was a who's who of the maxi crowd piling on against all but Bitcoin.

Giacomo Zucco stated, among other things, that "Bitcoin culture is security, adversarial thinking & skepticism," whereas "'crypto' culture is misleading marketing, fake-it-until-you-make it & gambling." Crypto, he said, "is peak fiat."

Swan Bitcoin founder Cory Klippsten made a video appearance, courtesy of a quote tweet reply to @tante from the account of the "Magic City Bitcoin Meetup," a Birmingham, Ala., community. In the video, Klippsten notes that, other than dogecoin, none of the 20,000 non-bitcoin tokens has ever made a second all-time high in bitcoin terms across two bull market cycles. This, he argued, means "they all go to zero in the long term because they are all essentially pump and dumps of varying degrees of success."

Sunny Decree said "Bitcoin is the innovation, crypto is just a marketing scam to steal your Bitcoin."

And Casa co-founder Jameson Lopp conceded that Bitcoin was "technically" a cryptocurrency but said it was distinguished from "crypto" because "nearly all crypto projects these days are DINOs [decentralized in name only]/ unregistered securities."

This gave an opportunity for one of the few apparent nonmaxis in the thread to take a shot at the others. Someone with the handle "WannaBuffett" took Lopp to task, tweeting "To put another away, by saying '"Bitcoin is not crypto",' what #Bitcoin folks mean to actually say is that '"Most other cryptos aren't actually cryptos'" (at least philosophically) if that makes any sense at all" followed by a crying-laughing emoji.

Relevant Reads: The Next Dominoes

Another week, another drama in crypto markets. The latest domino in an ever-widening systemic risk problem sparked, initially, by the collapse of UST and LUNA, is the once high-flying crypto hedge fund Three Arrows Capital (3AC), which had $3 billion in crypto assets under management as of April.

As CoinDesk's Shaurya Malwa reported, based on a Wall Street Journal report, 3AC confirmed the suspicions of many last Friday by revealing it had suffered heavy losses due to the LUNA collapse and is "committed to working things out and finding an equitable solution for all our constituents." The WSJ report said 3AC was on the verge of insolvency.

With fear of redemptions running high among crypto funds, and as talk of systemic risk continued to swirl, three firms around which there had been some suspicion of problems moved to distance themselves from 3AC. As per another Shaurya Malwa report, crypto fund DeFiance Capital, decentralized trading service dYdX and layer 1 protocol manager Avalanche all said they were not exposed to the 3AC fallout.

In the end, the other shoe to drop was not one of those three firms, but cryptocurrency brokerage Voyager Digital. As Oliver Knight reported on Thursday, Voyager, in a move reminiscent of Celsius' drastic move last week to curb outflows, limited withdrawals to $10,000 due to losses related to its 3AC exposure.

All of this did a real number on Voyager's stock, which fell 60% on the news, and forced it to take some aggressive moves against 3AC. As Sheldon Reback and Michael Bellusci reported, Voyager demanded that the hedge fund make a repayment installment by Friday or be declared in default of a loan that Voyager had provided to it.

Take the Crypto Work Survey

The latest U.S. jobs data is showing a massive shift of people in jobs, thought to be pandemic-driven, as workers seek better pay and flexibility. Technological innovations, particularly blockchain-based smart contracts, are also changing the way people earn money and organize. Together, these trends are changing the concept of work. CoinDesk is seeking your response to our survey to gain insights about the Future of Work.

Help CoinDesk gain insights into the working world of crypto by filling out our easy, anonymous Crypto Work Survey by June 26. Take the survey.