December 18, 2022

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

Reactionary politics leads to reactionary policy. I'm no politico so I can't say if reactionary policy is mostly good or bad, but I would bet on it usually being bad.

With that you can probably imagine my reaction when U.S. Senators Elizabeth Warren (D-Mass.) and Roger Marshall (R-Kan.) introduced a crypto-focused bill last week in reaction to all the FTX nonsense.

Cue my eyeballs rolling into the back of my head, because the bill totally misses The Point. Elsewhere, Jack Dorsey who aggressively does not miss The Point, donated 14 BTC to Nostr, a decentralized social network project. These seem unrelated, but a simple, somewhat loose thread ties them together. So let's dive in.

– George Kaloudis

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On testimony, Elizabeth Warren and The Point

Last week John J. Ray III, the new CEO of FTX who is leading the company through bankruptcy proceedings, testified before the House Financial Services Committee about the crypto exchange's collapse. I honestly don't think there was much to report from Ray's testimony beyond: a) the guy knows what he's doing and b) that he believes FTX's downfall was really just "old-fashioned embezzlement."

After Ray's testimony I think most were excited to tune in to former CEO Sam Bankman-Fried's (SBF) scheduled testimony in front of the U.S. House Financial Services Committee. But that testimony was unfortunately canceled on account of the fact that SBF was arrested in the Bahamas after U.S. authorities filed criminal charges last Monday. SBF was denied bail and awaits an extradition hearing in 2023, for which he will wait while sitting in a maggot-infested Bahamian prison.

Meanwhile, Sen. Elizabeth Warren (D-Mass.) took the opportunity, with crypto top of mind, to react with a bipartisan bill co-sponsored by Sen. Roger Marshall (R-Kan.) called the "Digital Asset Anti-Money Laundering Act." I'm not going to go over the bill point by point here but, if passed, the bill will require anyone who maintains public blockchain infrastructure to register as a Financial Institution (FI). This includes software developers or anyone validating transactions on a network.

These FIs would be required to do things like collect the personal information of people who use their software and comply with anti-money laundering (AML) programs to block funds related to crime. On top of that, it would ban any interaction with privacy tools like Tornado Cash (which is sanctioned by the Treasury Department) and privacy-coin protocols including Monero or Zcash.

On its face, the bill doesn't necessarily feel problematic, especially because it was drafted in wake of the FTX collapse. But here's the thing about the bill: It misses The Point. The Point being that a lack of corporate controls and opaque systems led to FTX's bankruptcy, not someone like me relaying bitcoin transactions with the computer sitting in my living room.

The bill misses The Point because it goes after something only related to FTX because the word "crypto" is involved – like how soccer and baseball are related because they are both played with round-ish balls, but a rule in soccer that bans sliding into first base would be kind of … weird (non-sporty readers: There's no first base in soccer).

Proving this, Senator Warren tweeted that:

"Rogue nations, oligarchs and drug lords are using crypto to launder billions, evade sanctions and finance terrorism. My bipartisan bill puts common-sense rules in place to help close crypto money-laundering loopholes and protect our national security."

If you are paying attention, this has almost nothing to do with FTX. To be clear, I'm not coming to the defense of FTX here. But I am coming to the defense of people like Evan Kaloudis (no relation, although I have donated to his open-source project efforts) who will have to implement a sophisticated AML program for the ZeusLN wallet he developed – a piece of software which is free and open source – if this bill becomes law. Much emphasis on "free" here.

On top of that, it is very critical to note that SBF was arrested without this bill becoming law, because he is charged with doing things – like securities fraud and wire fraud and money laundering – which are already illegal.

The hoopla around this bill comes from the fact it is primarily focused on financial surveillance, which wouldn't have stopped FTX from happening. In fact, the bill would make non-custodial use of crypto harder, which would drive users toward the FTXs of the world – not away from them.

In all, the Digital Asset Anti-Money Laundering Act is at worst a poorly veiled attempt at expanding financial surveillance, and at best it's just a bill that misses The Point due to a lack of institutional crypto knowledge.

On decentralized social networks, funding them and The Point

Elsewhere, Twitter co-founder and Block CEO Jack Dorsey donated a touch more than 14 BTC to Nostr, a decentralized social network. Some Twitter users told him he should look into it and within 24 hours Dorsey funded developer fiatjaf's Nostr efforts.

Nostr isn't itself a social network. Instead, it is an open protocol with a lean toward censorship resistance. The protocol doesn't use a centralized server, instead relying on user-run clients. With this client, users can send content around by writing a post, signing it with their private key and relaying it to others' servers. This relay network can enable others to build social media platforms using it.

I think the donation is quite cool. But probably not for the reasons you think.

You probably think I think it's cool because ever since Twitter was taken private there has been an overwhelming sense that users are looking for a better experience and this is a step in the direction of improving that experience.

Sure, that's cool. But what's cooler is that the funding of this project happened organically. Nostr wasn't the brainchild of some well-known tech billionaire; it is just a piece of open-source software that was born because, as fiatjaf told me over Telegram, "the old internet where freedom [was] winning is being killed and new, supposedly free platforms won't work in the long run."

Whether you agree with fiatjaf or not on that point, Dorsey discovered Nostr, used it and thought it was interesting enough to warrant funding. So while it didn't really garner attention until some well-known tech billionaire discovered it, it wasn't that billionaire's brainchild and that's substantially cooler than if it was.

Fiatjaf agrees, adding over Telegram that, "money isn't really the most impactful thing, but the fact that Jack used it and talked about it is more important."

The parallels to Bitcoin are there (please do not take this as a suggestion that Nostr will be as big, important or successful as Bitcoin): Nostr is an open-source, decentralized protocol that people will try to use because they are dissatisfied with current systems. At a minimum, I really am looking forward to how the decentralized social media story continues to develop from here.

Tying things together

Let's tie the Digital Asset Anti-Money Laundering Act to Dorsey's Nostr donation.

While not targeted at all open-source developers specifically, if this bill passes then a meaningful cross-section of open-source developers may be tagged as potential criminals. So too will be the people who run and use the open-source software they develop. This tagging won't stop everyone from using the open-source software, but it would certainly stop most people. This would in turn encourage broader use of large, custodial, centralized platforms like FTX.

And while things like Nostr wouldn't be covered in the passing of this bill, the bill still sponsors at least a partial muzzling of open-source software, the muzzling of which is a muzzling of free speech.

In addition, with the funding of Nostr, Dorsey shows that he isn't missing The Point.

The Point is that spectacular failures in centralized systems (like FTX) beget the need to build robust, decentralized systems that protect liberty and freedom and everyday citizens. (As corny as that sounds, it's true.) The Point is that centralization, in this case at least, is the issue.

A natural conclusion here is that this bill would not protect us from another FTX or crypto money-laundering loopholes. It simply isn't getting at the crux of the issue. I'm in no way suggesting that these senators are proposing this bill in bad faith; I'm only suggesting that the advertised purpose of a bill should be achievable given the laws that would be enforced in the event that the bill passes.

So in the same way that I look forward to the development of decentralized social networks, I also look forward to the development of laws that make sense in the context of what they are governing.

Takeaways

Grayscale Bitcoin Trust discount reached a record 50%.

TAKEAWAY: On Dec. 13, Grayscale Bitcoin Trust (GBTC) shares hit a record-high discount rate relative to the price of bitcoin (BTC), pushing past 50% for the first time after the U.S. Securities and Exchange Commission reiterated its reasons for denying an application to convert the world's largest bitcoin fund into an exchange-traded fund. Grayscale and CoinDesk are both subsidiaries of Digital Currency Group. Read more here.

Sam Bankman-Fried formally charged in US Court.

TAKEAWAY: U.S. prosecutors revealed a litany of charges against Sam Bankman-Fried, including wire fraud, conspiracy to commit money laundering and campaign finance violations early Tuesday. SBF was arrested Monday evening in the Bahamas, at the U.S.' request, and is scheduled to appear before a local magistrate court on Tuesday. In total, Bankman-Fried faces eight changes. Read more here.

Binance CEO warns staff of turbulent times.

TAKEAWAY: Changpeng "CZ" Zhao warned his staff to expect turbulent times ahead as the giant crypto exchange sees a wave of crypto outflows amid concerns about its financial health, according to an internal memo. "While we expect the next several months to be bumpy, we will get past this challenging period – and we'll be stronger for having been through it," CZ wrote to his staff. Read more here.

Podcasts Worth Listening To

Citadel Dispatch

Episode 63

Citadel Dispatch e63 – building nostr, a censorship resistant alternative to twitter with @fiatjaf, @jb55, and @MrKukks

CoinDesk's Money Reimainged

What the 2022 Crypto Year Revealed and How Humanity Failed Again

An introspective look into the industry, finding the successes which function as guideposts for the future despite all the failures.

The Breakdown, With NLW

For Once, a Positive Inflation Surprise

On today's episode, NLW catches up on the most recent inflation numbers. U.S. headline inflation for November came in at 7.1%, vs 7.7% the previous month and the 7.3% expected by surveyed economists. The Federal Reserve's preferred measure of core CPI was up just 0.2% month over month. This show looks at the numbers and market reactions, as well as what it might mean for the Federal Open Market Committee interest rate decision expected on Wednesday, Dec. 14.