Basketball Entrepreneur, Shaquille “Big Sexy” O’Neal just crossed the line. Here’s the Etherscan page for Shaq’s NFT project showing the sanctioned, illegal transaction. The US Treasury announced sanctions applied to Tornado Cash transactions beginning last Monday. I’m not suggesting that Shaq’s done anything wrong, but this is an example of why the Treasury’s attack on Crypto mixing services via sanctions is unworkable.

Who Gets Invited To The Crypto Mixers?

Mixers are tools within the Cryptocurrency ecosystem that allow users to deposit tokens, combine them with other people’s tokens, and then withdraw to an unrelated wallet. They can be used simply for privacy reasons, or it can be used to hide the tracks of illicit funds.

The US Treasury was obviously focused on the latter when it sanctioned Tornado Cash, with an estimated $455M washed through Tornado over the last few years by North Korean hacker group Lazarus. 

I’m not defending the ability to hack and launder money, but you can walk the line if one can actually be laid down. Lazarus has been a scourge on the Crypto industry since at least 2017 and I would love nothing better than to see them dealt with effectively and severely. But that’s the problem…

The solution to Crypto hacks needs to be effective or there’s no point.

According to Chainalysis’ research on the topic, for every criminal use of crypto mixers, there appears to be a legitimate use. So a large part of the pushback on this round of sanctions is to do with preserving privacy tools in an increasingly aggressive surveillance state that jeopardizes citizens’ legitimate need for privacy in everyday life. 

Privacy is normal and needs to be defended.

Among notable legitimate and extremely necessary uses of privacy tools that have come out since the sanctions announcement are Ethereum founder Vitalik Buterin using Tornado Cash to donate money to Ukrainians. This reduced their risk. Blockchain developers can also use untraceable funds to seed new projects without exposing their entire net worth.

However, this article isn’t about privacy. There’s plenty written about that elsewhere. I’m talking about why sanctions aren’t the right tool for this problem. 

Sanctions Didn’t Stop Party Crasher Lazarus

This isn’t the first mixer the US has sanctioned. In May, the Treasury sanctioned Blender.io, another mixing service that had also been used extensively by Lazarus group. In that case, the sanctions worked well to shut down the service.

They had no meaningful effect on the Lazarus group who simply kept hacking and moved to the next mixer.

Blender.io was a custodial mixer. Users deposited funds into a centralized custodian who would then mix your funds and return them. The people running the service were targeted by sanctions and shut down. 

Tornado Cash is structured differently. Rather than having a centralized custodian making decisions it’s simply a smart contract hosted on the Ethereum blockchain which holds funds prior to mixing and withdrawal. It’s just a piece of code that will continue running indefinitely and doing what it was designed to do. No one that can take it down. It is an immutable smart contract. 

Tornado Cash is Bitcoinesque. It cannot be changed. It cannot be removed. 

The Treasury seems to not really be aware of this distinction. The actual text of the sanctions has identified a range of wallet addresses associated with the smart contract as being prohibited to transact with. Treasury hasn’t identified any specific people or organizations, other than a website that hosts a front end for accessing the service. That makes this the first time the Treasury has sanctioned code, rather than people or corporations.

Enforcement: “Buzzkill” US Treasury Just Doesn’t Get It

How will this be enforced? No one really knows, but so far Circle has frozen USDC currently held in the smart contract awaiting withdrawal. Circle’s CEO doesn’t seem very happy about being forced to do this. There are also significant amounts of Ethereum and Wrapped Bitcoin also held in the smart contract.

BitGo, the issuer of Wrapped Bitcoin can’t freeze their tokens and Ethereum also can’t be frozen at the protocol layer. The only logical way that US based companies like Coinbase can comply with sanctions is to prevent tokens that have been through Tornado Cash from being deposited onto their platforms.

Which raises a huge issue. Because tokens can’t be frozen on the protocol layer, these tokens are free to move around in the Ethereum DeFi ecosystem prior to deposit on Coinbase. Regular users will have a very hard time knowing whether or not tokens that they receive are going to be accepted with major US based companies.

We don’t have any guidance from the Treasury on how this is supposed to be dealt with, but I imagine there are currently extremely frustrated calls between Crypto exchanges and the Treasury department trying to sort out this issue without breaking Ethereum.

The Treasury department might have just accidentally broken Ethereum fungibility.

Do I think that is the likely outcome here? No, not at all. But it does speak to how recklessly uniformed and uncaring the US Treasury is becoming regarding the collateral damage of using sanctions to solve every problem. There doesn’t appear to have been any consultation with major Washington based Crypto education groups like Coin Center and the DeFi Education Fund.

Will the US Treasury be educated enough to make restrictions and reform possible. We don’t yet know how strict the Treasury will instruct US corporations to be about blocking deposits from Tornado Cash. Using blockchain records, it’s perfectly possible to trace Tornado Cash use through several transactions. It’s less possible to do the same through a DeFi system which inherently mixes up funds so that their origin can’t be ascertained.  

The maximum enforcement would be to block all deposits from DeFi because some deposits would have touched Tornado Cash at some point in time.

This highlights how useless sanctioning a medium of exchange really is. Usually transactions with a particular party are the sanctioned activity. This is what it means to have effective measures against cybercrime. These sanctions won’t shut down Tornado Cash and they won’t stop Lazarus Group. They have the potential to cripple Ethereum, if they’re applied strictly. It’s fundamentally a losing game. The USTreasury is playing whack-a-mole with privacy tools. 

So what happens when a government enacts an absurd law that can’t be enforced and doesn’t really make any sense?

People immediately break the law.

Guilty By Association: Shaq, Fallon And Others Get Dusted

Numerous celebrities and notable Crypto figures including Shaq, Jimmy Fallon, Brian Armstrong the CEO of Coinbase, Crypto Exchange cold wallets and numerous others got dusted by Tornado Cash transactions.

Dust attacks aren’t new, they’ve been around as long as I’ve been in Crypto. They describe when a wallet gets sent useless or harmful tokens without their consent. There is no need to accept Crypto transactions, they just show up when someone sends them to your wallet. 

Someone with a balance held in Tornado Cash started sending small Ethereum transactions to a range of known celebrity wallet addresses without their approval or knowledge. On the first day of sanctions over Tornado Cash. 

Did Shaq violated sanctions? Arguably yes.

Sanctions violations are strict liability offenses. There doesn’t need to be any intention to perform a transaction with the sanctioned party. There doesn’t have to be any benefit gained by transaction. All that needs to be shown is that a transaction occurred.

There is a defense that best efforts were taken to comply with sanctions. The prosecuting body will look at what steps were taken to avoid breaching sanctions, that will affect their likelihood to prosecute and the severity of the punishment. But what could Shaq have done to avoid breaching sanctions?

There is nothing that anyone could have done to avoid breaching sanctions by receiving unsolicited Tornado Cash transactions.

Obviously Shaq and Jimmy Fallon are not going to get prosecuted for sanctions violation because someone else sent them some Ethereum, but the fact that these celebrities will need to be excused for something that is arguably a breach of US sanctions according to the letter of the law is a big problem. 

If The Rules Are A Bluff, What Happens Next?

The sanctions are at best ineffective. Tornado Cash is the second mixer that has been sanctioned because it was used by Lazarus. The first set of sanctions just meant that Lazarus moved to using Tornado Cash instead of Blender.io. I imagine that due to the lack of enforceability of this round of sanctions, they won’t even stop Lazarus from using Tornado Cash as their mixer of choice. 

Will it change how Crypto exchanges treat mixed funds? Unlikely. Major US exchanges already had a responsibility to refuse shady deposits under existing anti-money laundering provisions. There were already reports earlier this year of Coinbase refusing to credit deposits directly from mixers or funds that had recently been through a mixer. 

What is the point of sanctioning Tornado cash if it doesn’t shut down the service or slow down Lazarus group?

Well it will likely prevent law abiding US citizens from accessing a financial privacy tool for non-criminal purposes. Fight for the Future compared the sanctions to banning email because it can be used for phishing scams. The Cato Institute noted that “Punishing every American by going after technology is not the solution for dealing with criminals”.

Banning mixers to stop cyber crime is like digging up roads to prevent carjackings.

I’m much more concerned about the big picture problems with this style of enforcement. The demonstrated lack of basic understanding of how this technology works and what they are doing at the Treasury department is frankly terrifying. 

It’s one thing to deliberately destroy Crypto ecosystems with regulation. It’s an entirely different thing to do it by accident. 

The Ethereum blockchain is open and readable. There are numerous firms and hobbyists who monitor transactions. All eyes will be on Tornado Cash to see if it continues to operate or if the sanctions shut it down. In the day after the sanctions came into effect almost $3M moved through Tornado Cash.

Sanctions are a powerful tool, but they are completely unsuited to dealing with decentralized or ungoverned entities like Tornado Cash. There is no one for the government to threaten here. There’s just users accessing open source code to assert their privacy. 

If the US Government is going to bluff, I’d prefer it if the entire world couldn’t see that bluff fail in real-time. 

Tether FUD (Fear-Uncertainty-Doubt) continues, most recently with highly respected commentators such as Grant Williams weighing in and ascribing a high likelihood of the stablecoin being under-reserved and possibly fraudulent.

In this note we’re going to look at the claims and try to evaluate what effect it could have on our crypto investments it if it turned out that Tether was, in fact, a complete scam.

Tether is the first “stablecoin”, which is a digital currency that endeavours to maintain parity (a peg) with its counter-party instrument: the US dollar.

1 Tether (USDT) should equal $1 USD. There is constantly varying degrees of slippage around this (and any other stablecoin)

Tether is the third largest digital currency by market cap, at around $63B USD. Note also that I keep calling Tether “a digital currency” and not a crypto currency. This is because there is no Tether blockchain and USDT’s are not mined, they’re “minted”.

Ostensibly, Tether receives USD from depositors and then “mints” a corresponding amount of USDT and puts that into their depositors’ account.

This is where everything gets funky.

The depositor then takes that USDT on whatever ecosystem they’re in (these days mostly Ethereum or TRON) and begins moving it around to where they want it to be. They can buy Bitcoin with it. Or Ethereum. They can stake that USDT into myriad Decentralized Exchanges (DEX)  platforms like Sushiswap, Aave, etc, or even stake it into more complex yield farms and liquidity pools like Yearn, Curve, Compound, et al.

And they can earn yield on that. More yield than can be earned out in the legacy world. 5%, 7%. With some of the more complex DeFi strategies you can get north of 10% and if you want to go full “degen” (short for “degenerate”) you can ostensibly bag APRs in the triple digits.

Contrary to Bitcoin or Ethereum, where we know the providence of every single unit, we don’t know anything about Tether.

Every BTC or ETH mined is accounted for and visible. Every single transaction they’ve ever been a party to is logged to a public blockchain that anybody can access. And it’s all executed using protocols laid out in open source software that anybody can download and read.

But nobody really knows for sure where these Tethers are coming from or what happens to the assets backing them from which they are ostensibly reserved. Nobody knows for sure if newly minted USDT have any backing at all.

For all we know, and what people like Crypto Anonymous, @Bitfinexed, Bennett Tomlin and George Noble are alleging, is that Tether just pulls this stuff out of thin air.

If Tether is just minting USTD out of thin air and then using it to buy up Bitcoin, Ethereum and any other assets they can, then that’s a problem (and it’s also an exact microcosm of what central banks have been doing with intensified zeal since 2008).

The original Crypto Anonymous article (linked above) plotted Tether issuance with the rise in the value of Bitcoin and it does look quite bang on

However it is worth noting some of the key moments in crypto as it plots against Tether’s market cap over the course of 2021 after the Bit Short came out.

Tether starts out the year with $21B USD market cap. By the time Bitcoin hits it’s all-time-high on April 14th, it’s more than doubled to $46B, while Bitcoin has also more than doubled, starting out the year at $30K USD and peaking on the eve of the Coinbase IPO a little north of $64K USD.

Then Bitcoin levels off and starts falling, while Tether issuance keeps right on going. What else keeps right on going over this same period?

Ethereum. The price of ETH was $730 USD coming into 2021, by April 14 when BTC peaked it was at $2,436 USD. Ethereum itself peaks out on May 10 at $4,168 USD, and then crashes all the way down to $2,109 on the 22nd.

At this point, Tether issuance levels right off and has been flat ever since, while the  cryptos have been trading down and sideways (although this may be in the process of ending, as we speak).

Tether continuing higher as Bitcoin enters a correction is a similar dynamic to what happened in 2018, after the cycle high in December 2017, as noted in the Schrödinger’s Coin note. This is the point when Tether’s banking relationships were being terminated, and so the thinking goes, USDT was never fully backed after that point (if it ever was). Tether issuance continued to climb higher while BTC entered a bear market.

Now, in today’s case, can $40B in Tether issuance, fraudulent or not be solely responsible for a half-trillion in market cap in the case of Bitcoin and another, call it $380 Billion in Ethereum over the course of the year?

Granted, the free-float for Bitcoin and Ethereum are smaller than the circulating supply, and I’ve seen estimates as low as 2 million for BTC. Could a net 34 Billion inflow of Tether generate a lift somewhere north of 60B worth of the increased price of  BTC and some comparable lift in Ethereum?

The correlation is apparent. However could it also be plausible that Tether is running a similar market dynamic as cryptos in general? As enthusiasm and exuberance built over Q1 2021 did institutional depositors go into Tether more as did others into cryptos in general? Is Tether’s sideways motion it’s equivalent of a “bear market” which doesn’t manifest in a falling market cap because of that ostensible (albeit possibly fake) peg to the USD?

This is a separate question from whether it’s all a scam or not. Here we’re trying to tease out whether Tether is driving the crypto bull markets or a beneficiary of it.

From the Crypto Anonymous note:

“it still didn’t prove that Tether issuance was causing Bitcoin’s price increases. It was still possible that retail demand for Bitcoin was driving real USD into Tether Ltd. through some unknown mechanism; that Tether Ltd. was issuing Tethers in exchange for those dollars; and that those issued Tethers were then being used to buy Bitcoin. Under that scenario, Tether’s rise was being caused by Bitcoin’s demand, and Tether might be fully backed by dollars after all.”

This speaks to the two different questions. Where Crypto Anonymous seems to believe it’s either/or (Tether is fully backed and a beneficiary of the bull market, or it’s a fraud and driving it). But it seems possible to me that both could be true: Tether’s rise could be part of an overall crypto secular bull market and Tether could still be fraudulently padding their accounts by minting new, unbacked USDT. Perhaps aggressively so.

Grant williams enters the picture

Grant Williams was a co-founder of Real Vision who eventually parted ways with the company and it was taken over by Raoul Pal, the latter of which has gone “all in” on crypto. Williams, not so much.

Williams is a highly respected investment and finance commentator, who puts out a high signal, high quality premium letter called Things That Make You Go Hmmm to which I’m a subscriber. He does a fantastic podcast with Bill Fleckenstein called “The End Game”. Fleck and Williams are both crypto skeptics but I find it refreshing and useful to pay attention to well-reasoned skeptics. People who can put forth coherent arguments around why they don’t believe the crypto thesis, as opposed to shrill hysterics who are blinded by their own ideological biases.

The most recent newsletter edition titled Schrödinger’s Coin was a deep dive into the Tether phenomenon specifically. TTMYGH is behind a paywall, but he released this one publicly.

The note synthesizes the work done by Tether skeptics such as @Bitfinexed, Bennett Tomlin, George Nobel among others. The research these people have done on Tether, and its non-arm’s length “partner in crime” Bitfinex is formidable. From a smaller group of activists, I’d say it rivals the output, at least in terms of signal and quality, of the $TSLAQ collective (note that Williams is also a Tesla skeptic, as am I).

The problem, in a nutshell, and my own less intensive examinations around this arrive in the same place is that “Tether is a $60 Billion pile of liquidity that collateralizes a whole bunch of futures and leverage embedded in the crypto currency system”.

In the course of researching this, I’ve come to a slightly different conclusion that the case for Tether being a fraud may be essentially correct, and the ramifications of that culminating in a Tether Crisis would be significant and non-trivial, but they are not existential.

After the newsletter came out, Williams hosted a podcast with Bennett Tomlin and George Nobel to discuss. I came away from it persuaded that Tether could very well be a scam. I make little use of stablecoins but when I do I prefer Circle’s USDC instead, which is going public in the US soon and theoretically running a more transparent and regulatory kosher operation.

In the interview George Nobel used a “Bitcoin casino” analogy where participants used chips (Tethers) to go gamble in the crypto casino and then realize that when it comes time to cash out the value earned won at the gaming tables, the underlying chips themselves are worthless:

“Imagine we go to a casino, we go to Grant Williams’ casino and we want to play the game. So Bennet and I go to the Grant Williams casino and we go and buy a thousand dollars worth of chips. And then, we’d go play the games. We go play Bitcoin and Dogecoin and whatever coin. And at the end of the night, we have whatever we have. Let’s say we broke even. We have $1,000 worth of chips. And we go back to the window, and Mr. Williams is behind the window, and we say, “Can we please have our fiat back. Can we have our dollars back.” And they’re like, “Hmm, slight problem.” “What do you mean?” “Well, we don’t have the dollars.” And so then everyone on the casino floor realizes that they think they’ve got whatever, how many chips they have in their pockets, they think that’s real money. Well, turns out it’s not good for anything. So that’s really the simplest analogy I can give.”

That analogy is flawed because it assumes that the only egress out of the crypto casino is via the cashing out the worthless chips (Tether). But that isn’t the case at all. People wanting to convert the value held in Bitcoin or Ethereum into other instruments have a plethora of ways to do that – they can go into another crypto, some other stablecoin, or settle directly into cash on an exchange.

However, think about the following. Let’s pretend nobody is worried about Tether right now but that someday people become worried about another instrument that is seemingly printed at will out of thin air with no backing in increasing volumes. Let’s call that instrument a “dollar”.

Now imagine people trying to convert their dollars into anything non-dollar by putting it into cryptos, real estate, the stock market and then one day (“gradually, then suddenly”) confidence in the dollar collapses entirely and it becomes close to worthless.

What happens to the value of the assets that everybody bought using those dollars while they still held any value?

Will they also collapse to zero? No, in fact probably the opposite.

In the same conversation, Tomlin was talking about the idea promulgated by some that a collapse in Tether would actually raise the price of Bitcoin, as participants frantically attempted to dump Tether and move into something else:

“The people who say Bitcoin would go up as people try to get out of Tether might be partially right on the Tether exchanges. So what I would expect you would see in those cases is a huge premium open up between the price of Bitcoin on exchanges that primarily denominate in Tether, and the price of Bitcoin on exchanges that primarily nominate in US dollars. So on an exchange like Binance, where a lot of the pairs are against Tether, you might see people willing to trade absurd amounts of Tether for one Bitcoin, 10 million Tethers, 20 million Tethers, whatever, because everyone’s aware there is some risk of Tether.” 

Tomlin is describing the dynamics of a hyperinflation, perhaps without intending to. Again, substitute the word “Tether” with “Dollar”, and what are we looking at? A currency collapse.

What if it’s true?

Now, what if all that said, Tether is a complete fraud, and intrinsically worthless. There’s no collateral there to hold the peg, it’s all been spent on villas and yachts. Then what?

Tether is now in excess of $60 Billion and at least some of it is being used as collateral in various staking, collaterization and liquidity pools.

Right now there is $55 Billion Total Value Locked (TVL) into DeFi smart contracts on Ethereum, down from a record $90B back near the highs in May. While as much as 20% of Tether is locked in DeFi smart contracts on Ethereum, it’s estimated as much as 70% of Tether is sitting in centralized exchanges.

If a Tether Crisis occurs, it would set off a cascading failure of myriad DeFi applications as instruments collaterized in part by USDT would vapourize, causing a chain-reaction. An even larger liquidity shock would completely seize up the centralized exchanges, especially the ones with high levels of USTD reserves.

It would look like what happened across the entire space during the May crypto crash, except it might drag out for days or even weeks, if it turns out that Tether is more embedded into the crypto economy than most people thought.

However I think the ramifications of it being true that Tether could be a total zero are contrary to those who think it would mean the death knell for cryptos.

A Tether Crisis won’t kill cryptos. The crypto economy would take a hit, possibly a big one, and then it’s going to rebuild itself and keep moving forward. Ironically, that will all happen without any bailouts or regulatory interventions. Everyone involved is going to take full ownership for their own losses.  Imagine that.

In the end I think what Tether shows us are the dangers of being able to print value ex-nihilo and be able to use that as collateral or even currency.

Bitcoin maxi’s say that Bitcoin derives its value from the economic tradeoff involved in the energy needed to mine it, Ethereum is the same for now but after it moves to proof-of-stake one could posit the value is derived from the community and the market inertia of the ecosystem.

Even printing a digital currency out of thin air at whim and with no supply cap would be fine (in the sense of legal) but probably close to worthless. See: Safemoon.

But “minting” a stablecoin that is claimed to be pegged to some other asset, without being adequately reserved against it, would be fraud.

What is interesting to note is that if Tether is a complete fraud and what they are doing is essentially counterfeiting a fake currency peg, pay attention to what exactly is being counterfeit: they’re not pretending to mint Bitcoin because they can’t. Nobody can, which is entirely the point of crypto currency.

They’re pretending to mint a peg to fiat dollars, which are themselves backed by nothing and can be created at will, and using it to buy what? Cryptos.

Said differently, Tether tells us more about the flaws inherent in fiat currencies than it does about cryptos. Tether could be viewed as a microcosmic example of the USD being played out in fast-forward. When and if Tether implodes, we should watch carefully for hints of what could happen in a full blown USD (or any other fiat currency) crisis.

If / when Tether implodes and goes to zero, we may face yet another body blow that over time, cryptos will surmount and recover from. How much and how long depends on where we are in the cycle.

We deal mainly with crypto stocks which generally track the market, but for our readers who hold cryptos directly, we’ll review the defensive posturing so that we never get mangled in a liquidity crisis:

• • Don’t trade on margin (neither cryptos nor stocks)
  • Never leave your coins on an exchange.
  • Aside from speculative YOLO funds, avoid complex DeFi strategies that collaterize or rehypothecate your assets
  • Don’t hold any value in Tether. If you have to trade into USDT to get out of some exotic or thinly traded alt coin pair, immediately get out of it and move to some other asset.
  • If you have to make use of a stablecoin, use USDC or DAI.
  • I would specifically avoid Bitfinex and, Binance for different reasons, noting that Binance is also having regulatory issues in multiple jurisdictions
  • When using exchanges, use a known exchange in your own country. This is how I prefer it so (God forbid) should the exchange implode you are at least on home turf for any legal proceedings.    

What many crypto skeptics fail to appreciate is that increasingly more funds flowing into the crypto economy are intentionally on a one-way trip. They are going there with the intention of never being converted back into fiat. I see all of these weak points we just enumerated as indicative of the fiat world we are cashing out of of, not the crypto world we’re moving into.

When I really think about the effect a Tether implosion would have on cryptos, I suspect it will mostly depend on whether cryptos overall are already in a bullish or bearish cycle at the time it happens.

That is the nature of crypto, and markets in general. You can tell you’re in a bear/sideways correction when good news doesn’t do anything for the asset, and you can tell that you’re in a bull move when bad news is shrugged off.

Either way, the societal shift into crypto continues apace.

(This post was an excerpt from the premium version of The Crypto Capitalist Letter, which covers the global, revolutionary shift into the crypto economy with a tactical focus on garnering exposure via publicly traded crypto stocks. You can get a copy of the The Crypto Capitalist Investment Thesis for free when you subscribe to the Bombthrower mailing list, or cut straight to our trial offer of The Crypto Capitalist Letter).

]]> https://bombthrower.com/what-effect-would-tether-being-a-complete-fraud-have-on-cryptos/feed/ 2 https://bombthrower.com/bitcoin-is-de-dollarization-ethereum-is-defi-nancialization/ https://bombthrower.com/bitcoin-is-de-dollarization-ethereum-is-defi-nancialization/#comments Fri, 11 Jun 2021 19:44:19 +0000 https://bombthrower.com/?p=2361

Bitcoin is De-dollarization. Ethereum is DeFi-nancialization.

Lately I have been thinking a lot about the difference between Bitcoin and Ethereum. At the same time the world is witnessing the inexorable move to crypto in realtime. Some may question that assertion, given that the latest FUD cycle against cryptos has been one of the most intense that I’ve witnessed since getting involved in the space in 2013.

Behind the FUD we see actions. We see Russia dumping dollar assets (is that suprising?).

We hear Charlie Munger making almost childishly uninformed remarks on crypto, yet BRK is investing in one of the world’s most crypto friendly banks.

We see El Salvador as the first country in the world to make Bitcoin legal tender.

In my mind this has not only sounded the starting gun on de-dollarization in earnest, it goes beyond that. Back in the late 90‘s people like me were about the age of many of the crypto kids today, and we were talking about the Internet Asteroid headed straight at the telecoms and traditional media.

Today, pretty well everybody is aware of Bitcoin. They may have positive or negative opinions on it, but most people are figuring out that it’s here to stay and there is a spectrum of sentiment around that ranging from enthusiasm to denial. But I get the sense that traditional institutional finance sector doesn’t even see another asteroid coming, and it’s coming straight at them.

The new 60/40 portfolio will mean Bitcoin/Ethereum

Or maybe Ethereum/Bitcoin. Whatever your risk tolerance and investment objectives entail. I’ve been listening to the Bankless podcast lately and in more than one episode they’ve said something about Bitcoin as compared to Ethereum that I think is quite astute. It’s really helped me think about the two in terms of construction of a crypto portfolio.

They’ve said, in essence, that Bitcoin is for when you’re bearish on society and Ethereum is for when you’re bullish.

It’s not that I agree with that literally (I don’t), but it helped me refine the distinction I’ve always had around Bitcoin being the value and Ethereum being the execution in a coming tectonic shift into crypto.

In the olden days, bonds and equities had an inverse correlation. Bonds kept your portfolio afloat when the economy hit a soft patch and stocks went down (yes, in the olden days, stocks could experience bear markets, sometimes for months or even years). Conventional wisdom was to have a portfolio mix between equities and bonds, along some rule of thumb like 60/40 adjusted for your age, risk tolerance, etc.

We’re headed into a world where Bitcoin and Ethereum will fulfil the roles that bonds and equities did traditionally.

The basic thesis of my Crypto Capitalist Letter is that Bitcoin will be on the receiving end of an impending mother-of-all wealth-transfers. Many Bitcoiners think that if Bitcoin is “digital gold” then that means the incoming funds flow will be from the 10 Trillion dollar gold market. I think this is wrong.

Bitcoin’s looming funds inflow isn’t going to come from gold. Maybe some will, maybe some shorter term gold holders will jump ship to Bitcoin in much the same way that this latest down cycle since April has been driven largely by younger coins (weaker hands) selling out. (Overall I think gold and silver will also be a beneficiary of this great transfer).

But Bitcoin’s inflow will come largely from the more than ten times larger bond market. Not gold. Not 10 Trillion. 120 Trillion, of which 20 trillion of it already yields negative returns ( “return free risk”). A simple layer 1 Bitcoin lending program with an institutional level custodian like Gemini or Galaxy (whom we hold in our TCC portfolio) would yield 400 basis points right there, and that’s without even counting the price appreciation.

“The TAM is Everything”

But what I didn’t realize until the Bankless panel this week about the current state of DeFi is that there’s another 100 Trillion-plus market, and it’s going to be sending its value in a parallel mother-of-all wealth transfers. That wealth transfer is the flight of assets from the traditional banking system into Ethereum and into DeFi.

In my mind this is what DeFi actually means. Where financialization is the widespread hollowing out of all value and turning it into multiple layers of rehypothecated debt, DeFi is De-Financializing assets.

DeFi is where money gets intelligence and value can compound and where tokenized assets increase their purchasing power over time. It’s where savers are rewarded, instead of penalized and demonized. It’s where capital formation is possible.

Most institutions won’t be making this transformation. The majority of them will gravitate toward the Central Bank Digital Currencies (CBDCs), which as we say in The Crypto Capitalist Manifesto, CBDCs will be specifically constructed to preclude savings, make capital formation impossible and will be a honeypot of dependancy for the masses who allow their economic lives to be bounded by them.

But many of those institutional clients, the ones that see The Great Bifurcation coming, will make this shift, and they’ll bring their capital with them.

“I’m not excited about institutions in DeFi at all, I think they are just not the right users for this. This is about giving individuals financial tools that they’ve never had before such that they don’t have to go to an institution that rips them off”
— Spencer Noon

I see this playing out in real time in the world and in my personal experience, here’s three quick data points

1. Trying to set up a simple USD/CAD hedge with my bank for the business, something I had already done 10 years ago when the CAD strengthened above the USD. This time it took months of meetings and they want me to put up 4.5X collateral on the hedge and sign off on a personal guarantee.
2. Setting up that same business for EFT transfers for a large client and the bank solemnly informed us “you must possess a fax machine to use this system”. Uhm ok. I’ll see if I can dig one out from the back of my storage locker. Until recently their online FX system also ran only on Internet Explorer (which goes end-of-life next year)
3. My credit card company, until recently, charged me a fee when I overpaid my balance they owed me money in terms of an “inactivity fee”.

It is this is the type of institutional lethargy that is all tailwind and gasoline for DeFi.

In the case of the forex hedges, I’m now looking at places like Synthetix and hiring a smart contract developer to simply create the hedges for me. The way I envision it, anybody would be able to earn a return on their assets by staking the liquidity pool for USD/CAD, and Canadian businesses with exposure to USD currency weakness would be able to easily hedge for that without pledging their house (if you know anybody who can help me out here, my DM’s are open).

I’m cancelling that credit card and getting set up with one of the many new crypto backed credit cards that give you cash back on every purchase in crypto.

One of the reasons people are skeptical of crypto and fool themselves into thinking it’s some kind of passing fad (“ponzi” or the negligently uninformed “tulips”) is because this is happening so fast. In realtime. (They didn’t read Future Shock back in the 70’s, 80’s or 90’s or if they did, they either forgot about it or didn’t fully understand what it meant).

Bitcoin is going to eat the bond market and capture the flight from fiat currencies. It will become that digital gold or bond equivalent in a crypto portfolio.

Ethereum is going to demolish the financial institutions and probably be the front line against CBDCs, functionally.

CBDCs will be disposable money. Get it, spend it, use it on disposable stuff (if it’s algorithmically permitted) and that you don’t mind being surveilled buying.

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