#11 The Context: DeFi’s Big Boy Pants
Hi, hope you’ve had a good week. Here’s our weekly newsletter on all things crypto, put together by a team at YAP Global. As ever, we try to provide a neutral context for the main stories of the week, and offer a dollop of insight where we can. If there’s a reference to a client, we’ll flag it. Please feel free to forward the newsletter around if you think it’d be helpful, and of course, we’d love to hear from you — comments, brickbats, suggestions, or interest in talking more. Email us at thecontext@yapglobal.com.
[tl;dr]
Another landmark in the trading of crypto derivatives in TradFi. How fused will these two worlds get?
Ukraine continues to demonstrate that siege warfare needn’t hobble government, funded in large part by crypto
The launch of a new APEcoin has highlighted the attractions of, and reminded some of the perils lurking amidst, the world of crypto.
[DeFi and TradFi]
Goldman Sachs made the first crypto options trade by a major bank in the U.S., what may become a milestone in the fusion of traditional finance and its decentralised challenger. The move, says Galaxy Digital Holdings, a crypto financial-services firm started by former Goldman partner Michael Novogratz, may “open the door for other banks considering OTC (over-the-counter) as a conduit for trading digital assets." Goldman has been building up to this, last year opening up trading of non-deliverable forwards, a derivative tied to Bitcoin’s price that settles in cash, according to the Bloomberg piece by Yueqi Yang.
While this is presented as TradFi providing the big boy pants that will help make these kinds of products palatable to regulators, that’s only part of the story. DeFi has also built up its own derivatives industry that is partly inspired by TradFi, and indeed partly built by former bankers, but which has become an innovating juggernaut in its own right. Here’s a piece from Bloomberg last July, which already feels a bit dated: Bitcoin (BTC USD) Cryptocurrency Price Volatility Boosted by Derivatives Markets.
What’s still not clear is the relationship, or correlation, between DeFi and traditional assets. Australia’s Apollo Capitaltook a look in 2018 and again this month, and concludes that while in the short term there is likely to be correlation where the environment is “risk off” – i.e. in a crisis people are as likely to sell crypto as they are equities. But in a longer time frame, crypto assets “are still largely uncorrelated to traditional assets. If anything, it appears crypto assets have become less correlated over the last two years." So while it’s inevitable that crypto assets will be bought and sold in traditional markets, appetite for them will likely not rise and fall like traditional assets. For the longer term investor, which is Apollo’s audience, the lesson is obvious: “there is a strong argument for a small allocation to crypto assets within the broader portfolio for long-term, patient investors." (The New York Times agrees, in a consumer piece: Crypto is “hard to ignore at this point,” it quotes Michael Batnick, Ritholtz’s director of research, as saying.)
[Ukraine]
The war in Ukraine continues to probe the limits of what can be done with DeFi.
Ukraine’s Mykhailo Fedorov gives some detail in an interview about how the government is trying to leverage digital and crypto to continue providing services to its population. He talks about crowd-sourced intelligence, a digital inventory of property tied to an ID to help speed up rebuilding the country once the war is over, and how the telecom providers have managed to maintain a stable internet connection throughout most of the country, supplemented by Starlink terminals. All while preparing and signing a virtual currency bill into law.
The government, Fedorov says, has raised $55 million in cryptocurrency, all of it directed to the needs of the army. In an interview with Protocol Everstake CEO Sergey Vasylchuk talks about his role in setting up Aid for Ukraine, and the DAO to enable it. It took him two hours to set up. For a deeper account of these initiatives, check out Lawrence Wintermeyer’s piece on Forbes.
What’s key here is that the crypto donations can be used directly, since 40% of the vendors the governments is working with accept payment in crypto, according to an op-ed piece by Illia Polosukhin, Ukrainian co-founder of the NEAR protocol in the WSJ.
And one Ukrainian managed to escape the country in a hurry, despite being unable to transfer or withdraw his bank savings. Instead he traded some of his Bitcoin with a friend for Polish currency, and stashed the rest of his Bitcoin on a USB, the seed phrase scribbled on a piece of paper. MacKenzie Sigalos’ piece on CNBC is worth a read: Ukrainian refugee flees to Poland with $2,000 in bitcoin on USB drive.
And while the Ukrainian crisis has diverted attention from the Afghan one, there are signs of what can be done with crypto in a country where banking, and networks, are not functioning normally. AFP writes about an NGO using crypto (in this case a stablecoin) to help students in crisis-hit Afghanistan. With sanctions preventing bank transfers to Afghanistan, crypto has become the default method of international payment for some businesses, while for others it has become a better currency for receiving salaries than the falling Afghani. The NGO in question is Code to Inspire which has been helping Afghan women learn tech skills that may provide them an income and some independence.
[Apes, DAOs and Deja Vu]
There’s been some discussion after Bored Ape Yacht Club launched their new ApeCoin, which immediately tanked. (Here’s a explainer of what ApeCoin is and who’s behind it.) Some felt the new coin, some of which was given away in what’s called an airdrop to those who were involved in the launch, including VC giant Andreessen Horowitz, highlighted NFTs’ “power problem”, with Bloomberg’s Hannah Miller writing that the move “provided yet more grist for some of the harshest criticisms about venture capitalists’ influence and power" over DeFi.
Others argued it looked like an unregistered penny stock offering, with Amy Castor arguing that DAO governance tokens are taking the place of Initial Coin Offerings, or ICOs: “In 2017, we had initial coin offerings. In 2022, DAO governance tokens are stepping in to take their place — and they resemble offerings of securities in all the same way ICO tokens do.”
Castor casts considerable shade over not just Yuga Labs, the company behind APE, but also Andreessen Horowitz, which led an investment round raising $450 million, valuing Yuga Labs at $4 billion. She sees considerable risk should the SEC decide APE constituted an investment contract — and hence a security: “Yuga Labs is unwilling to learn lessons from the past. They think they know better. And a16z encourages this stuff directly because they know the game is rigged in their favour.”
Comparing anything with ICOs brings back uncomfortable memories. And if anyone needed a refresher, the author of the IGObit scam has finally been convicted. Details of the fraud in this CoinDesk piece. ICOs had a few big names behind them, just like more than a few NFTs: The IGObit website (archived) quoted Nancy Pelosi’s son, Paul, as saying it was “the best offering I’ve ever seen.” The shenanigans date back as far as 2017, according to the indictment, but it’s probably a good reminder of how any project involving coins could potentially be a scam, whoever is promoting it.
But there are always differing perspectives. As DeFi gets more creative in its financial instruments, so there will be appetite to figure out how to the system. Someone, for example, borrowed 5 Bored Apes to claim $1.1 million of the APE tokens: Is that considered a hack, an attack on the system or simply smart arbitrage?
[Tidbits]
Mining: There’s a gold rush going on in middle America as local governments try to lure crypto miners to their area. Thomson Reuters Foundation (whose newsroom runs separate from Reuters Editorial) explores the bitcoin miners in Kentucky, and the ambivalence locals feel about an industry which doesn’t seem to bring much to the local people. Two hundred miles to the south lies their future, as the Washington Post chronicles what happened in one small Appalachia town when the Bitcoin miners moved in. (The noise of the computers and fans, mostly.) While eventually technology might mitigate some of the externalities caused by mining, it’s going to be a battle to persuade local communities to be patient enough to wait. Another mining story, from the NYT here: Bitcoin Miners Want to Recast Themselves as Eco-Friendly.
Australia embraces DeFi? We noted the battle to be a crypto centre in Contexts #10 and #9 but Australia doesn’t usually get a mention. That might be changing: the government is certainly pushing it, saying that it plans to reform regulations for DAOs, de-banking and licensing for crypto firms. FTX Australia announced its arrival at a day-long event held at the ASX. Or is it all a ruse to win the younger vote in upcoming elections? Or could it be both? (SBF opens Aussie Blockchain Week as gov’t says we’re ‘open for business’) Here’s more detail on the proposed changes: Australia’s plan to create a crypto competitive edge in 12 steps and its call for feedback.
Is Malaysia considering adopting crypto and NFTs? The deputy minister of communications and multimedia has reportedly urged the adoption of cryptocurrencies as legal tender, though he has acknowledged it’s not his call. Currently payments in crypto are illegal. Honduras has denied rumours that it may be considering a similar move.
El Salvador can’t catch a break on its bid to become Bitcoin’s poster child: The government has postponed its Bitcoin bond issue, hoping to do so when better conditions allow. And using Bitcoin as legal tender is not going well: Most of its businesses, it turns out, don’t use the cryptocurrency, saying it had no impact on their sales. Too early to make the call, or a dead duck? It might be argued the government hasn’t thought this project all the way through, but major shifts like this don’t usually happen overnight, or even take on the first try. And this isn’t just a top down thing: local bank Banco Hipotercario sponsored a hackathon in February for Bitcoin apps. The ‘bankathon’ was cosponsored by the Open Bank Project, suggesting a gradual merger of Open Banking and the web3 world of crypto. (We’ve covered El Salvador in Contexts #4 and #3.)
Oh and another regulatory body, this time the International Organization of Securities Commissions (Iosco), lists all the things that it doesn’t like with DeFi, saying that such projects are rife with hidden risks, according to the FT.
[Reading]
A Time interview with Ethereum’s Vitalik Buterin: Worried about crypto’s future. The piece explores Vitalik’s childhood, his ability to write and synthesise ideas, the evolution of his ideas for what became Ethereum, and his emergence, by default, as its philosophical leader. It’s a role he described as “my curse”. The piece explores how he wields that soft power (well, mostly, which could be contrasted with how awkwardly China has wielded its soft power) but it also highlights how far from Vitalik’s vision crypto has strayed. (Time released the issue featuring Vitalik on its cover as an NFT, part of its TIMEPieces’ "Web3 community strategy”.
How far will the decentralised web (aka web3) go in redefining identity, especially when it comes to reputation?At present the debate, if that’s the right word, centres on whether it’s OK, desirable even, to remain anonymous, even if you’re the founder, owner or funder of a venture. But the value of knowing who that founder, funder or whatever is is because you want to assess their reputation, and hence the value of the venture. Kerman Kohli, Sydney-based investor and founder, explores how this might work in NFTs, Social Tokens and Scores: “Leveraging Web3 technologies to well-assessed Social reputation," he writes, “will enable people to see each other’s profiles (competency, worth, status, etc.) from the lens of verification instead of the lens of trust & unlock new levels of interactions.”
A thoughtful piece about the interaction of sport and NFTs, by Sporting Crypto, a newsletter from Pet Berisha (he also publishes on Smartkarma where I originally saw the piece). NFTs have most closely been aligned with art, and gaming. But there’s another space that seems ripe for growth: sports cards. The market for such things is insane – in 2020 it grew 142% with football (ok, soccer) growing 1,586%. Lockdown probably contributed to this. So the question is: would those collectors (and the card companies) be as excited with digital cards? Pet reckons yes: he noticed friends who had never owned an NFT or had a crypto wallet before create one so they could claim an airdrop of NFTs by E-Sports brand 100 Thieves. This is what they call a tipping point: The Window of Volatility & The Valley of Liquidity.
This newsletter is pulled together by a team led by Jeremy Wagstaff, formerly of the WSJ, BBC and Reuters and Samantha Yap, founder of YAP Global. Other members: Farhan Musa, Rebecca Campbell and Ruby Wu. Many thanks to Joey Woo for production. Any views expressed here are not necessarily those of the writers, YAP Global or its clients.