#21 The Context: CBDCs, a Present or a Present Danger?
China, Russia see advantages in digital currencies, but U.S. senators smell a rat
Hi, it's been a few weeks, and we're still picking through the carcass of the Terra collapse. Basic questions, such as do we actually know what happened? And how much, if any, responsibility falls to the industry to make amends to investors? These may be the abiding issues which determine the extent to which DeFi is “De”, and whether DeFi can broaden its user base.
The usual disclaimer: This newsletter collates the main themes and headlines of the week in DeFi/crypto/metaverse/web3/NFT land and tries to provide unbiased context. It’s aimed at anyone who wants to keep an eye on the space but isn’t following it too closely, or is on the hunt for story ideas and angles. It’s put together by a team at YAP (shoutouts to Joey Woo and Delon Chan for their help this week), and doesn’t contain any promotion of our clients (if one is mentioned, we’ll flag that).
Your feedback is as always welcome. Ping us at thecontext@yapglobal.com. Old newsletters can be found here.
[Tl;dr]
One investigation has concluded that Terra wasn't a hacker but a group of well-funded entities pursuing opportunities for arbitrage.
Terra has reinvented itself, partly as an effort to compensate investors. Will it work?
Central bank digital currencies are making inroads, highlighting their potential for governments to jump start economies, but also raising fears of surveillance and control.
[Terra: Do We Really Know What Happened?]
Crypto scams are painful, but because the underlying technology maintains a permanent and public record of transactions, it allows anyone smart enough to a) figure out what happened, and, b) to figure out what is happening sooner rather than later. But the Terra episode has challenged that:
Blockchain analytics platform Nansen has concluded that it may not have been one 'bad actor' (hacker, attacker, the usual words used) deliberately attacking the UST peg, but a small number of "well-funded entities" exploiting arbitrage and other market opportunities. One of these players may have been lender Celsius Network, a crypto marketplace platform, Nansen concluded.
It turns out another 'attack' on Terra had been going on for seven months, draining some $90 million, after exploiting a bug in the code of a smart contract belonging to Mirror, a protocol for on-chain price exposure to real-world assets, according to a team of researchers led by 'FatMan'.
Both of these cases raise troubling questions, the key one being: how much do the creators and managers of protocols, chains, smart contracts, NFTs etc know about what is going on in their network? Should they know? What is their responsibility in policing that network? What is the extent of their financial responsibility to those who lost money as a result of something happening on their network? And what responsibility do they have in informing users if they find something is going on which may be adversely affecting those users? What responsibility do they have to making public any changes they make, such as fixing a vulnerability they discovered?
There are lots of other questions that could be asked as well. But perhaps they all boil down to one: does the De in DeFi mean that once a DeFi product is released, so is any responsibility for its maintenance, integrity and protection on the part of its creators relinquished? In the case of the Mirror hack, which had been going on since October 2021, Mirror's developers quietly fixed the vulnerability, according to Vishal Chawla of The Block, earlier in May, just before the UST stablecoin began to collapse, although he says it's not clear whether the Mirror developers were aware of the exploit at the time.
(Story by Vishal Chawla of The Block)
[Terra: Whales or Minnows?]
And it's worth remembering that the utopian promises of DeFi raised by its supporters and creators bump hard against the reality for the individual investors who lost their savings. The New York Times explored the prevalence of the term DYOR -- do your own research in online groups, and found the term particularly popular among crypto fans. But in the process, it argued, the term had morphed into more of a rallying cry of faith than a sober exhortation to be cautious until the subject had been mastered.
Indeed in the complex and fluid world of DeFi research may not be enough. Stablecoins were for many much more than a meme. Rest of World found that residents of Argentina, Venezuela, Iran, Iraq, and Nigeria, saw stablecoins as a safe haven against their inflationary local currency. They lost everything when Terra crashed. Indeed, DYOR proved to be inadequate: "Valeria watched her savings dwindle to zero, unable to remove the money from the protocols, which had blocked withdrawals. “I invested in a stablecoin that today is worth $0.08,” she told Rest of World. “I feel sickened and helpless.”
The fear, for some, is that the Terra collapse could set crypto back 10 years, by providing governments and traditional finance to make a play for control over digital assets. If that happens, Liam 'Akiba' Wright of CryptoSlate argues, it's likely to be presented as a move to protect the retail investor -- i.e. the minnows. But opposition to crypto also comes from within tech itself, as shown by a letter drawn up by 26 tech experts urging Washington to resist crypto industry’s influence. (See 'Reading' section, below). And the Bank of England has said it is considering taking over collapsed stablecoin cryptocurrencies to avoid a cryptocurrency crash.
For now, the fall of Terra is not the end of stablecoins expanding their reach into the developing world. Tether has just launched a new stablecoin pegged to the Mexican peso to cater to the growth in Latin American crypto investors. The annual inflation rate in Mexico is 7.68 percent, its highest since 2001. And even Terra believes it has a second chance, although its relaunch as LUNA 2.0 got off to a bad start, but has rallied somewhat and is currently trading at about half its launch. The V2 version of Terra does away with the stablecoin but wants to preserve the ecosystem around it.
Indeed, Terra Labs has tried to find ways to compensate users, which is part of the reason behind Version 2. But in a decentralised world, how responsible are the creators for recovering funds? And is that even doable? We tend to forget this happens in the traditional world, if the political will is there, and if there is a clear criminal case of scamming. In the case of Ponzi scammer Bernie Madoff, admitted claims amounted to $18 billion, $14.5 billion of which has been reclaimed through legal action. MetaMask, a popular browser wallet, announced that it had partnered with Asset Reality to give victims of cryptocurrency scams a chance at recovering funds that have been stolen. Users who believe their wallet has been compromised can contact MetaMask who will then investigate and see if they have a worthy case.
(Stories: Oliver Knight of CoinDesk; The Coin Pope of CoinMarketCap; [John Herrman of The New York Times](https://www.nytimes.com/2022/05/29/style/do-your-own-research.html?); Leo Schwartz and AbuBakar Idris of Rest Of World; Liam 'Akiba' Wright of CryptoSlate; Yogita Khatri of The Block)
[CBDCs, crypto, hong bao and bullying]
Digital currencies, whether in the form of crypto or a central-bank managed digital version of the state currency, are demonstrating that necessity is the mother of invention, or at least of adoption. Both China and Russia, for different reasons, are embracing the CBDC. But this has raised another question: are CBDCs a tool of surveillance and national power?
China is using its central bank digital currency (CBDC) to restart the economy. Three Chinese provinces have announced plans to disburse roughly 90 million digital yuan (e-CNY) in “red packets” (hong bao) to restart the country’s economy following multiple Covid-19 lockdowns, according to local media reports.
And according to Forbes Russia, the Russian central bank has brought forward the launch of its digital ruble pilot project, apparently to help shield its economy from Western sanctions. How exactly this might work is not clear, but the assumption is that it could allow Russia to make and receive international payments, skirting around international sanctions. Despite central bank opposition, Russia may also allow cryptocurrencies, likely for similar reasons.
These moves have a political dimension. The U.S. is likely to do whatever it can to ensure that Russia does not use digital currencies, central or otherwise, to bypass sanctions. And there's even opposition to China's adoption of the e-CNY, with U.S. senators arguing in a newly introduced bill to the U.S. Senate looking to ban the use of the digital yuan by U.S. app stores. The thinking according to Senator Cotton is that “The Chinese Communist Party will use its digital currency to control and spy on anyone who uses it. We can’t give China that chance — the United States should reject China’s attempt to undermine our economy at its most basic level.” According to Reuters, the Chinese embassy in Washington dismissed the bill as “another example of the United States wantonly bullying foreign companies by abusing state power on the untenable ground of national security.”
CBDCs may seem like the polar opposite of crypto -- centralised, privacy-lite -- but there is anxiety among investors that they represent a threat to crypto, or at least to its potential as investments. If the good senators of America are right, then the opposite of a CBDC is Web3, with its privacy-preserving values baked in. But both face a more formidable foe: quantum computing. It's not quite there yet, but in theory everything we think of as cryptographically secure (and therefore private, and immutable) could be hacked with a quantum computer. David Chaum, one of the grandfathers of cryptography (and by extension the blockchain), is ready for that day. His xx messenger is a messaging app powered by his quantum-resistant and decentralised network. Chaum believes the threat of quantum computing's decrypting ability is just around the corner. (The interview with Chaum is worth a read. More on Quantum in this Coindesk podcast.)
Talking of grandfathers, Netscape founder Marc Andreessen has shared some lessons from Web1, as paraphrased from an interview with Bankless, are worth a read: Rather than treating [Web3] with skepticism, Marc has invested extensively seeing, for example, NFTs as a potential vehicle for producing “a level of creativity that we never even thought possible.”
(Stories: Andjela Radmilac of CryptoSlate; Oluwapelumi Adejumo of CryptoSlate; Giulia Carbonaro of EuroNews; Alexandra Alper of Reuters; Andjela Radmilac of CryptoSlate; Michael J. Casey and Sheila Warren of CoinDesk; and Jem Khawaja of Bankless)
[Tidbits]
Reliability issues: A software bug downed the Solana blockchain for four hours, according to Decrypt. Solana is a rising competitor to Ethereum, though its currency, SOL, has cooled off after hitting a high of nearly $260 last November. It is now trading at around $40.
VC funding for crypto projects fell in May, but many investors remain bullish (TechCrunch). Quite a dip, but based more on lower valuations, and the largest proportion of funds -- 21% -- are going into blockchain infrastructure, suggesting wiser and more long-term investors are coming to the fore.
The U.S. Department of Justice has charged a former OpenSea executive with NFT insider trading. Nate Chastain, who quit the NFT marketplace after an insider trading scandal in September 2021, was charged in connection with trading on confidential information about which NFTs were about to be featured on the OpenSea homepage. The original sleuthing for this came from a Twitter user called 0xZuwu.eth. More here.
Hotels Using NFTs to Create a StubHub for Lodging Reservations -- this is a better idea than it sounds, potentially: instead of hotels having to shoulder the possibility of guests cancelling rooms at the last minute, those rooms could be securitised as NFTs.
Singapore is exploring using crypto with DBS, JPMorgan and Marketnode. What's interesting about this is that digital assets could be traded on both TradFi and DeFi platforms, or, presumably, between them. More at the Monetary Authority of Singapore website.
[Reading]
Crypto Critics: For more on the 'Crypto Critics' letter (see 'Terra: Whales or Minnows?' above), here's the full letter in Support of Responsible Fintech Policy. There's a discussion about it on Hacker News, a 'debunking' by Preston Byrne, a former blockchain entrepreneur and now a lawyer, and a piece by Stephen Diel, a London-based software engineer, entitled Countering the Crypto Lobbyists.
Scam? What scam? They used my identity to flog a doomed cryptocurrency – and then things got weird. Not much more needs to be said after that headline; Alex Hern is the UK tech editor of The Guardian and is not a fan of crypto, but found himself caught up in it anyway. Worth a read.
Culture Clash: A look at Discord, the "world’s most important financial messenger, and a hotbed for scammers", according to Motherboard's Lorenzo Franceschi-Bicchierai . "Discord chats are not encrypted, public chat histories can be available to anyone who joins a channel, [and] impersonation scams are common," Lorenzo writes. "Attempts by Discord to design specific features for crypto projects have been met with wide backlash from its main user base of gamers, many of whom find crypto reprehensible.