#40 The Context: Blockchain’s other life
Can web3 solve old world problems like securities and cross-border payments?
Hi, hope you’ve had a good week. This 40th edition looks at how the precepts of crypto are finding traction in the TradFi world, surprising given the faddish nature of institutional interest in recent years. We also look at some of the stresses and strains on DeFi post-crash.
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 and doesn’t contain any promotion of our clients (if one is mentioned, we’ll flag that).
This was put together by a team led by founder Samantha Yap, and Jeremy Wagstaff, formerly of the journalism parish. Thanks to Ruby Wu, Sam O’Donohoe, Ewan Brewster, Becky Corbel and Delon Chan for their contributions. Your feedback is as always welcome. Ping us at thecontext@yapglobal.com. Old newsletters can be found here.
We have also recently launched season 2 of our podcast, YAP Cast: The Story of Money. Our host Samantha Yap speaks to different guests across the series to learn more about money as a whole, its past, present and potential future. If you’re joining Samantha on this journey you can find all episodes here.
[tl;dr]
Germany advances with digital securities, but questions remain about blockchain’s wider applicability
Blockwater default, BNB Chain hack highlight continued challenges
Getting Ethereum to scale is going to depend on Layer 2 innovation, says Vitalk Buterin
[The blurring border markers of crypto]
Although it’s rarely covered, there is a surprisingly active financial world where the precepts of crypto are being applied to terrain previously dominated by old-world thinking. We’ve moved beyond the concept stage, and are now seeing some significant initiatives that blur the boundaries between DeFi and TradFi.
Germany, for example, is pressing ahead with 'digitally native electronic securities’. Registration of these securities can be central or decentralised via a blockchain, LBBW and Vontobel have just issued their first digital securities on D7, Deutsche Börse's digital post-trade platform. These are centralised but are constructed using smart contract language, and so in theory could later be decentralised. The point of all this? To speed up both the issuing of structured products and the processing of transactions. Public blockchains are also on the roadmap, suggesting that some of this TradFi innovation could find its way to hook up and merge with DeFi.
Cross-border payments: "The current state of cross-border payments is not fit for the 21st century.” It’s a familiar refrain. But that it's coming from Ravi Menon, managing director of the Monetary Authority of Singapore, is meaningful. Singapore has been focused on trying to use some of the goodness from DeFi to speed up archaic TradFi banking systems. Menon's prescriptions include using private sector blockchains, and central bank digital currencies, or CBDCs, as well as securely-backed stablecoins or tokenised bank deposits issued by private sector players. At the same time it's clear Singapore isn't a fan of retail crypto, but still sees the protocols and consensus mechanisms of DeFi as offering potential solutions for TradFi problems. (Story by Laura Dobberstein of The Register)
What’s proving harder for governments is to encourage a DeFi ecosystem without interfering, or undermining what made their jurisdiction appealing in the first place. Portugal, for example, plans to impose a 28% tax on crypto gains, possibly sparking an exodus of all the crypto migrants attracted by relaxed immigration rules and affordability. A similar tax in India led to just that, with volumes on local exchanges falling and several founders and companies moving to Dubai or setting up arms in the likes of Singapore. That said, steps by the G20 to review crypto regulation framework may leave little wiggle room for DeFi projects, which may find themselves more tightly regulated, wherever they're based. But the borders are still unclear: U.S. lobby group Coin Center has sued the Treasury over its Tornado Cash sanctions, arguing it exceeded its authority. (Stories by Sujith Somraaj and Kate Irwin of Decrypt, Colin Wilhelm of The Block)
And it’s worth being sceptical when you read breathless headlines about mass blockchain adoption by traditional markets, as the FT's George Steer points out, observing Moody’s blockchain blind spot. We're never likely to see ‘mass blockchain adoption as their business model’ by companies for the simple reason a blockchain is usually not the best answer to a problem. But that there's any interest at all is striking and suggests that there's more usage of blockchain-related technologies to solve intractable problems within and between companies and industries to come.
Another problem is making these systems work. If you’re going to tinker with TradFi infrastructure you can’t afford the sort of embarrassing failures and hacks that have littered DeFi. This is why the news that the institutional DLT (decentralised ledger technology) payment platform Finality has delayed its launch for a year is probably not surprising. By then, the argument goes, the payment platform will be joined by other initiatives, including a financial market infrastructure sandbox in the UK, and a DLT pilot in the EU.
Then there are TradFi intermediaries grabbing a slice of the crypto pie. Protecting TradFi institutions and investors from the worst of the wild west that is crypto represents an opportunity for players like Mastercard, who has introduced an effort to allow card issuers -- usually banks -- to protect themselves and their customers from ‘risky and frisky’ transactions. This is a reflection of a turf war between card issuers over crypto. (Story by Simon Sharwood of The Register)
[Risky business highlight we’re not out of the woods]
We’re still in the midst of several trends which cloud the future direction of DeFi: ongoing stress, risk and uncertainty from the initial collapse of players like Terraform Labs etc and the vulnerability of DeFi’s infrastructure to hacks.
DeFi platform TrueFi says that Korea’s Blockwater Technologies had defaulted on a $3.4 million loan, according to Bloomberg. On the surface this is more about CeFi than DeFi, since TrueFi does not use the DeFi-industry-standard over collateralised loan approach, instead lending only to institutions with significant assets and conducting KYC/AML checks. But it still suggests there may still be time bombs ticking away. (Story by Sidhartha Shukla of Bloomberg)
On the other hand, those who benefitted from a rush to 'quality' in the wake of the crash are finding they may be back at square one. Circle's USDC market cap, for example, has dropped below $50B for the first time since Terra's collapse, as investors — no longer fearing a subsequent Tether (USDT) collapse and still harbouring a healthy fear of regulators — have moved away from the USDC stablecoin to others. (Story by Omkar Godbole of CoinDesk)
BNB Chain, a blockchain closely connected with Binance, halted business after a hacker drained an estimated $100M in crypto. Cross-chain hacks are becoming increasingly common, and the Binance Coin hack is a reminder of how weak a link they are. But it's what happened next that is as interesting: things could have been worse if validators hadn't ’sprung into action’, according to Binance's Patrick Hillman. “What we’re seeing here is that as we see more of these attacks on bridges, the communities that rally around these blockchains are getting much better at shutting them down quickly, updating their systems and being able to prevent a worst case scenario from happening,” Hillmann said. But that raises other questions: 26 validators were involved and able to act, suggesting that the BNB chain may not be as decentralised as appears. And, as hackers become more sophisticated, are we relying too heavily on the vigilantism of benign players in the system, rather than the code and structure of the system itself? (Stories by Nelson Wang, Sam Kessler, Danny Nelson and Francisco Velasquez of CoinDesk; Sidhartha Shukla and Anna Irrera of Bloomberg )
And we're not out of the woods. Here's a jaundiced, but not inaccurate, a summary of the state of this year's crypto collapse: Celsius reveals its creditor list, 3AC NFTs, Terra-Luna, Voyager, courtesy of Amy Castor and David Gerard.
[Tidbits]
Scalability is Ethereum’s post-Merge focus, says Vitalik Buterin, and in particular 'layer 2 projects' which use the Ethereum blockchain in an “optimized and more intelligent way.” An example of this is zkSync, which batches transactions, processing a lot of the data off the root chain, which is about to go live. It's currently the sixth largest layer-2 ecosystem. (Stories by Dylan Butts of Forkast and Martin Young of BeInCrypto)
Is there really such a thing as crypto addiction? The FT's Jemima Kelly writes about her visit to a Scottish manor that treats addicts, including those of crypto trading. I think she misses the point, though, when she concludes, “Crypto might be dressed up in memes and Dogecoin T-shirts, but it’s time we started seeing it for what it is: a rather dangerous form of gambling.” It's true that crypto has indeed fuelled a lot of addictive behaviour, but blaming crypto itself is a bit like blaming the stock market or forex market for trading addiction. Casinos certainly prey on addictive instincts, and there are parts of crypto that do that too. But when people talk about ‘crypto’ they are really talking about DeFi, an ecosystem of platforms and protocols, more comparable to the financial networks of TradFi than to the world of gambling.
Paypal’s screwup/U-turn, when it included an update that would allow $2500 to be lifted from their accounts if PayPal ever found them guilty of “sending, posting, or publication of any messages, content, or materials” that “promote misinformation” or “present a risk to user safety or wellbeing”, has highlighted how much control private companies have over transactions passing through their network or funds stored in user accounts. PayPal has since said the policy to fine customers for 'misinformation' was an 'error', but other actions by the company have suggested the company is reacting to a growing burden of KYC and AML requirements. For some this is a human rights issue: “This in itself is a huge blind spot for the financial system. There’s a very strong case to be made that the way democratic governments have gone about enforcing AML legislation is not compatible with human rights at all," writes Isabella Kaminski in The Blind Spot. But it also crystallises a new feature of banking that we're probably not watching closely enough: that any use of traditional financial infrastructure is not without risk. We assume that using such regulated infrastructure is safe, but as Isabella points out, that's simply not the case: look at Wirecard, for example.
[Reading]
Antony Lewis, who is always worth listening to, has had a go at a taxonomy of Metaverses, in what he calls The Virtual Worlds Type Indicator, or Metaverse The whole thing is worth a read, even if Antony steers clear at this point of trying to define what a Metaverse actually is. (Defining it may be hard when there aren't many actually using it: CoinDesk reported that Decentraland has just 38 daily active users)
[Events]
World Blockchain Expo | October 15th 2022 | Dubai UAE
Vietnam Blockchain Summit | October 19th - 20th 2022 | Hanoi, Vietnam
CoinAgenda Global | October 21st - 23rd 2022 | Las Vegas, USA
3rd Blockchain Expo | October 26th - 28th 2022 | Makuhari Messe, Japan
ETH Panama | October 26th - 28th 2022 | Panama City, Panama
ETH Lisbon | October 28th - 30th 2022 | Lisbon, Portugal
Web Summit 2022 | November 1st - 4th 2022 | Lisbon, Portugal
Singapore Fintech Festival | November 2nd - 4th 2022 | Singapore, Singapore
Solana Breakpoint | November 4th - 7th 2022 | Lisbon, Portugal
ETH San Francisco | November 4th - 6th 2022 | San Francisco, USA
[DeFi Definitions]
An occasional segment exploring one particular aspect of DeFi.
This Week: ‘Token Burning’ by Imogen Searra.
In August 2021, Ethereum introduced EIP-1559 to help reduce gas fees, make transactions more efficient, and make Ether more scarce through burning. Token burning refers to the act of removing tokens from a cryptocurrency’s total supply.
When a user was transacting, Ethereum’s base transaction fee would be sent to the network and burnt rather than going to miners’ pockets. Less than a year after EIP-1559 was introduced, $2.9 billion in Ethereum (2.5 million ETH) had been burnt. This was trackable on Watch the Burn which is no longer active post-Merge.
Burning is done by sending the predetermined amount of tokens to a wallet that does not have a known private key and is outside the network.
The wallet, known as a burner or eater address, is only equipped to receive assets. When tokens are sent here, they’re rendered inaccessible. The aim of token burning is to remove them from circulation, altering their availability and impacting their value.
Increasing value is usually the reason why protocols burn tokens. The less supply the token has, the more demand there is, thus, the more value it garners.
This is the theory behind token burning, which is similar to traditional financial companies buying back their shares. By reducing the overall supply of a cryptocurrency, the aim is to drive up the token’s demand.