#42 The Context: Apple approves NFTs but doesn’t budge on cut

NFTs find favour, but their future in the mainstream is uncertain

Oct 27, 2022

Hi there, hope you've all had a good week. We take a peek this week at how NFTs are attracting the attention of some unlikely folks: Reddit users and Apple. One story ends surprisingly well, but the other suggests there will, one day, either be a change of heart or a split in the digital economy.

We also look the continuing dance over DeFi regulation, with one heavy hitter weighing in with suggestions about how DeFi might self-regulate, while regulators duke it out among themselves over who is going to be responsible for corralling the rampaging steers of web3. Oh, and another section looks at how the DeFi Doldrums aren’t as subdued as they might seem.

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 contributions. Your feedback is as always welcome. Ping us at thecontext@yapglobal.com. Old newsletters can be found here.

[tl;dr]

NFTs’ growing pains are a sign of them hitting the mainstream, though not all with the same result
The race is on to self-regulate DeFi ahead of the regulators, but whoever starts the discussion needs thick skin
The image of a crypto winter is misleading. Some are certainly feeling the pain but there are some surprises

[Apple, Redditors, Penguins and NFTs]

NFTs may still be largely digital artwork, but they are no longer the punch line to a bad joke. That's taken some creative marketing, some interesting new collections, and the consideration of an OG tech player called Apple.

We talked in early September about the trend of calling NFTs anything but NFTs, and that seems to have worked well for some: Reddit Avatars are the Trojan Horse of NFTs that are on -boarding millions into Web3, and no one is talking about it. Reddit users, who once hated NFTs, have created some 3 million wallets and launched more than 86,000 NFTs, with a market cap in the region of $100 million.
Aptos, a new layer-1 blockchain, has now launched NFTs, something which will put the well-(VC)funded network to the test. Things seem to be going well, but can the scene compete with Ethereum’s? (Story by Andrew Hayward of Decrypt)
That's not to say NFTs are back to their roaring best. Trading volumes continue to decline compared to Q2, in line with trading volumes of tokens. That has not stopped “certain collections such as Pudgy Penguins, ENS and y00ts rising to prominence, while the launch of Sudoswap and its AMM model for NFTs garnered a lot of excitement and attention”, according to CoinGecko's excellent 2022-Q3 report (more on that below).
Apple, too, is jumping aboard, but only in a very Apple way. On the one hand it has formally approved allowing iOS apps to offer in-app NFT minting, buying and selling, but it has said such transactions must use Apple's rails for in-app commerce, and thereby cough up Apple's 30% cut. Creators are unlikely to be impressed, something noted last month by The Information. (Danny Nelson of CoinDesk, and Aidan Ryan of The Information)
Creators, of course, are key to the success of art-based NFTs. Some $1.8 billion worth of royalties have been paid out to creators of Ethereum-based NFTs. But that concept itself, is under threat, as explained in “NFT Royalties: The $1.8bn Question” by Galaxy researchers Sal Qadir and Gabe Parker.

[DeFi ponders self-regulation, US regulators circle]

Sam Bankman-Fried has sparked debate after proposing a regulatory framework. He described the blueprint as "just a draft”, and his critics have focused on three areas, according to Ben Giove of Bankless: blacklists, KYC and stablecoin regulation. Ben concludes: “[I]]f implemented, several of the proposals in his piece would erode the fundamental principles on which DeFi was built, while running the risk of stifling innovation and driving builders out of the US.”
Everyone agrees regulation is coming, however. And that momentum is building within the U.S.; the differences are mainly over which part of the government will do what. Here are several pieces from The Block on the latest noises from the US: Behnam: 'Just a matter of time' before crypto returns to conditions of spring crash; Yellen doubles down on call for more crypto enforcement; CFTC and SEC chairs may disagree over whether ether is a security. (Stories by Kollen Post and Colin Wilhelm)
The problem with trying to regulate or self-regulate is that the space is dynamic and organic, still developing, evolving and innovating. As cited above, NFTs are mostly still pieces of digital art, but that won’t be the case forever. And Decentralised Autonomous Organizations, or DAOs, are far from the finished product; members of MakerDAO, the largest decentralised finance protocol, have voted to break the DAO up into smaller DAOs. This is not trivial: there are some $2 billion of digital assets in the protocol's treasury, and the vote overruled opposition from a key investor, Andreessen Horowitz, which is ordinarily used to getting its way with its investments. How do you begin to regulate something when it's still exploring uncharted territory?
Back to SBF, there’s another episode he’s involved in which highlights the unfinished nature of DeFi. His FTX has decided to give a ‘one-time’ $6M compensation to victims of a phishing scam that allowed hackers to conduct unauthorised trades on certain FTX users' accounts. “THIS IS NOT A PRECEDENT," he wrote.
But effectively it is, in a decentralised landscape that prides itself on letting the chips fall where they may, where code is law. Indeed, Chainalysis has called this month Hacktober, calculating that with about $3 billion exploited over 125 separate incidents, it has been the biggest month ever for hacking activity. And that was on October 12.
As we’ve discussed before, part of the problem is with the term ‘hacking’. A lot of these cases are less about people breaking into something, and more about someone knowing enough to game the system. And in some cases, openly talking about it: the same person who exploited Mango Market has been bragging after rug-pulling the Mango Inu ‘shitcoin’. Avraham Eisenberg has been 'allowed' to keep $47 million of the $114 million-odd lost in the Mango Market case after a vote by DAO members in which they stipulated that they would not pursue criminal charges against him. And is this a bigger problem? Avraham says Aave could also be vulnerable.
Some moral hazard with your tea, anyone?

[What’s really going on in ‘The Doldrums']

Viewed from one angle, not much has happened in this space in a few months. But that view would be misleading. From another angle, crypto and DeFi have been remarkably resilient.

Spot market: Crypto prices have been becalmed since July, about half their levels in April. Trading is still dominated by Bitcoin and Ethereum, which account for more than half of all trade, although the balance between them has shifted slightly in favour of Ethereum. (Coingecko's Q3 2022 Cryptocurrency Report, always well worth a read)
Research by CryptoSlate indicates that while crypto has been volatile, it's not hugely more so than a lot of fiat currencies. Given one assumes a certain volatility with Bitcoin and Ethereum, that's saying something. “For a global fiat currency to lose 1.37% of its value in 14 days is alarming, but for Bitcoin, a 2.85% decline is mild to what many are used to seeing," writes Liam 'Akiba' Wright of CryptoSlate.
It doesn’t, of course, mean some people aren’t hurting. But they’re not necessarily the people you’d expect: Andreessen Horowitz, Silicon Valley’s ‘crypto bull’, saw its flagship crypto fund lost about 40% of its value in the first half of this year, while ProShares, the first US bitcoin ETF, has seen its share price drop 70% since its launch a year ago. (Stories by Steve Johnson of the Financial Times and Berber Jin of The Wall Street Journal)
DeFi, meanwhile, has quietly recovered somewhat, its market cap rising more than 25% quarter on quarter, but still 70% down from its highs pre-Terra. There’s lots more in the report, and a good summary in the latest newsletter from Apollo Capital.
There's also growing interest in DeFi beyond what some might call “Ponzi farms”, focusing on ‘real yield’, akin to TradFi where income really exceeds expenses. DeFi has preferred terms like ‘yield’ and ‘impermanent loss’, which are seen as, at best, misleading. (Story by Max Parasol, of Cointelegraph. The link to the piece might hit a 404 page; if so, just click on the link to the story lower on the page)

[Reading]

The Only Crypto Story You Need, by Matt Levine. Literally.

[Events]

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[DeFi Definitions]

An occasional segment exploring one particular aspect of DeFi.

This Week: “51% attack” by Otto Jacobsson

The environmental impact of Ethereum’s transition to proof-of-stake has been much highlighted, but less so how the Merge alleviates “51% attacks” and provides other security benefits. A 51% attack happens when actors take over the consensus mechanism of a public blockchain, i.e. controlling more than 50% of the mining hash rate (proof-of-work) or a majority of staked tokens (proof-of-stake) to further their own aims.

One actor being able to manipulate a public blockchain is contrary to the concept of decentralisation and would likely mean less trust in that chain. Even if an attack happens, it is almost impossible to alter the history of the blockchain. However, transactions can be censored or stopped, allowing double-spending.

For the most significant proof-of-work blockchain, Bitcoin, an attacker would need to spend several billions to complete a 51% attack (including buying miners and operating them). Theoretically, a group of existing miners could work together to complete an attack.

After the Merge, you need circa $10bn ETH (ETH price of $1,350 and 14.4m ETH staked) to complete an attack on Ethereum. The price of ETH is likely to increase as an attack progresses, meaning that it gets more and more expensive. Other security features make attacks unlikely, e.g. slashing and validators voting to restore the “original” chain.

A 51% attack is a genuine concern, but a major public blockchain has not been compromised in this way. However, blockchains like Ethereum Classic have suffered 51% attacks in the past.