On The Brink with Castle Island - Weekly News Roundup 11/8 (Tether Fud, Deals and More) (EP.16)

Episode Date: November 8, 2019

Matt and Nic from Castle Island Ventures review the top stories of the week in the cryptoasset industry. This week's topics include:  - Deals - News of the week - Tether Fud - Stablecoins

Brought down by bad mortgage investments, Lehman, which has 25,000 employees, will be liquidated. The federal government loans American International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more to Britain's ailing economy with a new round of quantitative easing. You print a couple trillion dollars, and all of a sudden, people start to worry.

So out of this worry, we have something called a Bitcoin. Bitcoin. Welcome to another episode of On the Brink with Castle Island. I'm Matt Walsh. And I'm Nick Carter. And it's freezing cold outside. Yeah, winter has come to Boston. Yeah.

It's a light news week, too, as well. But we had a big story in the Wall Street Journal that I think we can dig into and spend some time talking about. Yeah, it's our favorite topic. It's Tether and, you know, how Bitcoin, by extension, is a fraud. and a sham and so on. It's really, you know, intellectually stimulating topic. Tether is always on the fud. So this week on the podcast, we had Nick Grossman on Monday. If you missed that, that was a really good conversation. Talked about USB's thesis on the space. Talked about the regulatory environment. Talked about the things that Nick is excited about. So check that one out if you haven't already.

This week in deal. So we always do this segment as a way to highlight some of the companies that are raising money and some of the companies that are presumably going to be hiring. So there's a couple this week. So R-Weave, which is a decentralized storage protocol, they raised $5 million via a token sale to multi-coin, A16Z, and Union Square Ventures. I thought this was kind of an interesting one. So the product might look a little bit similar to Filecoin or Asaya, but it's going after this permanence of storage. So think about the internet way back machine maybe. but not having to rely on a central server. Yeah, I generally think that this is one of the non-monetary use cases of blockchains,

which is actually liable to yield some fruit. Although, I guess with SIA, the data itself is not stored on-chain. SIA is just a way for counterparties to find each other, basically. I think RWeave is more dedicated to, actually storing data or hash is on chain. Right. So, but yeah, it's, it's been around for a long time, the segment at least, and we'll see if Filecoin

is ever able to launch. It's been a long time. Yeah, I think the regulatory environment is really what we need to watch for there, and we'll see. They raised something like $257 million via a simple agreement for future token. So the real question there is, can that transmutate into a non-security. And that was in summer 2017, right? That's right. Yeah, that's right. A long time ago. So the next one, this is an IPO, actually, of a, I guess it's a non-crypto company, but so Silvergate, which is a bank that services 750 companies in the blockchain crypto asset industry. They went

public on the New York Stock Exchange on Thursday. Banking has been one of these areas that has been so difficult if you're a startup in the space. Thinking back to 2013. 1314, it was practically impossible if you had blockchain or crypto in your name to get a bank account. There was very few that were servicing the segment. And some have come in and out. Some banks have come in and out of servicing the segment. But Silvergate, definitely a forward-thinking institution. They have a settlement network for OTC traders and exchanges.

And this is good. This is a good development here. We need more banks. As funny as that sounds. Yeah, there's just a handful in the U.S. Signature, Silvergate. Yeah. Another one's starting with us.

Yeah, Metropolitan was in the business for a while. Silicon Valley Bank was in the business for a while, but it's really Silvergate and signature that are the two big ones right now. It's funny that one of the big barriers to adoption for these crypto companies is the lack of banking services. Yeah, you need the onramps. And so if, you know, a Coinbase or a circle loses banking, then you don't have an on-ramp anymore. So in some ways, it's, well, it is a critical piece of infrastructure. Yeah, people don't tend to know that part of the reason Circle left Bitcoin back in 2015 or 16

was because their banking partners had issues with fraud. Yeah, that's right. So, you know, that's something that we've seen time and time again, sort of this rapid migration to other banks when your bank cannot talk. tolerate the risk. So Coinbase has dealt with this over the years as well. The last deal of the week is E-Toro, which is a brokerage platform. They acquired Delta, which is a crypto portfolio tracking app for a deal that was reportedly $5 million. So it looks to me like a customer acquisition type of a play here for E-Toro. Some of these crypto portfolio tracking apps have a lot

of users and engaged users at that, especially when the price of the crypto assets is going up. You see a lot of people using these type of things. So interesting development. E. Toro really growing out their crypto business unit. Yeah, they love crypto these days, huh? Yeah, that's good. All right, moving on a couple news items. So we talked about this one last week, but it formally came out. So the SEC has reached a settlement with Reggie Militin, the founder of Veritasium. They conducted in the illegal $14.8 million ICO. It looks like they're being forced to pay back $9 million. million dollars in total fines. I don't think we have much to add here. This is a fraudulent project through and through, so it's good to see this one mopped up. Yeah. When I wrote my master's thesis on

crypto corporate governance or lack thereof in early 2017, late 2016, and actually very Tasium was one of the projects I called out as being, at the time I called it a shell token. in that the token had no use whatsoever. It was just a way to raise capital from retail investors. So this is a tiny measure of vindication for me. But, you know, the fewer cycles I can spend thinking about veritacium, I think, the better. Yeah, let's get that one out of our brains forever. So speaking of things that look kind of shady here,

Canadian regulators have seized the assets of an exchange. called the Einstein Exchange, which is, appears to be a collapsing exchange up in Canada. They were not making customer funds available for withdrawal, and it looks like they've been seized. So not your keys, not your crypto. What is it with Canada and Ponzi fractional reserve exchanges? Yeah, Quadriga, right? That was a huge. They just have the worst luck.

Yeah. I think I would say probably most Canadian Bitcoiners bought Bitcoin on Quadriga back in the day. So so many Canadians keep getting affected by these terrible exchanges. Yeah, be careful out there. So proof of keys is coming up pretty soon, right? Proof of keys. My related favorite topic. Yeah, lobbying exchanges to institute proof of reserves.

It'll happen one day. If we yell at them enough, tweet at them, they'll feel the pressure. They'll do it. You know, these exchanges going down, I'd never heard of Einstein exchange. I suspect a lot of people hadn't, but having some sort of a proof over reserves, I think is a really important thing to work towards as an industry. If you just think about the counterparty risk that's tied up in some of these exchanges, think about some of the OTC desks that have exposure, not obviously to Einstein exchange, but to the larger ones.

There's a real domino effect here that I think people would be surprised at how large it could be. So we need to insist on a professionalization of the reserve standard. Yeah. And basically, my view on this is we can either as an industry be proactive and police ourselves and ensure that exchanges are behaving well in terms of keeping a full reserve. Or the regulators will eventually catch wind to the fact that many of these reserves are not fully backed. and we'll get fire and brimstone and chaos. So we have the opportunity here to actually try and behave better collectively

and institute some sort of standard. And if we don't, then we're going to get, you know, kind of a Sodom and Gomorrah firestorm situation. I think longer term, so proof of reserves in the immediate term, definitely. Maybe in the future, proof of reserves with multi-sig, with the actual customer having a key. That's what I want to see. I want to see the custodian with one key,

maybe a second custodian with another. It's a choose-your-own-key scheme type of thing that I really want. But the unfortunate thing is from a regulatory environment. I don't think that that's on the roadmap. I don't think that they understand assets that can be separated via key signature schemes. Yeah. And some people say proof of reserve is a half-me. measure, you know, because really, why should you, how dare you be okay with the fact that people

hold their coins on exchange? But ultimately, that's what many people do. Last week, I tallied up, or two weeks ago, I tallied up all the bitcoins held with custodians. It's an astonishing number. It's something like 20%. So people treat exchanges as banks. So what we're saying is, well, let's acknowledge that reality and let's make these equatechanges. bazae banks, you know, let's hold them slightly more accountable. But yeah, obviously the ultimate end goal is to move fully towards a non-custodial model. Right. All right. Did you read this Ray Dalio piece on LinkedIn? I think crypto Twitter almost broke with how many times it was retweeted. Yeah. So if you haven't read it yet, definitely worth a read. Ray Dalio is getting more and more

apocalyptic in his pronouncements these days. The title of the blog was The World has gone mad and the system is broken. So it's another kind of stark reminder that we're living in totally uncharted waters in terms of central bank driven experimentation. And I don't know about you, but every time I read one of these, I imagine that the last paragraph that he wrote had something to do with now might be a good time to check out, you know, crypto assets or Bitcoin. He's still building his position. His conclusion is by gold, I think. But it would be easy to see how your conclusion from reading that would be to find another gold-like hedge and to buy some of that. Yeah.

He hasn't mentioned Bitcoin yet, but I'd be shocked if he didn't have an opinion on it. Yeah, I think that's right. All right, so why don't we move on to the big gripe that we have of the week? So in the newsletter, we called it another tether piece, aka a University of Texas academic, finds that umbrellas cause rain. And so that was inspired by your tweet. set the stage here. What are we talking about? So let's zoom out a little bit. We'll rewind. I think the thing to remember here is that there's a

huge, huge chasm between practitioners, you know, traders, people that are involved in markets and people that are watching from the sidelines. And in crypto, this chasm is wider and deeper than virtually any. And I would say in traditional finance, that's very much the case. I mean, You have academia, you find it, you know, professors at business schools, and then you have actual traders who have exposure and value risk. And the academia, in my experience, couldn't be more divorced from the reality on the ground. So we'll perface it with that. And then, you know, historically Tether has been this kind of bugbear for Bitcoin critics

who decided that Tether was. completely unbacked. So not that it was only fractionally backed, but there was literally no backing whatsoever behind Tether. And then they also devised all these conspiracies about those supposedly unbacked tether as being used to buy Bitcoin. And so then some academics, I guess, caught wind this conspiracy and decided to perform kind of a data-driven analysis to confirm it, essentially. So I would urge you to read the paper. I think it's still called as Bitcoin really untethered. So it was initially published online in 2018.

It was pretty much ignored. And then it looks like it's been accepted to the Journal of Finance now, which is actually kind of shocking because that's quite a good journal. I mean, if that actually gets published, if this piece of junk actually gets published in that journal, it would be a disgrace. Well, I think what is likely to happen here is the Journal of Finance, you know, they probably don't have crypto natives involved in that journal. And so to them it's okay, probably most of the folks running it, you know, have a pretty

negative opinion of Bitcoin. And so since this confirms their priors, they'd be okay with running this, even though it's shoddy work. I thought Jeremy Aller had a really good take down of the Paul Vigna article in the Wall Street Journal, echoing a lot of the things that you're saying and are about to say. So let's just actually quickly recap. what the paper says basically so they look at the they look at the Bitcoin price between about 2017 early 2018 and then they actually look on-chain they see when tethers are being issued

because you can see everything on-chain and they look at outflows from BitFinex's wallets and so then they basically correlate that with Bitcoin price and they find that at times of high outflows of tethers Bitcoin price subsequently rose and so they they do pretty naive analysis and say, well, if you believe that these tether outflows cause the Bitcoin price to move, that explained something like 60% of the total return of Bitcoin in the period that they looked at. So that's basically the crux of the analysis. And then the other thing they find is that there's kind of, there's a cluster of large addresses that were responsible for lots of the movement in Bitcoin and Tether.

And so then on that basis, they make the inference that there's a single whale, a single entity, which was basically controlling the price of Bitcoin in 2017. Yeah. So let's, I mean, let's dive into the large addresses maybe first. So this is very easily explained by the fact that exchanges use omnibus accounts to actually facilitate these transactions. So anyone that knows anything about how these markets work, which it wouldn't take long to actually understand this. You know, this is basically because the exchanges pool all of customer balances that come on and off the exchange. Yeah, and to an unsophisticated individual looking at on-chain data, it's very easy to find, like, sinister patterns there.

But, yeah, there's pretty simple explanations for the clustering effect. Yeah, so traders were trading. So, you know, like, real big takeaway. And then, you know, the response I have to the paper, having read it and the original, and actually a paper that was critical of this paper, there's basically a few ways that I think the methodology isn't sound. So first of all, it's a short sample period. It's about 400 days. That's really not that long.

It's very easy to take a dataset and approach it with a motivated perspective and find statistical significance. Anybody that's done a stats class knows that the risk involved in evaluating a dataset, is that you basically overfit the model. And so if you're looking to kind of torture a dataset and find a conclusion that you knew you wanted to find, you'll find it. You'll absolutely find it.

And so for the one year period, in the period, Bitcoin was appreciating the entire time. So you could have correlated any number of factors with the returns and found a positive correlation. You could have correlated a time series, which was just days. So that would have been correlated with appreciation

because Bitcoin was going up. So the fact that they took these moments of high on-chain usage and found that Bitcoin returns followed that, that's not very meaningful. I would have liked to see how these correlations held up in a variety of market environments. For instance, throughout all of 2018, right? When tethers were still being issued,

but the price was declining. So that would have really confounded the analysis if they had considered that extra period, but they didn't. So we have actually about five years of data on Tether, but they only considered one year, which is intensely suspicious to me. The second thing has to do with the way that they targeted return periods. So what they did was they looked at the periods of high outflows

from BitFenex Tether wallets and high inflows to those wallets in terms of Bitcoin. And so then they use that to isolate. the 1% of hours in the 400 day period with the highest flow. And then they looked at the returns subsequent to that. But if you looked at on-chain data as much as I have, one thing you notice is that volatility, the volatility flow relationship, they are presuming it goes one way. So they presume that flows lead to volatility, essentially.

But I can tell you they also go the other way. It's not necessarily a case of X causing Y. Why could also be causing X. So in this case, when there's lots of volatility, that also catalyzes wallet address movements on chain. So their sort of presumption here is that the on-chain movement, the issuance of Tether is what caused the returns. But it's also the case that returns cause,

they catalyze lots of on-shin movements because traders see volatility in the market. and then, you know, they want to position themselves and trade and so on. So their methodology just sort of naively picks out high volatile periods by definition. So it's not especially meaningful to me that it just so happened that those periods were high return periods for Bitcoin because they're picking out two variables that are just naturally correlated with each other. And then the last explanation is that traders might have been watching tether movements from

these wallets. which is we actually know that traders do this because there's all these bots on Twitter which say, look, tethers have been issued. So if big traders were watching the issuance of tether and they thought that other traders would trade against that, they might have been incorporating that into their trading style and, you know, making buys when they saw tethers being printed, not because the tethers themselves were influencing the market, but because traders knew that other traders were watching tether. So, you know, there's like plenty of totally plausible explanations here, which the economics didn't consider.

Lastly, the very simple thing that Jerry Maler also said is that traders were buying tether to buy Bitcoin and altcoins. Right. So, you know, it's comical that, you know, this is sort of dismissed as a potential reason here. It's very normal to me that tether issuances would ultimately be followed by Bitcoin and all coin prices, right? because those traders were using Tether to get access to the market in the first place. Yeah, so this is a great point. So let's just think about what the product market fit is for Tether, which, by the way, it has outstanding product market fit in a really good use case.

So, you know, there's no argument that BitFenects into, you know, Tether as well are kind of perceived as these shady, shadowy kind of financial firms and instruments. And that's really a function of the fact that BitFinex is a non-regulated exchange. It's located outside the United States. And it's historically had a really hard time keeping a banking partner. It's lost banking at every single turn, which has forced it to kind of do these janky workarounds, partnerships with access to fiat on ramps that might be a little bit suspicious. And it owns tether, right?

So a tether being like a one-to-one backed stable coin. So that's just setting the stage. Now, what is tether actually being used for? And as far as we can tell, it's being used to evade capital controls in mainland China. And so the main use case seems to be people getting into tether, Chinese people getting into tether as a way to get their money out of China. And onto crypto exchanges. And onto crypto exchanges. So the easiest way being to kind of buy tether and then maybe go buy Bitcoin and, you know,

Patriated somewhere else basically. Yeah. So imagine that you're, so there's definitely the evading capital controls use case, which we know people in some of these states with capital controls, they prefer stable coins to crypto because stable coins are stable, right? Imagine you're a big trader. You're trying to, you know, you're trying to get access to crypto. And you don't want to be exposed to exchange risk for the period that you're sending coins

to an exchange, which, you know, the big. Koinesco period is typically about an hour. So instead of buying Bitcoin on the street from a broker, you buy Tether, then you send that Tether to a crypto to crypto exchange, which only takes crypto deposits. And as many of you will know, Tether is the main kind of reserve currency at many of these crypto to crypto exchanges. I would say alongside Bitcoin. But again, if you're a trader, you'd probably prefer to kind of hold hedged exposure in the form of Tether. So that appears to be the main thing it's used for. I mean, I guess some governments might frown on that,

but it seems to be a totally conventional use case in crypto. And that would explain the kind of price action that these academics found. Yeah, it would explain the price action. I mean, we also know that a lot of OTC brokers, including U.S. OTC brokers, have been using Tether for an awfully long time. And of course, they're kind of migrating to more regulated, options like USDC and the Paxos dollar to some extent for certain counterparties, but it's definitely still in use. And so, you know, all you'd have to do is talk to some practitioners to understand that,

you know, real people are using this stuff and there is a market there. It just seemed highly unlikely to me that this is a total fraud, I guess, is my long and short. Yeah, and I mean, you know, people will probably accuse us of Tether Apology, but like, I think if you wanted to uncover a fraud here, the only way you could really definitely know that it was fully unbacked was if you were BitFinex and you had access to all of their audit trail and everything. You know, keep in mind, this is being sort of negotiated between the New York Attorney General's office and Bitfinex right now. It's definitely clear that at one point, BitFinex, the backing of Tether, dropped to about 74% plus a kind of a subprime loan because one of their counterparties ran off with $850 million.

But so according to that, you know, at one point prior to their counterparty stealing money from them, it was fully backed. And then they obviously did the Leo token sale, raised a billion dollars, and then it was backed again. So I would be shocked, incredibly shocked if it emerged, you know, somehow that the court had been fooled and, you know, all of that evidence was fabricated and so on. that tethers were in fact backed, you know, not at all. That seems completely preposterous to me. You know, regardless of the veracity of whether they're backed or not, looking at returns for Bitcoin is not the way that you would perform that analysis. You would have to ultimately just go to the ground truth there

and find out if there's a bank account with corresponding dollars in them. Totally. I mean, the thing that really irks me about this whole thing is that the fact that it's an academic from a well-respected institution that wrote it, and then the fact that Paul Vigna, who is actually perceived as someone that knows what he's talking about, he's written a couple books about crypto, the fact that he had this in the Wall Street Journal, I can't tell you how many people reached out to me this week that don't know really much about crypto assets, but are really curious with, oh, I saw that the, you know, tether, it's all a scam, blah, blah,

what do you think of this article? It's a really bad thing for the industry. And I mean, it seems very deliberate to me. So I think the reason this is such appealing criticism of Bitcoin for outsiders is because it wraps up the whole 2017 run in a really nice bow. And it says there is one causal factor here. Forget about the adoption, yada, yada. It was actually one malicious trader or market maker that caused the price appreciation. And people love to believe these convenient stories to explain price action, which is why journalists, are always writing headlines about, you know, X causes Bitcoin to appreciate. And so if you can take all of the 2017 appreciation for Bitcoin and you can say, this is the fault of one entity and it was fake, you know, and all of those returns weren't real, that is like amazing catnip for someone that has hated Bitcoin for a long time or been a professional skeptic and so on, because they get to say, oh, those crypto bros, they were totally right. wrong. Like we, you know, the educated outsiders, we knew there was something shady going on.

And we knew that those Bitcoin returns were backed by air. I'll remind you, people also said this about the 2014 bull run. Right. From about 100 bucks to a thousand bucks. They said, yeah, it was just the Willy bot. So, you know, obviously those people were completely rebutted by the subsequent bull run where Bitcoin, you know, far surpassed a thousand dollars. But, It's, you know, this is very common behavior, I would say, by academics and the press to kind of collude to create these narratives about the returns being somehow false. You know, so what I would like to see actually would be for tether to dissolve somehow. So for them to redeem all the outstanding tetheres and honor those obligations and actually just fold. And then at that point, we would know for sure whether Bitcoin's price was, you know, somehow propped up or buoyed.

due to the existence of Tether. I mean, I think that would actually be the most ideal scenario. So, you know, Bipf and X, if you're listening, end the FUD and just dissolve Tether. Well, that's a, I thought you were going to ask for a public apology by, by Paul Vigno. No, I mean, so he knew every journalist that published that story, you know, they knew that it would be absolute cat in it for the kind of Bitcoin skeptic audience. So, you know, they were never going to not publish that story. Yeah. All right. So that's our rant on Tether and BitFinex. My guess is that we'll probably have more of these rants over time.

Yeah, it's the number one stick to bash Bitcoin with. By the way, for anyone that thinks that this somehow vindicates their altcoin relative to Bitcoin, you should actually read the paper. What they find is that the Alcoyne returns are even more affected by, you know, or purportedly affected by the Tether flows. with something like 60% or 65% of the returns being allegedly due to these tether flows. So, and the other interesting thing is, you know, let's say Tether, you know, really has zero dollars backing it. And it's a gigantic fraud. And it goes away next week, you know, it dissolves. It collapses. What that does is probably affects Bitcoin to some degree.

But really what it does is it kills liquidity for these crypto to crypto exchanges that rely on Tether. and it's unclear to me that another stable coin would be able to fill that gap. Yeah, I was having that conversation with someone this week, actually. So if you think about the different categories of stablecoins, so you have the fully backed in regulatory compliant ones like USDC and the Paxos one and the Gemini one. Well, TBD on the regulatory compliant front, I mean, I think they're going to run into a ton of issues, especially as they're plugged into defy now. Well, they're not plugged into defy all of them.

USDC is rampantly used in defy use cases. So I guess it would have to be a KYC type of interaction there. Well, it's not. Well, that's interesting. It did not realize that. Taking time bomb, in my opinion. If you look at what could fill the void for tether, I think it's unlikely that it would be one of these fully KYC'd coins.

It would be more likely to me that it would be something like die, potentially. But there just simply isn't enough dye to go around. You know, keep in mind, dye creation is a function of people's willingness to open CDPs. So they raised the debt ceiling. I think there can be now over 100 million die issued. But keep in mind, Tether is colossal. It's $4.5 billion outstanding. It exists on five or six blockchains. So die probably couldn't fill the gap there either. Right. So die wouldn't be able to fill that gap. So I'm not sure what would be able to fill that gap. Yeah. My guess is it would just be a liquidity crisis

for all those crypto-to-crypto exchanges, especially the unregulated ones that rely on Tether, and it would probably be catastrophic for some of those long-tail coins which only traded those exchanges. So that's the thing that always entertains me when people bash Bitcoin with the Tether stick. Tether going away would be far worse

for all of these long-tail assets, which just trade against Tether. So what do we have going on next week? We've got an interview on Monday with the Erbit guys, right? Yeah, so this is one of my favorite ever podcasts that I've done. So definitely tune in for that one. We have a special Easter egg in there. And so it's with Christian Langallis, better known as Bitcoin Sign Guy,

who now works for Talon, the company that administers Erbit, and Logan Allen, who's an engineer at Talon as well. So if you are curious about Erbit, this is your 101. This is what you tune into to learn about it. We talked about the system architecture objectives. the way it works, really entertaining and deep podcast. I'm glad that it's a 101 because Erbit has been one of the hardest projects for me to actually just grok. So that's why we did the pod. Looking forward to it. All right. So keep an eye out for that next week and have a great

weekend, everyone.