On The Brink with Castle Island - Weekly News Roundup 1/31/20 (Proof of Stake Tax Policy, Popper on Bitcoin and Nic's Presidential Endorsement) (EP.38)

Episode Date: January 31, 2020

Matt and Nic from Castle Island Ventures review the top stories of the week in the cryptoasset industry. This week's topics include:  - Nic's Presidential Endorsement - Proof of Stake Tax Policy - Popper's NYT Article - Ripple IPO? - Super Bowl Picks and much more news of the week

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 the Bitcoin. Bitcoin. Welcome to On the Brink with Castle Island. I'm Matt Walsh. And I'm Nate Carter. And I've realized that I've been fumbling the entrance to that. So I don't know. We might have to move over to like your idea.

Yeah, I just gave Matt a stern lecture on how he's been like stuttering saying the On the Brink. I can't say the On the Brink podcast with Castle Island. So I think it was just going to be welcome to On the Brink. That's kind of like the precondition of being a podcast or like saying the words. Yeah, it's bad. I don't know what's going on. So anyway, from now on, you know, we're changing things up. It's on the brink.

Welcome to on the brink or from the citadel, right? From the citadel. I don't think people get that. People don't get that. I don't know. That's a great meme. And a reality now, actually, as you will find out in subsequent episodes of this podcast. Oh, right.

That's good tease. Good news. No one knows what you're talking about it. We're not telling you who. But maybe you can guess. I don't know. Well, let's talk about some deals and fundraising as we normally do to start off just two this week. So there's a company called VACT.

This is a commodities post-trade settlement company that uses blockchain. They received a $5 million investment from Saudi Aramco's venture unit. And then there was a deal out of Belgium, a company called Settlement. Get it? Oh, that's actually. It took me a while, actually, to get that. They raised $2 million. from KPV Ventures and Medici Ventures, which is the affiliate of Overstock.

So quick deal week. Moving on to news, there's a couple of personnel stories, a couple of big jobs got filled. Mark Wetgin, who's former chairman of the CFTC, who's also previously an MD at the DTCC. He has taken an EVP job at Miami Exchange Group, building out a new suite of derivative products for, quote, digital securities and crypto assets. So good, see more infrastructure being built there. And then former Coinbase president and COO, Asef Hergey, has joined Figure Technologies as its new president. Figure, for those of you who don't know, is the company that was started by Mike Cagney, the former CEO of SOFI.

And they're doing home equity loans and other products on a blockchain backend. So a couple of interesting personnel stories this week. And then did you see this news about Coinbase custody and Bison Trails joining the Proof-Stake Alliance? Yeah, pretty interesting. So as with many things in crypto, there is a lack of clarity from a regulatory perspective. I mean, and, you know, we make fun of sometimes that the people say, oh, there's no clarity on the securities laws. But like on the tax issue, there really is no clarity. The IRS has been all over the place on this.

And they released some pretty flawed guidance, in my opinion, recently. And, you know, they seem to maybe be walking it back. Like, it's a huge, huge mess. And proof of stake tax issues are something that. people don't really talk about very much because I think, you know, it's, you don't want to admit that like a large fraction of the kind of revenue for these protocols is just going to be siphoned off to the government. But that's what it looks like having talked with a few kind of tax professionals. Currently, the IRS's interpretation seems to be, although we, again, we haven't had clarity on this,

seems to be that your takings in a proof of stake world would be taxes ordinary income, which is kind of disastrous, actually. It means that the protocol has a security budget, but it's leaking, you know, maybe 30% of that to the government. So it's kind of inefficient in that way. That is not a desirable property, that's for sure. And you might ask why this doesn't apply for proof of work. Well, you know, I guess it does, but your A6 are all.

also depreciating as well. So the fact that you have a physical kind of capital good that you can depreciate that sort of offsets the tax set. Right, right. But yeah, so this wouldn't be good for proofs to take chains if the, if this, you know, more onerous tax perspective is opted for. So I guess, you know, we'll see. So it's tax and it's also, I think, whether or not some of these networks would qualify to be securities, which is a big question. That's another one. Yeah. maybe, you know, there's even been a little bit chatter. And the CFTC chairman Heath Tarbert actually alluded to this of a transformation back from commodity to security if these networks were to re-centralize.

So it's a two-way street, apparently. This security to commodity, which they say happened for Ethereum, potentially back to security. And maybe proof of stake is like sufficient to trigger that. in my opinion, probably not. But again, TBD, like, we're kind of an untrammeled, unprecedented territory here. Yeah, I mean, well, it's a new technology. It's not surprising. Yeah.

Actually, one of our guests on an upcoming podcast, I won't disclose, who just yet did find a case study of a non-security becoming a security. Really? So that's pretty interesting. Another really good tease. You're doing a good job teasing. podcast. You have to listen to it now.

So just keep on listening to this podcast. You have to. Subscribe, unsubscribe, resubscribe, and leave a five-star review. We do have some extreme high-quality guests coming. We went to SF. We interviewed a bunch of people. Those would be coming out over the next few weeks. The Andrew Yang story was kind of interesting this week.

He went on Bloomberg and he was asked about the crypto and blockchain industry. And the soundbite was that the U.S. needs to fix it. it's a hodgepodge regulatory policy. And so what he's referencing, of course, is the state-by-state money transmitter licenses that startups, and really a lot of firms, even entrenched firms, have to do in order to operate their businesses at a state level. So I, for one, am in total agreement with the fact that this is a hodge-podge mess. If you think about this from a startup perspective, you know, startups don't have a lot of capital to start with, and you're imposing this really onerous path forward where they have to go state by state, understand the individual nuances,

which are, by the way, changing quite a bit. And some of these states are just impossible to do business with. Historically, I think Wyoming had been one of those states. That has changed. But at one point, I believe that they had a capital requirement if you were operating Bitcoin business, you'd have to have an equal amount of regulatory capital as the amount of deposits you had on board. So it was just not possible.

Hawaii has historically been really hard. New York is a disaster. So I think having some sort of a national framework, whether that be something like a fintech charter or something else, just to unify what the rules of the road are for state money transmission would be very, very helpful for this industry for the startups, but also frankly for the existing firms. I mean, bigger firms in this space also have to go state by state. You have states like New York where it's just unclear sometimes what you even need to do, what you're asking for. you're talking about personal disclosures that are really above and beyond what a typical regulator would ask for. So it's a total mess. I guess the only surprising thing to me here is that like Andrew Yang even knows about it. That's kind of interesting. I haven't heard any other presidential

candidate talking about the industry. Yeah, he's the outlier there. Yang has been quite consistent on this actually. So this isn't the first time that he's advocated for a federal regulation of crypto startups. So I totally agree. I think it's a great policy. I'm, I'm also on record as one of the first members of crypto Twitter to endorse Yang, although I have since rolled, I've withdrawn that endorsement. Big story. The coveted Nick Carter endorsement, yeah. Well, why did he put into this?

Because he endorsed blockchain voting, which is really stupid. So, yeah. But I mean, his Bitcoin commentary is great. So on the same interview with Joe Wisenthal, who is the only good mainstream journalist. on the topic of Bitcoin, the only one. I challenge you to name another. Yeah, he's a really good follow on Twitter as well.

But hold on, let's go back to this. So you withdrew your endorsement over the fact that he likes blockchain voting. That's tough. It doesn't take much to get in your bad time. I'm very fickle, yeah, for sure. And also he posted cringe. You can't post cringe, you know, super lame. But yeah, anyway, so Andrew Yang also said on this interview,

you couldn't stop Bitcoin if you tried. Well, I'd have, I'd be inclined to agree with it. Talk about capitulation. You know, we're already in the, with the five stages of grief. We're in the bargaining stage. Yeah. Pretty cool. Yeah, well, let's see if more candidates talk about it.

I'm sure they won't. But there was also a clip of Representative Emmer in a speech you gave in Congress yesterday saying, it's the same thing. You can't stop Bitcoin. He also recommended the Paul Vigna book, The Age of Cryptocurrency. That's a good book. to his colleagues. Yeah, it's a good book. Yeah.

I mean, I'd actually recommend that book. I think Nathaniel Popper, although he hates Bitcoin, but he wrote a really good book, Digital Gold. I thought that was a good gateway drug for a lot of people. Yeah, you wonder how he can spend like a year researching a book on a thing that he clearly dislikes intensely. Why don't we actually move on to that piece? So Popper wrote a piece.

So Nathaniel Popper, New York Times columnist, he wrote a great book several years ago called Digital Gold. It was really kind of a history of early days of Bitcoin and how it got to where it is. But his thing now is that he just writes these pieces every six, eight weeks just bashing Bitcoin. And it's kind of funny at this point. So he wrote this piece that has a headline on it. Bitcoin has lost steam, but criminals love it. And the net net is that dark marketplaces operate using Bitcoin, which is not super surprising to me.

any disruptive new technology, I think, is going to see adoption from criminals, you know, similar to, I guess you could point to the early days of the internet. We're really big with not just criminals, like fringe elements. So early days of the commercial web, you had pornographers being early adopters, early days of email, you immediately start to see like scams, princes asking for money and things like that. Bitcoin's going to be used for a lot of different things out there. And similar to dollars, some of them are going to be nefarious. I think the overall, there's no data to support an argument that the primary use of Bitcoin is criminal enterprise. I think it's just laughable at this point. In fact, all of the data says the opposite.

And weirdly, he put this, he got this data from chain analysis. You know, I think they're fairly credible. It's showing that, you know, it's about 1% of Bitcoin transactions that are associated with the dark web. And his takeaway from that is criminals love it. So, you know, I'd love to what fraction of cash is used for money laundering. I mean, you see the most prevalent bank note right now is the $100 bill for the first time since, you know, dollars have existed really, as opposed to the dollar bill. So a huge, huge fraction of cash is used for, you know, illicit purposes, storing large amounts of value outside the purview of the state. So you could write the exact same article about cash if you want it. Like, I don't really understand

like his positioning here is so like mendacious. Yeah, and if you ask, you know, if you just look at the criminals who have been caught by the fact that they're using public blockchains, you're talking about, this is like the worst thing to use if you're a criminal because it's traceable on chain. So ask the guy who was behind the BTCE exchange how traceable and how much of a good idea it is to use Bitcoin. I mean, that's how he's now spending his life in jail as a result of being traced on a blockchain. Yeah, I think Popper is actually, I don't think it's strictly malice, but it does seem rather lazy because he's written the same article like five or six times now, like virtually the same article. Yeah. And it's like, where are the good journalists? Where are they? Well, you know what, though?

We just talked about it for five minutes and it was all over Twitter. So maybe he's getting the page. He's living rent free and crypto Twitter's heads. Very sad. Very sad. Well, moving on to a more upbeat topic. So Genesis Capital released their digital asset lending quarterly snapshot for Q4. So this is turning into one of my favorite reports in the industry.

So Michael Morrow was on the podcast to start the week, who's the CEO of Genesis Capital. This is the subsidiary of digital currency group. They have an OTC trading desk and they have a lending desk that lends you Bitcoin and lends you dollars in the inverse, obviously. So I thought there was a few notable insights in this that are worth talking about. So the company has originated $3.1 billion in loans in 2019. 1.1 billion of that was in Q4. And then cash loans, U.S. dollar cash loans, and Bitcoin loans dominate that loan portfolio. So 85.4% of loans are coming from Bitcoin and U.S.D.

And so you might ask, like, why is cash such a big part of this business? And also, maybe we should talk about why you'd borrow Bitcoin in U.S. dollars. But, and actually, why don't we talk about that first? So the primary use case here for borrowing certainly would be to go short on the asset. So borrow the assets go short. There's also a working capital element here where trading firms would just need inventory at certain points. And instead of having that capital tied up in custodial arrangements or on exchanges, they might just need it immediately. So there's a piece of this market that's probably just working capital.

I mean, people always characterize lending as just lending. to short sellers, which is not the case. Like having spot Bitcoin is useful for a whole bunch of things. Right. Now, the dollar part of it is interesting because you can make good rates on dollars. And part of that is because cash is just hard to come by in this market. So the supply of cash in the crypto markets is limited. So it makes it harder to borrow in certain cases.

And as they point out in the report, cash rate increases tend to lead to Bitcoin price increases. So, you know, kind of naturally follows the supply demand relationship there. And a lot of this seems to be stemming from a function of the forward yield curve. So more arbitrage opportunities opening up, desire for leverage from hedge funds and crypto asset miners. So I thought this is really interesting. The capital markets around Bitcoin are maturing really, really rapidly with places like Genesis and BlockFi and you're seeing a more robust lending market emerge. You're also seeing what I would characterize as an insatiable appetite for dollars in the form of stable coins in certain pockets of this market. And I would suspect that some of this is actually

coming internationally where people just want to get like US dollars and stable coins are presenting a pretty interesting value proposition there. That's probably going to be the story of 2020, I think it'd go either way. It depends if the big stable coins can stay outside of the crosshairs, the regulators. We know tether's already in the crosshairs. But if unchecked, I think stable coins will keep growing. Stable coins, you know, this could be the quote unquote killer app of this part of the market, I think. Yeah. Even long before Bitcoin was a twinkle in Satoshi's eye, stable coin entrepreneurs had been trying to create digital, stable, you know, assets in the form of Eagle Liberty Reserve, talked about it on a podcast with Peter McCormack that just came out.

You know, this was considered the Holy Grail. And then Bitcoin came and turned this whole thing upside down by not indexing itself to any sovereign currency. But then it kind of ironically ended up being rails to distribute these fiat denominated digital coins. Kind of an interesting, you know, history rhymes. Well, it's an emergent property here. It's an emergent property that people figured out that, hey, what else could a blockchain do?

And here's the interesting thing. The stable coins built on Bitcoin and later Ethereum, they do 100 times more volume than the pre-Bitcoin, the Liberty Reserves and the E-Gold's did. Well, they have massive distribution here in the fact that there are exchanges, there are custodians already built out for Bitcoin. So the infrastructure that was built for Bitcoin is now being repurposed to move dollars. to move dollars around. That doesn't mean the bitcoins are relevant, but it looks like stable coins have exhibited massive growth and will continue to exhibit massive growth.

And if you look at transactional usage, the velocity of tether is about 45, 50. That means your average tether turns over 45 times in a year. Bitcoin is closer to six. So, you know, people use Bitcoin while storage, but they actually transact in these stable coins. Fascinating kind of development. really. And I, you know, maybe a sign of market maturity. Who knows? I mean, there's definitely

this sort of Damocles hanging over all these stable coins in the form of an enforcement action, though. I hope not. I think that, I think there's a path forward here. I think the big question on some of the stable coins, and I think what you're talking about is just the, uh, within the network. So everyone is onboarding and KYCing onto these networks theoretically, um, these centralized stable coins, but commerce between participants on the network in that stable coin, that is not necessarily being policed and monitored. Not at all. And the issues administrators don't have the ability to, really.

I think there's a question on if they have a need to. I think that the argument would be that, you know, if I hand you a $100 bill, that's not something that we necessarily need to disclose. But if you turn in $10 grand to the bank, you do need to explain where it came from. Right. So I think it's exactly that same concept. However, regulators have historically not believed that, or they believe there's a disinology between physical cash, which you can't transport large amounts of at a distance and digital

cash. So regulators tend to, you know, try and scrutinize digital versions of this more harshly. Although I, you know, I think it would be great if they applied the physical cash standard are two digital cash. I am not sure they're going to, though. Well, I think we had Dan Matosheeski on the podcast, and he talked about, you know, if cash was invented now, it would be illegal. Yeah. Yeah. It's sad and true. It's sad and true. And, you know, even Egold, wasn't regulatory noncompliant until the Patriot Act was passed after 9-11. And that massively increased the scope of Finston and the bank secret.

CECRISy Act. Right. Right. You know, maybe in the next few years, the Bank Secrecy Act will be challenged in the Supreme Court. Maybe. And the U.S. will have a chance to turn back from this path that's going down as a surveillance state. That would be great. Yeah.

Did you see Brad Garlinghouse's comments at Davos? So Brad Garlinghouse is the CEO of Ripple. He said that he made some hints that his firm may be IPOing within the next 12 months. That's common. That's comical. I think that's just catnip for the ripple holders. I mean, I would love to see their public disclosures. Can you imagine? I mean, if you thought that the WeWorks S1 was just fireworks, can you imagine reading the ripple S1? We make all our money selling this token to a bunch of retail users. IPOing is the last thing they'll ever want to do because the scrutiny that comes to the public markets is so significant. Imagine if they had to disclose the fraction of their revenue from the sale of sales. software versus the sale of XRP. But, you know, what if they, they used the S-1 to tell the story of how they discovered XRP?

Yeah. Blue, blue gold, they call it. They just stumble across this token. Gushing out from the fund. We didn't issue it. We didn't issue it in illegal security. We found it. They found it.

Yeah. This joke is never going to get old, by the way. Yeah, it really isn't. You listen to any good podcasts besides ours this week? So I did one with Peter McCormack. It's a history of altcoins. And he put it a rather provocative title about the history of failure in all coins. But actually, I just find outcoins fascinating, especially the early ones.

Because there are so many like interesting experiments and they all like died like miserable deaths for the most part. So so this was a really fun episode. I actually did a lot of research for it more than maybe any other podcast I've done. So you tune into that one. There's some pretty fun alt coins back in the days. Remember prime coin? We talked about it. Yeah.

They actually found a bunch of Cunningham Prime chains, whatever that means. I looked into it and there's no scientific value in that whatsoever. But at least they got to, you know, like virtue signal about doing useful proof of work. What about feather coin? Do you talk about that one? That was a big one. But it was just totally undifferentiated. We tried to focus on the ones that were like the first, for some reason.

So, you know, peer coin, first proof of stake. you know, first out coin was name coin and the first ICO, master coin. So we focused on a lot of the firsts. J.D. Willett. Who's the, J.R. Willett? I want to interview J.R. Willett. Hit him up. Yeah, I think he's on LinkedIn, right? Yeah, he's on LinkedIn.

Yeah, so I want to like dive deeper into the history. We have some really interesting podcasts coming up with the individuals that were involved in the prehistory. It's true. Bitcoin. So I can't wait to do those. But yeah, I want to get J.R. Willett on here. You know, make the case for MasterCoin. Well, I'm looking forward to that.

So that wraps it up for the week. Anything going on this weekend? Yeah, there's a game of football. Yeah, well, whatever. I don't know what we're going to do when the NFL season's over. Like, you know, I saw a tweet from like, maybe he was an Andreessen partner or something, saying that like VCs don't like sports. Oh, we love sports.

I was so indignant about that. This podcast is mostly about sports, and then there's also some crypto. I just don't like it when the Super Bowl comes around. The Patriots aren't in it. It just doesn't feel right. Yeah, you've had a good 20 years. You had a good run. Who you're rooting for?

So maybe you can redeem yourself with your Super Bowl prediction. So I think the 49ers are going to win by two scores. I think the Chiefs are going to win. And I think it's going to be a one score game. Safe pick. Yeah. safe pick. Mahom's pretty good.

He's good. I'm a little bit worried on the football point. There was a rumor coming out of Nashville that Tom Brady was in town looking at private schools yesterday. Brady to the Titans. That cannot happen. Yeah, he posted a picture on Twitter of him like walking down the tunnel. Very cryptic.

What does it mean? I don't know and I don't really like where this is going. It's okay. you'll find someone in the draft. Nope. 30th pick. More than happy with Tom and let's just run it back.

So you guys are going to get to watch Matt as he goes through this process of dissolutionment and despair. We'll see. It'll happen someday, but not this year, hopefully. All right, so Super Bowl picks her in. Hopefully Matt can redeem himself.

He's made some historically terrible predictions on this podcast. Well, I wouldn't even call myself a prognosticator or predictor. I usually just pick the Patriots. Yeah, that's true. Yeah, that's worked historically. Historically has worked. Yeah, like the stock to flow model too. Yeah, well, the price, what's that the rationale there is the precious always goes up. Yeah, the price of Bitcoin according to this model. Right. That's pretty elegant model. Oh, by the way, the FT, the Financial Times, they're not fans Bitcoin. They said today, they came out and said they don't think the halving is going to cause the price of Bitcoin to increase. So, I mean, the very unfortunate situation of being on the same. same side. They're believers in efficient markets, I guess. They do, but they also hate Bitcoin. So, you know, strange bedfellows. Having is coming up. It's something like 99 days away. Yeah.

Yeah, it's not far. Yeah, we're going to have to have a social event or something. Yeah, we'll celebrate. We'll add it to the Bitcoin holiday schedule. We have it. We have a Bitcoin holiday calendar. You can't see it because this is audio, but we do have one. Our friends over at Fidelity made it for us. all right well that's it um thanks for listening everyone and we will catch you on monday with a new episode of on the brink