On The Brink with Castle Island - Weekly Roundup 08/12/22 (Tornado Cash OFAC'd, Dai reconsiders USDC, Merge scheduled) (EP.339)

Episode Date: August 12, 2022

 Matt and Nic return for another week of deals and news. In this episode:  Underwhelming Taproot adoption Tornado Cash gets sanctioned by OFAC Is Tornado a better mixer than coinjoin Why the Tornado Cash sanctioning is the first of its kind How much of the liquidity in Tornado Cash was illicit? Are we at a turning point in financial privacy? Why was Tornado Cash specifically targeted and not other mixers Account-based versus UTXO systems and their effect on your ability to segregate funds Can you really sanction a blockchain or smart contract? The crypto wars of the 90s continue Is Ethereum the biggest crypto platform for privacy today? Is Dai at risk from USDC? The Merge finally gets a launch date BlackRock launches a Bitcoin spot trust Sponsor notes: Subscribe to the Coin Metrics State of the Network newsletter

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 into Britain's ailing economy with a new round of Concentive 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.

of Bitcoin. Bitcoin. Welcome to On the Brink. I'm Matt Walsh. And I'm Nick Carter. This episode is brought to you by Coin Metrics. And here is the Metrics Minute. So today's Metrics Minute, we are looking at Bitcoin. Actually, remember Bitcoin.

So the Taproot upgrade went live last November. Hasn't had a ton of adoption. There's only 11.74,000 Bitcoin stored in Taproot outputs, 0.06% of all Bitcoins. That compares to Segwit, which eventually after a couple of years, around three years, ended up accounting for 80% of all Bitcoin transactions. So definitely a pretty different trajectory in terms of top route outputs versus Segwit. And what do you think that's attributed to us?

I mean, I would say that Segwit, it's not surprising that it got massive adoption because it's essential to the lightning network being possible. But what is taproot essential for that we're not seeing right now? Yeah, taproot didn't have as clear use case envision for it at the time it went in, whereas Segwit very clearly, you know, solved transaction malleability, which made Segwit, which made lightning possible. Taproot does, I think it gets used in the Taro protocol, which is a way to put dollars onto lightning, for instance.

But yeah, there just aren't that many systems which are shovel-ready, which use taproot. So it does kind of raise questions about this sort of system for adding soft forks to Bitcoin. If we spent five years adding this support for taproot and then there wasn't actually a lot of uptake, you know, there might be a disconnect between sort of the development side and then the actual business side of using Bitcoin. I feel like we could do an entire podcast series on Bitcoin core development and what it's like, what it's been like, and where it's going, because it seems like there's a lot in flux. A lot of developers leaving that project right now, unfortunately.

Yeah, there's a lot of attrition. Peter Willa recently, or is it Peter Willett? No. Vladimir Van der Leyen. Yeah, Vladimir. Yeah, Vladimir. But Peter, Peter also stepped back. I don't think he's fully going away, but he gave away his, did he give away his commit access?

That sounds right. Yeah. Matt Krollo, of course, had a thread last week decrying some of the fundamentalist aspects of Bitcoin culture, which... Oh, sounds familiar. Sounds familiar. I'm no stranger to that. And, yeah, Vlad van der Leyen basically said on Twitter, Bitcoin isn't really that rewarding for him anymore. And he's probably going to move on to the next challenge soon. So actually, pretty like, if you look carefully, you see there's a lot of attrition in Bitcoin Core. I think they're just going to work on other projects, right? Like grin and... Primecoin, some of the stalwart projects. I mean, it is a tough development environment because things move so slowly, maybe by design. But, you know, it's got to be pretty unrewarding if virtually nothing ever changes.

Yeah, I mean, if you just hang out on Bitcoin Twitter, you would be very bearish on the project generally. It's a good thing. Some of these institutional allocators over at BlackRock aren't hanging out on Bitcoin Twitter because I don't know if they would like what they're seeing. Yeah. If that's your standard for a project is the sort of average intellectual caliber of the supporters on Twitter, then Bitcoin would be in a tough spot. So yeah, thankfully the world of Bitcoiners is much broader. Exactly, exactly.

All right, so that was the Metrics Minute. Good job over at Coin Metrics. Get us the Metrics Minute a little bit earlier is what I would say. Yeah, you know, one piece of feedback I would like to pass along to my colleagues at Coin Metrics is if you get me the metrics minute before we record the podcast. That would be really greatly desirable. Because otherwise, I have to just add a little bit. Yeah, just, you know, we don't ask for much. That was the metrics minute. All right, let's hop into some deals of the week here. I love starting with Castle Island deals. So the first one up is Ancible Labs. This is a payments company,

payments platform. Two veterans of Visa, really excited to back this company. They've raised $7 million. and around led by archetype. We participated in it along with A partners, ARCA, ENIAC, and others. So congrats to the Ancibel team. So Ancibel is such an interesting deal because they are focusing on seamless off-ramp from crypto into Fiat, right? So a lot of people focus on-ramp.

It's like, okay, how do we get people to get their hands on cryptocurrency if they have Fiat? Ancibel is reversing that. They're like, actually, there's a lot of people that have crypto or crypto assets, NFTs, et cetera, that's where they start. And then they want to go to Fiat. It is a foreign concept to want to like sell a cryptocurrency. It's surprising the industry never really, you know, built that yet.

We did, yeah, we thought about the one direction we just didn't even ever. It didn't occur to us that you might want to go the other way. The thing is, if you're an on-ramp business, you kind of sort of assume that someone already, you know, has an exchange account and so they can go in and out, right? But if someone is receiving cryptocurrency in exchange for services rendered, you know, they sold an NFT, for instance, or they just got paid in a stablecoin, for instance, how do they go back to Fiat from scratch, not having an exchange account? So now that the crypto economy is actually more vibrant and more people are actually receiving crypto assets in the course of their everyday lives, you know,

Ancible contemplates, how do we go back to Fiat? It's kind of clever because we never had to think about that before. Yeah, it's so funny. This is the category that just seems very obvious, but hadn't existed. So really excited about the Ansible team. Next one up is Ladis Capital. This is a crypto fund. They have raised $60 million for their second fund.

Next up we have Creator Dow, which is unsurprisingly a Dow focused on content creators. They raised 20 million from Andreessen, initialized, and others. Next up is Merkel Science. This is a blockchain analytics company. They have bolted on $19 million as an extension to their $24 million series A round of financing. Blockchain analytics will be a busy category. Certainly a lot going on in the OFAC world that we'll get into. Oh, yeah.

Next up, this one wins my vote for Best Name of the Week. Vespian Energy, which is a... a renewable energy company converting landfill methane gas to Bitcoin. There raised $4.3 million from Polychain Capital. Now, I'm guessing you probably don't know the reference here. I was just going to say why is that your favorite deal? Because I see one called Pignata coming up, and that's my favorite. No, there's some other good names, but this is a reference to Starcraft, actually.

Vespian gas is sort of one of the... resources, which is you often, the game will basically berate you that you don't have enough. I see. I'm embarrassed to say that I just finally started reading Dune. I've never read it before. Wow. And there's an unbelievable amount of naming in the asset management world tied to that book. A treaties, for one, the big fund based in Boston, had no idea where that name came from.

Tons of crypto startups named after Dune concepts. as well. But yeah, isn't it cool when you finally read like a, you know, something from popular culture and you realize, like, you read a great work of literature and you realize how many things in popular culture reference that thing that you just never knew. Yeah, it's really, it's cool. And I wonder how long it takes to start getting things named after you. Like, will there be three body problem names popping up? Those already, they already are in the cryptos space. Yeah, like, um, Solaris is it? Silaris. Tri-Solaris is I think the name of, the solar system of the antagonists. No spoilers. There's also, it's not photons, but it's like,

oh, yes. What are they called the particles that are entangled that the antagonists used to spy on earth? And the ones that sort of block your brain from fully functioning. Something like that. I feel like we've had those on Earth for a long time. We just don't know it. Great series. By the end of it, I just didn't understand what was going on, though. So the first couple books really were great. The third one was a little out there. It got really psychedelic. All right.

Well, next up, we have another well-named company, my opinion, Kashmir, a Solana Enterprise Wallet System. They raised $3 million from Coinbase, FBG, and Y Combinator. Next is my pick for name of the week, Pignata. This is an NFT Media Management platform. They raised $21.5 million from Greylock, Pantera, Volt, and others. Then we've got Unstoppable Finance, a DeFi Wallet Company. The stoppability of Defi put to the test this week, I'll get into that.

They raised $12.8 million from Lightspeed, Rockaway Blockchain Fund, and Fabric Ventures. And the last one is Injective. This is a protocol. It's focused on Defi. They raised $40 million from Jump Crypto and Brevin Howard Digital. So those are the deals of the week. Still a lot of deals happening. Oh, totally.

So there was basically one news item this week, which puts everything else into perspective, I think. Reddit Community Points. Yeah, right. They're live on Arbitrum, I think. Is that right? Yeah, that's, that is. It's in the news. Reddit finally launched their community point system on Arbitrum.

If I was still a Redditer, I would be totally psyched. I tried to go on to Reddit today. I don't have a user account, and it forced me to set up a user account to actually get onto the system. All I wanted to know was how do I fix my Lenovo laptop, which keeps on breaking. And there was a thread. And I couldn't even read it, which I don't remember it being like that. That's tough. Yeah, it's more of a walled garden these days.

Yeah, I don't like that. I don't like that. But it looks like I'll get some community points if I sign up for it. So I love community points. So tornado cash. I mean, that's the story. That was the story. And now we can move on to the next one.

All right. All right. Why don't you tee up what happened here? All right. So OFAC, the Office of Foreign Asset Control, which is basically an entity you'd not want to mess with under any circumstances. Subsidiary of the Treasury Department. Yeah, of all the government agencies, they're sort of like one of the worst ones to be on the wrong side of. They sanctioned a contract on Ethereum, Tornado Cash, which is a zero-knowledge-fied mixer, effectively.

So you deposit funds into it. unknown what happens inside of it, right? Think of it like the shielded pool on Cache, and then you withdraw funds. And so the deposits and the withdraws are lit, but if you're doing them in denominations of, say, 10 ether or whatever, it's impossible to associate a withdrawal with a deposit. And so that makes it a fairly good mixer,

I would say arguably actually better than any of the coin join systems where there's a lot of ways to shoot yourself in the foot and basically end up associating your deposit with your withdrawal. So Tornado Cash was immensely popular. Hundreds of millions of value inside of the pool in Eath and other assets and billions in terms of turnover. So the entire contract was basically sanctioned by OFAC. Really unclear what U.S. citizens can do. if they have funds inside the contract.

Unclear what happens if you receive funds from the contract, which started happening at scale, kind of new terrain because normally OFAC sanctions individuals or entities. This, as far as I know, is the first time they've actually sanctioned a pool of liquidity on a public blockchain that's not actually really owned or controlled by anyone. And it immediately just sort of caused chaos in the defy space. Yeah, so that's a good. summary. So I'll add a little bit to that. And so the Treasury Department's Office of Foreign

Asset Control has sanctioned 38 cryptocurrency wallet addresses. They specifically call out Tornado's role in laundering over $455 million worth of cryptocurrency in the Axi Infinity Ronan Bridge hack that the North Korean-affiliated hacking group, Lazarus Group, was involved in. Tornado Cash also played a role in the Harmony Bridge attack, the Nomad Bridge attack. So it's a popular public smart contract system for the North Korean government. And so I guess the first take here is just that this is part of a much broader than crypto enforcement targeting cutting off North Korea's access to capital, to outside capital. It seems like that's why this is happening. Blinken, the Secretary of State had a tweet, which he later deleted, that effectively said that North Korea runs tornado cash.

Which is not true as far. It's not true. There's sort of known individuals that I don't believe in North Korea that run it. Chainalysis has a breakdown here. So there's, I mean, there's an awful lot, and we'll get into this, there's an awful lot of legitimate reasons why you would want transaction privacy on public blockchains that have nothing to do with North Korea or stolen funds. something like 20% of all funds flowing through tornado can be tied to sanctioned addresses.

I believe another 10% would be stolen funds. So there is a good deal of illicit activity on tornado cash, but not the majority. What else would you add to that? Yeah, so actually Alex Svehnevich from Nansen estimated about 35% of funds. in tornado at the time of the sanctioning were illicit, whether coming from known sanctioned entities or from hacks. I mean, it was certainly a popular place to put your funds for hacks on, but it does raise an interesting question because basically it just gives you financial privacy.

And Vitalik was a known user. I think there was a use case where people were putting funds in tornado cash to make donations to folks in the Ukraine. So there's always reasons why you'd want financial privacy. It's the same reason you can't just read anybody's bank's name. But, you know, people generally prefer to have their financial matters be private. I believe there is a payroll use case. You know, you're a corporation.

You want to pay your staff, but you maybe don't want your staff to know precisely what everybody is getting paid, you know, things like that. Maybe you don't associate. corporate address with your own corporate entity, right? There's plenty of innocuous reasons why privacy is a normal thing you'd want. In this case, it was very clear that North Korean entities specifically were performing a lot of these high profile

defy hacks and then immediately washing the funds through tornado cash. And as we just said, a lot of the funds were connected to that. So a large percentage of the funds. So the question is, you know, is there some tipping point, you know, effectively? Is there a de facto tipping point where a contract like this at some threshold of illicit liquidity becomes primarily an illicit contract? Because it seems like that must be the case, right? Like if it was half a percent,

maybe that isn't sufficient to catalyze OFAC into action. Yeah, that's an interesting question. A couple other things here. So if you were found to be doing a trend, transaction with someone who's on a sanctions list, an SDN list. There's some pretty serious penalties associated with that. The charges of willfully avoiding U.S. sanctions here can bring up to 30 years in prison. So you talk about OFAC being an agency that you don't want to mess with. 30 years in prison is no joke. We're not talking about an SEC fine, for instance. And so you're going to see folks take this very seriously. Circle immediately blacklisted all of these addresses, for instance, for USC.

What's interesting is that the definition of doing a transaction with someone on the SDN list for Tornado gets really complicated because let's say that someone sends you funds that cycled through Tornado cash. They effectively went from those smart contracts into your address. What do you do with them? Technically, you just got airdropped a criminal offense that could carry 30 years in jail. And so there's an incident right now where someone is dusting the accounts of a lot of celebrities like late night talk show hosts and things like that. There's not a lot of case law

to support what you would do. I will say that if you're a professional investor and you have a custodian, you ought to have already known about this. And so firms like Fidelity Digital Assets, for instance, have a policy on what they do with air dropped assets that come from locations that you don't know about. And certainly like a Castle Island account at Fidelity, if it were to get dropped ETH from one of these contract addresses, we would not be able to take possession of that. Fidelity would have a process to dispose of that and report it to the regulator. If your custodian does not have that process in place, that's a red flag. That should be something that you're doing as part of a non-boarding diligence process,

dealing with any crypto intermediary, really. So things start to get really complicated here in terms of just the tactical, what would you do if type of scenarios here around this OFAC issue? Yeah, it's an interesting one because a bunch of like crypto, Twitter personalities and entrepreneurs and then regular old famous people and entities are getting airdrop 0.1E from this contract. Is the US government really going to determine that strict liability for all these people who are obviously not complicit in the fact that they received these, they effectively received this cash against their will?

No, like something will be figured out, you know. it's just that the system isn't compatible with this model of push payments. It assumes that it's the more popular pull payments model. There is an interesting nuance here in terms of UTXO versus account-based systems, right? So if it was a UTXO system, you could actually, like Bitcoin, right? Think of a UTXO model like a bunch of different cups with different amounts of water in them. And together, all of that water is your Bitcoin. effectively receiving a transaction just means you get a new cup with a new quantity of water in it.

You could always just put that off to the side and be like, you can inform your wallet software if it's sophisticated. I'm not touching this cup. It's tainted. You leave it over there. And I'm going to transact with all these other remaining cups and you start pouring them, you know, things like that. Ethereum is an account model. So you just have the one account, right? You have whatever, Brian Armstrong.eath. And you receive a transaction. that's basically commingled, right? It's just that the quantity of ether you own is incremented. So that ether you receive is immediately commingled with the remainder of your ether. There's no way to actually segregate the illicit ether you've received from tornado cash

off into a different account without effectively mixing it all together. So that's an interesting nuance there of the account-based versus UTXO-based system. Clearly the government's going to have to figure out or at least clarify what do you do if you're inadvertently sent some funds that you just don't want. Well, if it's happened to you,

listening to this podcast, I sure as hell would not spend it. I would not touch it for now. That's my point is you have no way of identifying that specific quantity of ETH. Right. I guess what I'm saying is that if you get any amount, I would make sure that you bring that balance down to as low as whatever that amount is.

If you're moving funds out of that wallet, I would not be, I would not be trying to use any of the money. Then it depends on like your accounting methodology. Like for illicit funds, you're using a FIFO system or like, you know. Yeah, LIFO or maybe just a specific lot method or something, which I guess you can't do. It's weird, yeah, because if you, if it means that your account is effectively frozen until you can get a letter. from a lawyer saying it's not my client's fault, obviously. Now you've invented an extremely effective griefing method to screw with people and immobilize their funds if they're publicly known. So I guess just backing up and going bigger picture here, there's two ways to look at this.

One is that this is a massive sweeping action against privacy and that there's massive First Amendment issues here because this is a neutral piece of technology. It's not only. by anyone. The technology does not have a political standpoint. And effectively, we are, as a country, masking people's ability to have private transactions for plenty of permissible legal reasons, which you outline some of the payroll use cases, which are no-brainer use cases here. The other side of this is that it appears that this is a way that the North Korean government is financing their repressive regime. And so it seems like this is an effective. effective way to prevent money from going into that system. And what would happen if they keep on doing

this and they finance a nuclear attack on the United States or something like that? So it's a very sticky issue, but I think this is going to be one that plays out in a court of law. What's your general sense of the stakes here? Yeah, I mean, look, the question is, are we a nation that respects individual liberty and financial privacy, or are we not? You know, if we're a totalizing state like China, then nobody has any presumption of privacy whatsoever, and everything is transparent to the government. That's not the America I'd like to live in, so obviously there's some ways to go after crime through the financial realm, but that doesn't mean it's worth obliterating everyone's privacy. I'll give you another example. North Korea historically made money by counterfeiting U.S.

dollars. I don't know if they still do, but that used to be one of their ways to fund themselves. We didn't abolish cash because some of the dollars in circulation were derived from North Korean counterfeit presses. Right. So you're really throwing the baby out with the bathwater here. And if my prediction would be, you know, in the next 10 years or so, we are going to demand financial privacy because it's just a fundamental right. Privacy is a fundamental right. There is no presumption that the government has the right to peek into every single transaction, every behavior you're undertaking.

Obviously, that right has been eroded, especially since most of finance got digitized, since the 70s, since the Bank Secrecy Act, since the third-party doctrine was instituted. But I see it as a pendulum swing. I think it's going to swing back. And this is going to be one of those key wedge issues. Does it even make sense for the government to sanction a set of blockchain address? addresses, which can't really contest the sanctioning, right? Can Ethereum itself hire a lawyer and contest this? No. Can I, if I were individually sanctioned, could I ask the government for a

basis and actually contest that in a court of law? I probably could. But here, there's no even, is there even a way for the affected individuals to, which is thousands of people, to contest the sanctioning. You know, it seems like this is also, in my opinion, a violation of due process because it's a very sweeping action. It's indiscriminate. It's against many, many individuals, many of them with perfectly licit use cases and intentions and no apparent way to push back against it. So I would agree with that. And what I would say is that this has been happening way before blockchains. And so if you think back to the privacy wars and the crypto wars of the late 1990s, which I think we're really well recounted in a book called Crypto by an author

named Stephen Levy, which came out in 2002 well before blockchains, talking about the birth of PGP and SSL and some of these core primitives that we just take for granted on the internet today and how you have transaction privacy. These were very controversial topics at the time, and there was a view that the federal government should have full oversight over cryptography, which is just such a foreign concept to us now because we live in a world where you go on HTPS instead of HTTP and you have the ability to use a credit card online. But you wouldn't have those fundamental abilities to use the commercial web in the same way you use it today if some of the proponents of anti-privacy were actually successful in the late 1990s.

And that book really goes into detail on it. So I think it's an extension of that. I mean, we're talking about do you want to live in a world where you can't use HTTPS? and everything you do on a browser is public. And we decided as a society that we wanted to have privacy on the internet. And we want to give folks the ability to do that. And this is an extension. This is a logical progression of the internet, sending value peer to peer, same as cash, same as what you said.

And so I think this can be broadly framed if you just zoom out as just the crypto war is continuing. But now there are blockchains involved. Yeah. And I can't decide if encryption is a bigger battle than financial privacy. Maybe just because I'm a finance bro, but I think the financial realm is the most important battle here. I mean, frankly, encryption also pertain to finance because internet commerce is only possible with encryption. But, yeah, I mean, if you don't have financial privacy, you end up with a system where the government has just insight into every kind of transaction, everyone's behavior completely. It's just not, it doesn't comport with American values.

You know, so it's interesting that the biggest platform for private transactions is built on Ethereum and it's not built on Bitcoin. It isn't Zcash. It's not Monaro. It's not the privacy coins and it's not, you know, it's not the original coin, Bitcoin. What do you make of this? I mean, does this just show that the product market fit for Ethereum is so large that a bunch of stuff is moving over that chain? Yeah, so there's been some interesting discussion about it. So one school thought says, well, this proves that Ethereum is actually the cutting edge here

because that is the thing. If you're, you know, getting the flack, that means you're over the target, right? So why is the U.S. government not gone aggressively after Monero or Zcash or CoinJoin, which is the Bitcoin non-custodial tumblers, which are different though? maybe they sort of have in some ways here and there, but this is a broadside attack on tornado cash. And it's because tornado cash is doing the most volume, right? And, you know, by far, maybe more than all of the Bitcoin tumblers combined,

have done all the coin join systems. And that kind of shows where the puck is going in terms of real world usage, right? you know, maybe two, three years ago, you could say, well, Bitcoin still dominates in terms of darknet marketplaces and, you know, various coin join services. But that just probably isn't the case today. Tornado Cash is also arguably easier to use system. It's harder to shoot yourself in the foot and to de-anonymize yourself because it really is, if you trust the sort of zero knowledge magic, it really is pretty opaque what's happening inside the contract, as opposed to world pool or, um, you know, wasabi or samurai where there's space, unless you're like an expert

in this stuff, you're most likely going to associate your inbound transaction with your outbound transaction. So to me, the fact that the government's focusing on Ethereum based smart contract shows they're actually dominating in terms of liquidity and usage. So that's kind of a changing of the guard that you should pay attention to. The other thing is world pool is still operating. It actually had its biggest volume day ever after it was sanctioned because the world is actually bigger than the United States, believe it or not. And so it wasn't shut down.

You could have probably shut down the Bitcoin. coin-based tumblers because they are using a central coordinator. So you go after that NAD. And the coordinator matches up the inputs and the outputs, basically. Tornado cash exists on a blockchain autonomously. You can really inhibit U.S. NAD's ability to participate, but you can't actually shut it down and it is still going, which kind of shows the strength of that model. Yeah, so two reactions to that point on Ethereum versus other chains. One is that we found information in this disclosure around the Dow hack, the chain analysis had the ability to de-anonymize certain types of coin joins that were happening on the Bitcoin network. And so maybe it is

that the U.S. government has the ability to actually see into some of these transactions on other networks in a way that they don't on tornado. And so I had to take this step. And then number two is, to your point on transaction volume, there's just more assets that live on top of Ethereum. So there's more stuff to steal. And so North Korea is more active in stealing ERC20 tokens and all sorts of other stuff that's living on bridges and decentralized protocols and centralized protocols. So there's just more stuff going on on the chain. So it's not surprising that, you know, that's where you have to tumble things on the native chain that you steal the funds, right? Yeah. So I don't think it makes sense for Bitcoiners to say I told you still on this. First of all, it just shows that Ethereum contracts

are where the real world kind of utilities. occurring for a start. And they've eclipsed all the coin join systems because they're simpler and arguably better. Second of all, this shows that Ethereum is on the cutting edge in terms of being cypherpunky, right? Yeah. Bitcoiners love to consider themselves the cypherpunks and so on, but do you see Bitcoiners going toe to toe with the government running a contract that's still doing volume, even though it's been sanctioned by the Office of Foreign Assets Control? Like, this isn't just rainbows and kumbaya anymore. This is like serious business. This is fighting for one of the most critical battles of the generation, which is financial privacy and pushing

the envelope. I mean, we'll get a constitutional outcome here most likely, in my opinion, I think it might take time. It'll probably say something like, yeah, the government can't just blanket sanction a blockchain contract. That's pretty interesting. Front lines is not necessarily, the foot soldiers aren't necessarily bit corners. At the same time, Bitcoiners can say I told you so on a couple of factors, which is Ethereum infrastructure is very centralized around infura and alchemy. And they turned them, they turned off the front end. You know, they immediately basically rolled over and turned off the ability to interact through those infrastructure providers, interact with tornado cash. And that was a vulnerability or weakness Bitcoin has been talking about for a long time.

Running an Ethereum full node is kind of pretty hard. and so if everybody was able to do that, everybody would have been able to use tornado directly, but because there's this intermediary layer because running Ethereum full node is relatively hard, that centralizing force meant that it was easier, that it was basically a more brittle system. So, you know, solutions to that can be built.

But, you know, I would say that sort of vindicates like the Bitcoin attitude about the cost of full node really mattering, and I expect that Ethereum will update their thinking on that. The other thing is that we haven't talked about the role of USC, which is, USC froze their liquidity in tornado cash almost immediately, as I kind of expect them to do as a U.S. organization. They didn't really have a choice. It was a small amount of liquidity in the pool.

But that kind of showed where their heads at in terms of compliance with these kinds of things. Not surprise, to be clear. An interesting case study would be like, what if Pakistan or Indonesia or, you know, the UAE or Rwanda asked them to freeze liquidity? You know, where is the line? You know, do they comply because the U.S. entity? Do they comply with that foreign governments ask? That would be interesting to see. But U.S.D.C. immediately froze their liquidity. And U.S.D.C. is the defy liquidity dollar sable coin. It comprises a big part of the maker protocol.

Yeah, I mean, and die is basically wrapped USDC, right? So now we have this like whole set of other crises within Defi where people are thinking themselves, huh? So USDC can sort of immediately blacklist this contract, but USDC is the lifeblood of defy for better, for worse, including via die. So obviously people were sort of aware of this like you'd people like Amin Soleimani talking about this for years and years. But, you know, Dai went in a certain direction of being largely backed by USDA so it could hold the peg. And now that's sort of a really interesting challenge. If we're going to deal with a more hostile regulatory environment, putting pressure on USC, does that just defang a large fraction of all defy liquidity and potentially expose it

to being frozen completely? And there's some rumblings today as we're taping this that makers look there's some proposals being floated to effectively get off of a USDA backing, which my mind would be a really dangerous place to be, just from a stability of the system perspective. But maybe that's the direction some of the community wants to go. Yeah, I mean, I always actually thought that removing single collateral die, which just used to be called die, which was the die backed by ether, going to multi-collateral die, including USDC and even then real world assets, was a mistake.

but the reason they did that was because it was very hard to hold Dye to the peg without establishing a negative interest rate which you probably don't want to do for a stable coin right you don't want to punish people for holding it an example of a stable coin that does do that is Rye the stable coin created by reflexor labs but it didn't get traction I think probably because there's a negative interest rate associated when it trades above the peg and so if Dye die swelled to an enormous size. I mean, in the billions, I think it might have even eclipsed 10 billion at one point. If you insist that the collateral back and die must be Ethereum,

you know, an uncensurable underlying collateral, you're going to have those issues with the peg management all over again, which is the reason they went to these other types of collateral. And you're probably going to have to impose a negative interest rate, which undermines a lot of the the reason people like die, basically. So it actually is really stuck in a tough position right now. Yeah. So the vulnerabilities in DFI, I think, will be the second order effect to watch here.

I'd expect that we'll see this play out here over the coming weeks, just from a tactical perspective, and there'll be more stories around the clarity or lack of clarity around receiving some of these funds. But we spent a lot of time on it because I think it's one of the biggest stories in the crypto industry. for the past year actually. Yeah, I mean, it's the biggest attack on D5 we've ever seen, in my opinion, directly from

the US government. It tells us a lot. It exposes a lot of the cracks in Ethereum, which if you're a Bitcoin or you laugh at, if you're an Ethereum, you're like, okay, how do we fix this? Right. So we learn a lot about that. It shows us a lot about some of the issues in DFI. I mean, it's just a fact.

And then it's, I think, potentially legally, really interesting case. So to me, one of the other things. most fascinating developments to date in crypto. So moving on, the Ethereum network, it's getting closer to the merge. So there's a date, it looks like, and the third and final TestNet merge was successful this past week. So it looks like this upgrade could be as soon as September here, if nothing goes wrong. Yeah, what is it, September 16th, something like that?

That's right. Is that a third? It's going to be like the Bitcoin having where there are parties and stuff, probably, right? I mean, the Ethereum issuance is declining by more. than the last having would have done for Bitcoin. So the various blogs out there call it what a triple happening? It's just the ultrasound money. It's just becoming more ultrasound, you know?

So it's triple, I think, because A, the inflation rate is just coming down as it moves to a per mistake model. B, there's the element of the fee burn. So you burn some of the fees and so you have more deflation from that. And then C, a lot of the steak ether is also locked up for a long time. So certainly if you believe in the halving stuff, you probably believe in the merge. If you don't believe in the halving, which is my camp, you might think it's less important, the marginal dynamics. But the inflation rate is pretty high in Heath right now.

So it may well have an effect. I think that's right. Did you see this CoinFlex news? So CoinFlex has files for structuring in Seychelles. So Roger Aver took him down. Yeah, not. I mean, that's another one where they have been on this podcast in the past. I thought that was a pretty good podcast episode.

There wasn't a long gap between the episode and the dissolution of coinplex. Is it like the Sports Illustrated cover curse that you come on the podcast and bad things happen? I think Up Only has that a little bit more. So they had Zucco on and like immediately there was financial privacy enforcement from OFAC like the next week. That was pretty tough. Up only is infamous for that. You go on up only and like, you know, bad things start to happen to you. That's so they haven't invited me on.

Well, yeah, just be careful going on there. You know, people were suggesting that like maybe Gary Gensler should go on and talk about the public policy or something. So the actual biggest institutional news of the week, I'd say would be BlackRock's entry. BlackRock, of course, has a partnership with Coinbase. They've also, they're also launching a Bitcoin Trust. a private Bitcoin trust given the client's exposure to spot Bitcoin. Yeah, daily liquidity product it looks like and more geared towards institutions, so bigger ticket sizes.

So these products have been around for a long time, but they're great products. They're kind of a no-brainer if you want to buy Bitcoin through a wrapper and through an intermediary. Why wouldn't you do it this way? So BlackRock making their presence felt here in the crypto industry. That was pretty quick from the Coinbase announcement to product announcement. It'll be interesting to see what else they have up their sleeve. Yeah, and from Larry Fink saying there's no client demand for crypto, maybe a year ago to this.

But yeah, they're clearly jumping in here. It's always one of those things you see. And I don't even know for in a bear market anymore, but, you know, like large movers like BlackRock, maybe waiting until the froth from the bull market has died down to actually make their move. You think we're not in a bear market? I don't even know how you define these things. but I think everyone thought we were entering prolonged one, and then the S&P rocketed 20% off the lows,

and Eats had this incredible rally. Bitcoin a bit of a laggard, but still rallying off 17K. I mean, funding is still actually pretty active in the venture market. We're not in a recession, I guess, according to the MBER. I don't get that. Jobs are growing. Last month, inflation print was, 0%, so all as well.

I guess. I don't know. Gas is still pretty expensive, but it is an election year, so we'll see. It could be that asset prices do well here heading into the end of the year, you know, right now. So two SEC related things this week. So the first one is that Coinbase disclosed that they're complying with an SEC inquiry into their crypto staking program. So that'll be interesting. I'm sure the angle for the SEC is, Do these things look like securities? So, you know, on Coinbase, you can hold things like

Tezos and earn a yield there. So that's one angle. The other is that the SEC is proposing a rule that would require hedge funds with over $500 million in AUM to disclose their crypto-related activity. It just continues to be the case that the SEC has not done anything constructive for the crypto industry in terms of here's a framework, here's a place that you can go to to talk about whether or not your income compliance. It's all just rules and enforcement, really. And the worst of all, IRS staffing up to the tune of 87,000 new IRS agents. One wonders where they will even come from. I mean, who, you know, as a kid, says themselves, I want to be an IRS agent when I grow up. My grandfather was an IRS agent. Okay. Well, was he excited to do it or what was his attitude? He went to private practice, but I think it was

a more noble calling back in the day. When, yeah, when you're paying your taxes was an honorable thing, and you kind of knew what it would be spent on defense or bridges. The IRS does a lot of good things in terms of catching fraudsters and things like that, but I think there's been a pretty broad overreach with these, I guess they're called John Doe summonses. So IRS sent one to S. Fox this week, basically seeking all the records for anyone that's ever done over 20K in volume on the platform, which is just insane.

Can you imagine that happening to like a Fidelity or Schwab? It's like anyone with over $20,000 I want all their trading records. That's such an invasion of privacy. But these crypto companies are some of them aren't well-staffed and so can't fight. And so you don't even learn about this stuff half the time. But Coinbase very publicly a couple of years ago came out and fought this like tooth and nail, which was a great service for their customers, protected a lot of people. But this is crazy.

Like you'd never get away with this by sending one of these requests to a well-staffed, financial services for him. It's just insane. Well, I think that's everything for the week. I think we spent about half of that podcast on Tornado Cash. Yeah, I mean, that was the top story for sure. We didn't even have time for the three arrows shenanigans of the week, but I'm sure there'll be some shenanigans. We'll just bucket them all into next week. We're just assuming this shenanigans, but yeah, our favorite segment. I know you may have gotten used to that, but it'll be back. Yeah, we've got some good episodes in the hopper, so we'll be back to two a week. have one coming out on Monday. So we'll see you on Monday. Have a safe weekend.