On The Brink with Castle Island - Weekly Roundup 08/25/23 (Coinbase v Circle, Tornado Cash indictment, chat app tokens) (EP.446)

Episode Date: August 25, 2023

Matt and Nic are back for more news and deals. In this episode:  The Bitcoin halving is coming up We review the Republican Presidential debate We review the state of New Jersey Coinbase takes a stake in Circle Hidden tensions between Coinbase and Circle BH Digital releases a stablecoin report USDC is challenged due to their inability to pay interest The DoJ charges the founders of Tornado Cash with AML and sanctions violations Did the Tornado Cash token hurt the founders' case? The problem with chat apps creating their own tokens FTX is working with Galaxy to liquidate some crypto SBF isn't happy with his prison meals Prime Trust was up to some shenanigans Content mentioned:  BH Digital, The Relentless Rise of Stablecoins Sponsor notes:  Coin Metrics STATE OF THE NETWORK — From East to West: the Global Pulse of Stablecoin Transactions In Coin Metrics State of the Network Issue 221, we provide a data-driven overview of halvings and their implications in anticipation for Bitcoin's upcoming 4th halving

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 Concentuteease. You're printed a couple trillion dollars, and all of a sudden, people start to worry. So out of this worry, we have something called the Bitcoin. Welcome to On the Brink. I'm Matt Walsh.

And I'm Nick Carter. And this episode is brought you by Coin Metrics. And here is the Metrics Minute. For today's Metrics Minute, we're talking about the halving in Bitcoin. You know my feelings on the halving. But yeah, let's dig into it. It's priced in, right? It's always everything was.

priced in from the inception of the universe. It's always been priced in. Because you think markets are efficient, right? I don't because otherwise I wouldn't be a professional active investor. I think there's alpha out there. But I don't think it's to be found in Bitcoin halvings. I don't think the alpha is there. Bitcoin's experienced three halvings since Genesis. The fourth takes place in April 24. There is 1.5 mil Bitcoin to be mined over the next 120 years. years. Bitcoin minor revenue is about $25 million a day. Transaction fees constitute around 4% of minor rev. Really not a lot. So that's the having coin metrics has a longer report on it. I mean, it's notable in terms of it's going to challenge minor economics further. But yeah,

is it going to cause a magical rally for Bitcoin? I don't think so. Once your metrics minute. Doesn't the magical rally usually happen a few months after the having? Is it going to cause a magical rally? Isn't that the formula? I think that's completely illusory. I think it's total, the notion that there's four-year cycles, like, look, Bitcoin crypto generally correlates with global liquidity conditions.

It doesn't really correlate with supply changes. It doesn't make sense either. Global liquidity conditions seem to be improving, now? tightening at the moment, actually. Oh, I think the rate environment's going to change here. Maybe. So, Yeah, I mean, Bitcoin's issuance rate is going from, what is it, 1.8% at the moment, or is it 0.9%?

I've forgotten. Either way, we're talking about a single digit, less than single digit change in annualized issuance. People think that's the only variable that matters for supply, but that's not it. There's a lot of existing supply that can either come on the market or not come on the market. So people just hold that variable fixed in their head and they're like, oh, well, if you modulate the amount of new supply coming online, that has a deflationary effect. What about all of the coins that have already been mined that are held by entities that can choose to sell them or hold them or do whatever?

Like, what about those coins? I think everything about those ones? Did you ever? Yeah. Come on. Don't overcomplicate it. Just keep it pithy. just the number go up machine.

No, it's just, look, I want people to be long because they believe in the asset and they get value from it and they like the qualities that it has. I don't want them to be long because of a myth, right? So that's a problem I had with the stock to flow people is you're selling people in the asset class based on a fiction.

And when the fiction clashes with reality, they become disillusioned, then they sell. So you were never any better off, right? They're not buying it because they have conviction. They're buying it because they believe a fantasy, that Bitcoin's price is an inverse function of its issuance rate, which is a delusional thing. That's why the stock to flow is so bad, particularly that one.

I can't believe how mainstream that stock to flow model got at the peak of the market. And a lot of people that should have no business. Yeah, a lot of smart people were talking about stuff. People with CFAs believed in that. I mean, actually, ostensibly small. smart people were repeating it. Well, there's a lot of things that people believe they're not true. So stuck to flow is just one of them.

Did you watch the Republican debate last night? I did. I did watch it. Yeah, I don't know. I don't know. It was interesting that Pence got the most speaking time, even though he's not at all. He's not even remotely the front runner from within that group.

all the single issue voters out there in the crypto topic i don't think you had much to go off of last night there's yeah so who are the menu i don't think it was mentioned right they had time to mention UFOs so but that there's yeah UFOs got airtime but not not monetary policy so bevecque so bevec like crypto i think desantis we think likes crypto also and then yeah desantis is on the record liking crypto and not liking cbc BDCs. So we know where DeSantis stands. We know where Vivek stands. I don't know but anyone else. The rest of them seem more of the kind of neocon sort of NatSec vibe where they would think the crypto is like somehow bad for the U.S. That's kind of the vibe they're giving.

I mean, Chris Christie, I was in New Jersey last week and I was on some of those roads. And I just don't know if I can support someone who oversaw a road system that is just so terrible. It's just, it's incredibly bad. And do you know that in New Jersey, you can't pump your own gas? I did know that because I go sometimes. I drive through there and it's like I try not to stop and get gas in New Jersey because then I have to talk to some person who has a fake job pumping gas. It's horrible. And then you have to tip them. It's like, what are we doing here? We're breeding a whole state of people that don't know how to take care of themselves. Well, it's that and it's like, it's just so awkward. You go to the gas stage. It's like, oh, I don't have any cash. Like, do you tip them? Do you

not tip them? I don't know what the etiquette is. Do I Venmo them? Like, come on, guys. It's an unnecessary. These jobs don't need to exist. The roads are terrible. I will say the shoreline is great. It gets a lot of bad publicity, but the shoreline's terrific. So, Chris Christie probably had the best line of the night where he called Vivek, like a human chat, GBT or something. He's basically calling him a nerd.

Yeah. He made a reference to Obama, and then Vivek came back and said, well, why don't you hug me like you hugged Obama and get me elected? Oh, yeah. Did Christy hug Obama? After Hurricane Sandy, he hugged Obama when Obama came to visit, which I don't think you can really fault him for that. It was a good one letter. Yeah, look, you can hug your political opponents. Yeah, I think we could use more of that.

It should just make people hug each other. Speaking of political opponents, tough, tough week. for progosian, huh? Gesh. Well, tough in that he's deceased now, yeah. Yeah, he's not coming down for breakfast. Yeah, that's, he's gone. So, I mean, but not that I know really much or anything about Russia,

but, like, if you attempt a coup against Putin of all people, like someone who actually assassinations with want to abandon dissidents in far-flung countries, you have to imagine that you either need to succeed at the coup or accept your, fate. Like he chose some kind of weird middle ground. Yeah, the whole thing was so perplexed. It's like, perplexing. This guy's going to Belarus to hang out. All of a sudden, he's in Africa. Then he's dead in a plane crash. And everyone's just kind of like, yeah, that makes sense. If you fail in a coup against Putin, how could you imagine he would not seek revenge? Like, Putin is a man that cares about loyalty

over everything. I guess, yeah, you take the shot at the king and you just can't miss. Yeah, he missed. in a big way. That's crazy. I mean, so there was news on that front this week. Almost no news in the crypto industry. Although we did do a podcast. We got back on the board with a Monday podcast.

Yeah, we've been a little bit delinquency. So you sat down with Darshong Baija of Cordora. Good episode. Good episode. Talked about risk management. Talked about the crypto credit markets, which is something that I didn't really want to talk about. But it was nice to talk about it with someone who was thoughtful.

Crypto Credit markets. given what's happened over the past two years, not the most enlightening, fun topic. No, I mean, they're recovering, though, actually, if you look at, you know, the under-collateralized credit sector in crypto, after the collapse of 22, it's been up this year. It is.

I mean, just credit has not really been a feature of the market until very, very recently. It's just there's almost no borrow out there. Yeah. We also have tokenized treasuries. There's some interesting stuff in terms of yield-bearing instruments on chain. So I don't think we can write it off just yet. So that was a fun episode.

And then we did have some deals this week. So the first one is Coinbase. So Coinbase has taken an equity stake in Circle. They have dissolved the center consortium, which was that joint venture between the two companies that was the issuer of USDC. And they have solidified a partnership around USDC. So my understanding is this Coinbase would not be able to go out and do their own stable coin as part of this. So they're maintaining that alignment.

It seems like there's some good upside for both companies here in the sense that circle gets Coinbase on the cap table. There's alignment around that USDC product. And then Coinbase being a public company is able to lock in some clarity on the long term net interest income value that accrues to that company as part of this strategic relationship. Yeah, this was very interesting. So first of all, center was kind of rubber stamp. Like they didn't have any real power of their own. So it makes sense that they were dissolved. Also, my understanding is, and I don't want to get this wrong,

but my understanding was that the rev share between Coinbase and Circle was dynamic. It actually wasn't a static rev share. and I believe it had to do with where the USDA's themselves were custodyed. So I think Coinbase was eligible for a greater share if a lot of USDCs themselves ended up in Coinbase. Interesting. Was not aware of that. Yeah.

So again, I could be wrong in this. And so given that, I think there is actually a degree of tension in the relationship because their interests are actually opposed. and, you know, depending on where the USC end up settling, that influences the economic nature of the deal. So I had always felt or had felt that it was actually a kind of contentious relationship and that they would either break apart or get much closer, get much more integrated, that the status quo couldn't really last, basically. So it seems like they chose the option of getting much more explicitly entangled with each other.

which makes a lot of sense. We talked about this this week a little bit, the two of us, but whoever controls distribution here is going to be a kingmaker in the stable coin category. And for now that's Coinbase in the United States. But at some point in the future, you get more retail brokerages, you get maybe some banks that offer stable coins on their retail platforms. Whoever has that distribution to the end customer that wants to hold these stable coins will really be in a position to pick which stable coin they want to be able to offer as

the default. And the default, if you have any sort of an interest rate regime, is just going to make a lot of money. Yeah, we've been obsessed with stable coins lately. That was that great report that came out from Brevin recently this week. Yeah, Peter and Brevin, that was an awesome report. Yeah, we're going to put that in the show notes. Really highly recommend you read that full of data that otherwise doesn't exist about who's using what kind of stable coins. for what I've been very focused on them. Most of my talks this fall season will be about stables. I mean, the thing that really occurs to me is

USDC is challenged because it can't pay interest. And I think that explains a lot of the decline in capitalization of USDC. And if you look at when the supply of USC started to fall, that coincides with the hiking cycle for rates. and tether is in a different spot because tether holders often can't access U.S. financial markets that easily. They can't get access to treasuries. U.S.DC has so much more churn. U.S.C. holders redeem and create U.S.D.C. all the time as a percentage of the market cap, the churn in U.S.D.C. is much greater. So I think it's going to continue to be challenged

until they can figure out how to pay interest. But under U.S. securities laws, is just no way to do that in the U.S. No, that's not going to happen in the U.S. anytime soon, unfortunately. So, I mean, it could just be that the future of stable coins is offshore. And that's just the way it is. Right now it's been running the data. 75% of stables are offshore issued offshore. And these are U.S.D. stables.

This was at parity before FTX collapsed. It was about 50-50. And then post-FTC. X, U.S. regulators turned super hostile. Interest rates kept rising. Stables pled the U.S. All right. There was another deal this week. So you actually referenced the credit markets and some of the D5 protocols that are emerging there. So one is Maple Finance. So this is a decentralized credit marketplace. They raised $5 million from Block Tower, Tiogo, GSM framework, and others. Yeah, awesome. Reyes. Congrats to the team over there, Maple.

Lastly, we have B2C2. They acquired Wharton, which is a French market-making firm. A little M&A there. So those are the deals. It's sort of the end of August doldrums on the deal front. But deals are getting done in the market. So there's always a lag here on the announcements, but I think it's picking up over the past few weeks.

We've been seeing more and more deals get struck, more and more term sheets get signed. It's starting to pick up. Yeah, I would say in the news front, it's just kind of more bad news, though. it'd be nice to have I'm not even asking for good news I'm just asking for a month period of just no news no news the first one is the DOJ so more active here so the Department of Justice has charged the founders of tornado cash which is of course the cryptocurrency mixer it's a open source set of smart contracts

and the two folks that invented it have been charged with money laundering and sanctions violations So obviously it's a terrible thing, I would say, that North Korea and Russia are using this thing and able to evade these sanctions. However, this is just a super complicated legal footing here because really what you're doing, it looks like you're prosecuting the development of open source software, ultimately. This is not a company that was doing this. This was just a set of open source smart contracts that these two guys put out in the wild. And North Korea ended up using it to launder a ton of money. So I don't know how this will play out, but I would expect that Coin Center and the EFF and some of those civil liberties groups will probably get involved in this case.

Yeah, this one is pretty complex. I mean, I think the crux of the issue is whether the, defendants here, you know, incurred managerial efforts to facilitate the usage of the protocol, potentially allowed these illicit actors to use it, or whether they were just merely publishing open source code. So I think that's probably the key distinction here is did they just merely author the code that was then utilized by licit and illicit entities to achieve privacy? or did they manage a broader system, which really facilitated the illicit usage here?

I think that, in this case, the DOJs is taking the latter approach. And this is a project that raised some venture money too. And there was a venture fund that was named as part of it. So it's kind of a weird, this will be really interesting to see how this one plays out. I wonder what the thesis there on the, why you'd fund something like this. I mean, where were you going to make money? There is a token. So honestly, my hypothesis here is that if they just issued the code as kind of an altruistic thing

and left it alone and weren't involved thereafter, I think it would have actually been fine. But given that there was a token, they had a financial interest in it, that I think it's a little bit different at that point. So do you need tornado cash? I didn't even know that there was a token on tornado cash. So do you need the token to actually use the platform? I don't think so.

I think the token was incentivizing liquidity provision on the platform. Oh, that's interesting. Then, yeah, these guys might be. So think about it like that. They're profiting because they own some of the token. They're profiting from the usage of the platform. They're incentivizing people to deposit, which increases the anonymity set, which increases the privacy, which makes it more useful for an illicit entity.

so that's where you get into questionable territory. Yeah, that's not good. Yeah, that's not good. Also, the DOJ has access to their signal messages. Is Signal backdoor? I'm starting to think it is. What's up with that? I mean, I wouldn't be saying things on Signal

that you don't want people to read. Certainly the same thing goes with Telegram. So what's left? Nothing. IRL conversations. No, I think you got to write it on a piece of, paper and then burn the piece of paper that's that's how it goes yeah apparently these guys had been in negotiations and discussions with the DOJ so maybe they voluntarily surrendered their communications

and that's how they'd access but if signals backdoored I don't know I don't think that'd be good yeah that's sort of like the the one thing that a lot of people think is not backdored so yeah that would not be good. I don't know. All these CZ Binance signal messages were all because someone just gave up a phone. So it wasn't like they hacked signal for that one. Yeah. Do you remember mobile coin? I do. Mobile coin. Yeah, that almost took down FTX, actually, the mobile coin short there. Yeah, that was weird. FTX lost a ton of money. Maybe that was when the whole started. But yeah, mobile coin was started by Moxie Marlin Spike, right? It was like Josh Goldbar and Moxie Marlin's bike.

It was so weird because Moxie certainly was deeply involved in the project and then kind of pretended he wasn't and acted belatedly as if it was an arm's length thing and Signal just happened to

use incorporate mobile coin because it was the best technology. It was like, dude, you basically created mobile coin. So you have obviously an economic interest in promoting it via signal. But he basically backpedaled on this and pretended like it was completely arm's length.

And I mean... That whole thing was strange. I think at this point, we can very safely say we have plenty of evidence now. Just because there is a chat app that has lots of distribution, hundreds of millions, 300 million users, signal, billions in the case of Telegram, that doesn't mean that if you create a free-floating crypto token to be used as the currency on the app that's not a theory of value. That doesn't cause the token to accrete sustainable value. We can confidently, and I think permanently say that.

Is that fair? I think that's fair. It's fascinating because there's technology, entrepreneurship, and then there's, hey, I want to go start a new currency and be a central banker. And it's kind of hard to do both, to be honest with you. It would be like if Apple was like, yeah, you know, you'd use Apple stock to buy things on the app store now. People wouldn't do that. It's free floating. There's tax consequences.

It's annoying to now do all this FX conversion. The frictions in a freely floating asset in a payments context are insurmountable. Just use stable. The question is like, okay, well, why didn't they just use stifference? label coins because the way they monetize these apps in the case of signal and kick and telegram is by issuing this token by selling it whether it's institutional or retail so but they're they're trying to back they're trying to back into a use case for the token the real use case was just non-deluded financing yeah it's like a chart of do you have a business model yes or no and if you

don't have a business model issue a utility token that's the 2017 Playbook. Yeah, but it's still with us here in 2023. So I'm sick of it, basically, is what I'm saying. Just use a stable coin for God's sakes if you actually care about creating crypto payments on your app. And if you don't, then I think it's obvious what you're doing. Yeah, yeah.

Agreed. All right, so what's next year? We got a bunch of FTX news here. So what's the first thing? So they have tapped, John Ray has tapped Galaxy Digital to basically manage out their liquid cryptocurrency. positions. So to start staking them, start hedging them, whatever they're going to do with that, who knows, and then start selling them. So it looks like there's a tremendous amount of

sell pressure on the horizon here. It does. And I don't have the exact numbers here, but yes, it does look like they're going to be liquidating, what, 500 million to a billion of a crypto portfolio, which I think is mainly large caps. So, yeah, bad news. I think it's going to be. I thought, I thought they didn't have any Bitcoin. What happened here? They have other kind of Bitcoin instruments though, right? But is it GBDC? Something like that. They do hold a bunch of GBT. Yeah, which is crazy. I cannot believe that they did not sell that as they were panicking in the last few days there.

I think part of the objective is to kind of sterilize the exposure there. And so go delta neutral on the position. So that would mean that they'd be putting on hedges. So effectively pressure on Bitcoin. Interesting. Well, we'll see how that plays out. Another thing that we saw this week,

so Farmington Bank, which was that Rinky Dink, podunk bank that Romnik Aurora from FTX led the deal in and that had an association with, I think it was Noah Pearlman, right? The former compliance guy from Tether, maybe.

So anyways, they bought this bank and overpaid for it wildly, that bank has been shut down. It's been hit with an enforcement action from the Federal Reserve. They will wind down operations. So the era of Farmington Bank is no more. Yeah, that was a sorted episode in U.S. banking history, I think. And that's not the only FTX, SBF news this week. Did you see from the hearings, there was a, recently his attorney appeared in front of one of the judges and said that, you know, he's not being given access to vegan meals in prison. Yeah, he's having, he's only having bread and water and some peanut butter.

So, but this is self-inflicted, right? So obviously there is food in the prison, but Sam's just kind of refusing to eat it, I guess. I don't know. They're not accommodating his veganism. I mean, Do you have a human, I guess this is a question, do you have a human right to be a vegan if you're in prison? Like what if you said, I have, what if you said, I have a specialty diet where I only eat fried chicken and ice cream? And that's my human, like I can't eat anything else. Does the prison have to accommodate you? I think, well, aren't there religious reasons for being a vegan? But he's not. He's just a vegan because of his ideology, no, not religion. But you'd have to think they have the infrastructure to do it for people that have a real reason, not just a fake reason.

And so, you know. Yeah, I mean, so his lawyer kept on calling meat, flesh. He kept on saying that the person was only serving flesh in their meals, which is really... I didn't get that. It's like, what are you just getting the skin of the chicken? I don't get that. Just, it's called meat. It's not called flesh.

also apparently Sam doesn't have access to his MCM and his Adderall in prison yeah so he wants Adderall that's the thing I mean isn't that going to get you a little bit too wound up and it's also like yeah I mean I don't know if we should be really giving prisoners Adderall I kind of want to keep them calm right yeah it just seems like a terrible idea it's like you you're not running a Ponzi scheme anymore what do you need the Adderall for yeah what does he need to focus for just chill out start writing your book, like whatever you're going to do. Did you see that they came out and they talked about what his defense is going to be?

So the defense team came out and said, we are pursuing the defense that we are blaming the lawyers. So they're going to be blaming the advice that he got from Fenwick and West saying, these lawyers told me that all this was okay. So taking all the customer money and using it from my personal market making firm slash prop shop, that was what Fenwick and West told me to do. They told me that I could do that. They told me I could get my dad

$10 million gift from customer money. They told me that I could go put $550 million of customer money into a Bitcoin mining company. That's what Fenwick and West told me to do. Can you imagine if that defense worked? Then everybody could use it. I'd be like, yeah, my lawyer told me to do racketeering or to rob a bank.

It was his fault. It's really going to change the game for these lawyers. It's crazy. It's like, yeah, my lawyer told me to tell Romnik Aurora to go lie to all these lending companies. Sam was just following orders. It's crazy. I didn't realize that. I mean, that's a terrible defense.

Like, why can't you just go with the insanity defense? Because we don't have any lunatic asylums left, Matt. We covered this. They got rid of them all. Oh, man. It's crazy. I mean, his best bet here. I should get paid for this consult.

You just have to say that you're all, you're tripped up on all this cocktail of medication that you're on and things got a little crazy and you actually need to seek help mentally. Yeah, I think that'll be part of it. I think they'll talk about how they're all cracked out on stimulants. Okay, moving on to other crazy insane nonsense. Prime trust.

My God. Prime trust really misbehaved over there. So they apparently... Clown car of an operation. I didn't even know where to start with these people. Apparently they bought 77 million of ETH on the open market at the absolute Pico top because they had given clients the wrong deposit address

and lost the keys and they needed ETH to honor withdrawals. So they were just buying ETH on the open market at very high prices so that they could on our withdrawals. That's crazy.

There's also a footnote. So we're talking about the day one declaration. So Prime Trust is the Nevada-based custodian that was using, well, I guess that lost a lot of customer money. Anyways, they went insolvent. And companies like Swan Bitcoin had their entire business built on top of them. Wait, hang on a sec. Can we just acknowledge the fact that people depositing Bitcoin into Swan Bitcoin

were funding Prime Trust purchase of Eath? Yes, and then do you know what? To be very clear. So then swan Bitcoin's customers put money into Swan Bitcoin, which puts money into Prime Trust. Prime Trust was using customer money to go buy USDT, the Terra Luna debacle coin. And to market buying. UST, not UST. Yeah, sorry, UST.

So they were buying that stable coin at the top. They lost all that money. and then they were buying ETH at the all-time top. I mean, and these guys were considered the adults in the room. Like they actually had real regulatory licenses, you know? Yeah, but they weren't really considered the adults in a room.

They were considered the JV Jokers. I mean, no one would invest in a company that was building their stack on top of Prime Trust. Well, we didn't know how bad it was, but a lot of people used Prime Trust. I mean, they were very popular backend for crypto. They were. There were.

So I just don't understand why people in this industry are just such lunatics with the disregard for common sense. I don't get it. Like how many more stories like this do we need to hear? I don't know. Is it low tide yet? Can we get these people washed out? So that's prime trust.

Yeah, Reid, the Bravenor report on stable coins. It's very good. Why do they recommend that? Aside from that, I think we're out of news. Well, I think that's the news for the week. There wasn't much. So we squeezed some out of a rock there. But there's always FTX news.

And maybe we'll have some SAB-121 updates next week. All right. So I think that's it. Everybody have a safe and healthy weekend, and we will see you on Monday.