The Breakdown - Is Jack Dorsey About to Announce a Bitcoin DeFi Platform?

Episode Date: November 13, 2021

This episode is sponsored by NYDIG. On this edition of “The Breakdown Weekly Recap,” NLW follows up on the story about the politics of bitcoin with an SEC commissioner’s recent essay on decentralized finance (DeFi). He also looks at the forthcoming Taproot upgrade, and how it may coincide with plans from the newest division of Square - TBD - to announce bitcoin DeFi plans.  NYDIG, the institutional-grade platform for bitcoin, is making it possible for thousands of banks who have trusted relationships with hundreds of millions of customers, to offer Bitcoin. Learn more at NYDIG.com/NLW. Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell, research by Scott Hill and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Dark Crazed Cap” by Isaac Joel. Image credit: Eva Marie Uzcategui/Bloomberg/Getty Images, modified by CoinDesk.  

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world. The breakdown is sponsored by Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, November 13th, and that means it's time for the weekly recap. This week, to me, was all about Bitcoin and its relationship with the world. It was, in other words, a macro week. week. We started with the big inflation print. The numbers were crazy to many people out there. 0.9% growth month over month and 6.2% CPI headline inflation between October 2020 and October

2021. The number was the highest in 31 years. Now, these numbers create a lot of issues. Certainly for the Fed, it challenges the Fed's desire to keep interest rates low even as they start their taper of asset purchases. Will this put more pressure, however, on them to actually raise interest rates faster than they'd like to? Perhaps. But then again, they're concerned if the Fed is correct that these still are transitory factors, supply chain factors, for example, that even if more persistent than imagined, will eventually

write themselves, versus a more sinister sort of price inflation leads to wage inflation, leads to price inflation leads to wage inflation type of cycle, then they don't want to be too aggressive or recalibrate too hard because they could then trigger a recession and we'd be back to square one. So the point is that it's a challenge for the Fed. It's also a political challenge, certainly especially for the Biden administration. Biden's White House is trying to get through a $2 trillion tax and spend bill, and this could impact how that happens. What's more, just more broadly, growing prices faced by consumers are dragging down Biden's approval rating and making it harder for them to push through anything in their agenda. When it comes to Bitcoin, obviously,

as we've talked about a couple times this week, the high inflation print immediately sent Bitcoin to a new all-time high at close to 69,000. That triggered a number of traders to open levered longs, which were then almost immediately liquidated thanks to a completely different macro factor coming in. The same day that we got these inflation print numbers was the day that rumors started to fly around that Evergrand, the beleaguered, problematic, much-in-debt Chinese real estate developer was defaulting on nearly $150 million of loans, triggering potentially a bankruptcy process that could have huge knock-on effects with all of their debt holders all over the world. I said at the time that that crazy day showed three things.

First, that Bitcoin is trading as an inflation hedge. Alex Kruger, in fact, said it was the first time he had seen that actually happened in a short-term market context. Second, it also showed that Bitcoin still remains a risk on speculative asset for many in the traditional finance world who have come over to the Bitcoin cause over the last year and a half. Even if one thinks that Bitcoin is a great long-term hedge against inflation, that doesn't mean that by mandate they're not going to have to be sellers when markets go risk off, which is exactly what happened on the Evergrand News, which, by the way, ended up not being exactly what it seemed like, or they seem to have made at least some of their debt payments,

so that situation remains a big thorny toe for anyone in markets anywhere in the world. Anyway, the third thing that I said is that this clearly showed again just how much market structure mattered and how much leverage has a huge impact. Even for a narrative guy, narrative is only one part of the story of what's going on in markets, and very often market structure explains more than narratives do. But now let's turn to another topic that we haven't had much context to cover recently, which is Defi. On yesterday's show, I talked a lot about the politics of Bitcoin and where Bitcoin and Crypto

sit in the larger political discourse at the moment. Interestingly, I actually missed one relatively significant paper that came from SEC Commissioner Carolyn Crenshaw. And I think before I give you the TLDR on that piece, I'd like to point out a debate that has been happening in the traditional finance world, even among people who generally like Bitcoin and Crypto. That debate is whether the U.S. will follow China's past. in trying to outright ban crypto.

NIDIG sponsors this podcast and they are helping banks, corporate treasuries, and fintechs integrate Bitcoin into their products and balance sheets. See why Bitcoin means business at nidig.com slash NLW. That's nydig.com slash NLW. There are some, like notably Ray Dalio, who believe that as Bitcoin and crypto get bigger, they're painting a bigger target on their back. And for them, they point to the actions of China this year, the CCP, ban of mining and then ban of crypto trading as exemplary. There are others who say the U.S. despite

its failures is not the CCP. It doesn't have that sort of control. It won't and can't engage in that sort of banning. And I think that every week that goes on, I don't know how anyone could credibly argue that banning is the likely path forward. This week's latest example, again, as I said, comes from SEC Commissioner Carolyn Crenshaw, who wrote a paper published in the International Journal of Blockchain Law in November of this month, a piece called Statement on Defi Risks Regulation and Opportunities. This is something that's not being discussed very much. I only noticed this because Nick Carter tweeted it because he is referenced in a footnote and good on you, buddy. The point that I want to make is that this paper suggests such

a fundamentally different approach to thinking about defy than we've seen from other regulatory statements. I'm thinking about the speech that then CFTC Commissioner Dan Berkovitz, who's now moved over to the SEC's enforcement division gave over the summer. That speech was all about how Defy protocols are likely breaking the law, and it was very tough talk and Wild West analogies and all that sort of stuff that we've come to associate with, frankly, more the SEC than the CFTC, but again, Berkovitz is making that move, so this kind of makes sense. Still, let's look at the language that Crenshaw uses. She writes, Defi presents a panoply of opportunities. These projects are evolving incredibly fast with new and interesting potential,

Considering the relative infancy of blockchains that support the scripting needed for sophisticated smart contracts, defy development is particularly impressive. Now, moving on from that initial statement, you often see from politicians a sort of lip service to the idea of promoting and preserving innovation, right? Whenever you have someone who doesn't like crypto, they say that they're focused on two things. Yes, of course they want to preserve innovation, but they don't want to do so at the threat of investor protections. We've talked endlessly on this show about investor protections.

And usually when you're presented with those two things, the preserving innovation thing really goes to the wayside. And to me, that seems not to be the case here. Crenshaw's primary concern seems to be summed up in the section called unregulated markets suffer structural limitations. Even the choice of that framing is huge. She is presenting problems that will limit this market, a market that she then, presumably, or by extension, wants to be unfettered by those limitations. She points to a much more plain-worded and frankly rational set of concerns, writing, while defy has produced impressive alternative methods of composing, recording, and processing transactions, it is not rewritten all of economics or human nature. Certain truths apply with as much force in defy as they do in traditional finance. Unless required, there will be projects that do not invest in compliance or adequate internal controls. When the potential financial rewards are great

enough, some individuals will victimize others, and the likelihood of this occurring tends to increase as the likelihood of getting caught and severity of political sanctions decrease, and absent mandatory disclosure requirements, information asymmetries will likely advantage rich investors and insiders at the expense of the smallest investors and those with the least access to information. So again, what I think is clear-headed here is that these critiques aren't about defy specifically. They're about human nature and economic systems of which defy is one. But let's really bring this home by looking at her conclusion. She writes, for defy's problems, finding completely,

compliant solutions is something best accomplished together. Reimagining our markets without appropriate investor protections and mechanisms to support market integrity would be a missed opportunity at best, and could result in significant harm at worst. In conceiving a new financial system, I believe developers have an obligation to optimize for more than profitability, speed of deployment, and innovation. Whatever comes next, it should be a system in which all investors have access to actionable material data, and it should be a system that reduces the potential for manipulative conduct. Such a system should lead capital to flow efficiently to the most promising projects, rather than being diverted

to mere hype or false claims. It should also be designed to advance markets that are interconnected, but with sufficient safeguards to withstand significant shocks, including the potential for rapid de-leveraging. In decentralized networks with diffuse control and disparate interests, regulations serve to create shared incentives aligned to benefit the entire system and ensure fair opportunities for its least powerful participants. Again, to be so clear, this is not banning rhetoric. It in fact largely aligns with what people in this space are saying and believe it. I think the document is hugely positive in terms of the state of discourse, and I hope Commissioner Crenshaw's colleagues pick up this sort of tone. There's a chance for these dialogues to improve starting just

next week. On November 17th, a hearing before the U.S. Congress Joint Economic Committee will be held called demystifying crypto, digital assets, and the role of government. The witnesses include Alexis Goldstein, the director of financial policy at the Open Markets Institute. Tim Mossad, a research fellow at the Harvard Kennedy School, an adjunct professor of law at Georgetown Law, Kevin Werbach, a professor of legal studies and business ethics, and the director of the blockchain and digital asset project at the Wharton School at the University of Pennsylvania, and Peter Van Valkenberg, who's the director of research at Coin Center. Now, Jerry Brito, the head of CoinCenter, says this is one of the smartest hearing panels

I've ever seen. And while I agree that it's a lot better than we've seen in the past, I still do have the critique that there are no builders or investors really in this. Yes, there are academics who might touch into that, but that's a really big part of this space whose voices just aren't going to be heard in this context. Still, it definitely doesn't seem like they're setting it up to be a bash fest, so I'm optimistic and we'll be looking forward to seeing what happens. Still, I'm not sure that's the most exciting thing we'll see next week, and so let's wrap the weekly recap with some prognostication.

So in July, Jack announced that Square was creating a new business unit, focused on, quote, building an open developer platform with the sole goal of making it easy to create non-custodial permissionless and decentralized financial services. Our primary focus is Bitcoin. Its name is TBD. Many when that announcement happened said this kind of sounds like they want to do defy on Bitcoin, but I think there's more to the story. So let's now discuss Taproot. Taproot is the biggest upgrade of the Bitcoin network in four years since the Segwit update. There are a lot of technicals to what the changes are and a ton of great papers and primers out there on this. And if you just Google Taproot Bitcoin or Taproot upgrade, you're going to find so much out there. For the purposes

of this show, the key thing to know is that the technical changes will enable better and expanded privacy tools, scripted transactions using less block size and becoming cheaper, and effectively then enabling smart contracts. Here's how Crypto Briefing described it. In the Bitcoin Network's current form, smart contracts require an immense amount of space to be stored on the blockchain. As transaction fees are a function of the amount of space a transaction wants to occupy in a block, creating smart contracts on Bitcoin is very expensive. This is because such complex transactions have to link all public keys associated with any smart contracts, making the kind of DFI projects found on Ethereum completely impossible. Taproot will combine the public keys of the users

participating in a smart contract and create a new public key. That key can then create a unique signature, which is only possible for that particular combination of addresses. These digital signatures are called Schnorr signatures invented by the German mathematician Klaus Schnor in the 1970s. These signatures have two advantages over their previous implementations. First, they hide individual users' private keys in any smart contract, meaning only the unique combined public key is visible on the blockchain. Second, they drastically reduce the amount of space required in any block to create complex smart contracts. Things are getting juicier, right? Taproot opens the door to Bitcoin Defi. TBD seems to be interested in that. But is there anything else out there to

raise our spidey senses. Well, yes. In a recent earnings call from Square, Jack was asked when and if they were going to add more currencies than just Bitcoin to Square. He said we're not. Our focus is on helping Bitcoin to become the native currency for the internet, and we want to. We have a number of initiatives towards that goal. Cash app is just one. We're going to be building a high-roll wallet with Bitcoin mining, a consumer device to mine Bitcoin at home or in a business. We believe this focus is important. We believe it's right. And a lot of it has to do with the resilience, the fundamentals, the principles that Bitcoin offers. We also want to make sure we're giving back to as much as possible, and it's also reflected in our purchase for Bitcoin wallet, Bitcoin mining, and our new

business unit called TBD, which is focused on building a developer platform to enable more ideas around decentralized finance on the Bitcoin stack and the stability that it offers and all the resilience that it's had over the decade plus. So we're going to release more details on what TBD is doing. We have a white paper on November 19th, and we're real excited about our focus. So just to connect the dots really clearly, the taproot update, which could enable a totally different era of Bitcoin Defi, is slated to go live after Block 709-632, which is currently slated for November 14th. Less than a week later, TBD is about to announce its white paper about Bitcoin Defi. Do you see where we're headed? Until tomorrow, guys, be safe and take care of each other.

Peace.