The Breakdown - ‘Piles of Risk’: An Outlook for Autumn

Episode Date: September 5, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US. NLW reviews the key events from August with an eye to how they will shape September and the fall, including: Sanctions The Merge Institutionalization Fundraising  Regulation, legislation and enforcement  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company ensures the safety of your funds by employing five key fundamentals including real-time auditing and recently increased $775 million insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - I.D.E.A.S. 2022 by CoinDesk facilitates capital flow and market growth by connecting the digital economy with traditional finance through the presenter’s mainstage, capital allocation meeting rooms and sponsor expo floor. Use code BREAKDOWN20 for 20% off the General Pass. Learn more and register at coindesk.com/ideas. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “Razor Red” by Sam Barsh and “The Life We Had” by Moments. Image credit: sakchai vongsasiripat/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.  

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 nexus.com, and ftX, and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, September 3rd, and that means it's time for the weekly, or in this case, monthly recap. Now, one quick note before we get into this, there are two ways to live. listen to the breakdown. You can hear it on the Coin Desk podcast network feed, which comes out every afternoon and also features other great CoinDesk shows. Or you can listen on the breakdown only feed, which comes out a little bit later in the evening. Wherever you listen, I so appreciate everyone

who is taking the time to leave ratings and reviews. It's making a huge difference. Thank you, thank you, thank you. Also, a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. Finally, I want to tell you about CoinDesk's new event, the investing in digital enterprises and asset summit or ideas, which is designed to facilitate capital flow and market growth by connecting the digital economy with traditional finance. Join CoinDesk October 18th and 19th in New York City for a 360-degree investment experience where you can source and invest in the next big deal in digital assets. Use code breakdown 20 for 20% off a general pass and register today at coindesk.com slash ideas. All right. So at the beginning of each month, Ikekeyes,

Kling does a monthly update that looks back at what happened the month before and plays forward some trends and predictions for the month ahead. Included in it is a massive list of the big events in the industry. Now, this is a great tool for reviewing at a high level the key things that happened. However, it is a really long list, and my brain likes to organize things by category. So for this weekly recap, what we're actually going to do is a monthly recap where I'm going to try to take some of the key events that Travis put in his newsletter, his list of events, and organize them into categories that help us get an overall picture. Now, the first and most significant category, for sure, bar none, without question, is sanctions.

On Travis's list, he included the following events. U.S. Treasury sanctions tornado cash smart contract. USDA-C. blacklists every sanctioned eth address. infura and alchemy block access to tornado cash, anonymous tornado cash users send tornado cash eth to many famous docked eth addresses, and developer of tornado cash arrested. So to do a quick summary of this situation, what happened is that the U.S. government, through the U.S. Treasury Department, through their Office of Foreign Assets Control or OFAC, sanctioned Tornado Cash. This is kind of a remarkable move in the sense that sanctions

have historically applied to individuals who are suspected of wrongdoing. We have seen crypto sanctions in the past, but it's specific addresses that are associated with criminal actors. This is the first time we've seen the actual sanctioning of a protocol. Now, the second big part of this, as noticed by Travis and others, has to do with the response from crypto companies. Many, particularly those domiciled in the U.S., raced to blacklist the associated addresses. On his list, he had USDC and Fura Alchemy, but part of the thing that people were surprised about is that many front-end Defy protocols also started sanctioning these addresses. People were surprised because weren't these protocols supposed to be decentralized and thus

censorship-resistant? Isn't that what the whole point of decentralized finance was? Well, that has opened up a whole set of questions. And I think the discussion of decentralization, how important it is, why it's important, to whom it's important, to whom it's important, and in what context it's important is a big part of this sanctions conversation, and something that I think will be a clear legacy of this month. Now, it wasn't all companies in crypto that immediately made these sort of blacklists. Tether, for example, has very publicly fought against it, reinforcing their decision last week when they said that they would wait for law enforcement

to request that they actually took this action before doing so. They actually came out rather harshly against USDC's approach to these sanctions, saying that it could interfere with ongoing law enforcement. A third dimension of the sanctioned story was the arrest of a developer in the Netherlands. Part of what made this so dramatic is that we haven't had and we still really don't have any good information about what he's being accused of. There are very different implications if, on the one hand, he's suspected of some criminal enterprise and also on top of that happens to be a tornado cash developer,

versus he was arrested explicitly and exclusively for his work on tornado cash. That would be a much more dramatic precedent to be set. Some third parties have suggested that it might have to do with Russian state-aligned enterprises he's worked with in the past, but the reality is that we still don't really know. A fourth dimension of the sanctioned story is the potential legal battles that will follow. Coin Center has been exploring a suit based on OFAC not having statutory authority to do this, and even some congressmen have been trying to get a few more answers about how OFAC sees its authority to sanction an entire protocol.

Regardless of whether those suits go through, regardless of what happens in the future, the reality is that there is very likely to be a freezing impact in the interim. Much of the discussion has been developers saying, look, I like what I'm working on, but not enough to be arrested for it. And of course, that has prompted this broader discussion of decentralization, which frankly I think is really, really healthy for the space as a whole. But anyways, all in all, this is absolutely by far the most significant event of August. No question. Nexo is a security first platform built for the long run with everything you need for your crypto. Five key fundamentals, including real-time auditing and insurance on custodial assets, safeguard your funds. Making Nexo the right place for you to buy, exchange, and borrow against your assets safely.

Learn more about Nexo's reliable business model and start your crypto journey at nexo.io. That's nexo.io. Eager to make more informed decisions around crypto, chainelysis is here to help. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigations support for all crypto assets. For organizations like Gemini, Crypto.com, and BlockFi. gain unparalleled visibility and maximize your potential with the leading blockchain data platform by visiting us now at chainalysis.com slash coin desk. The breakdown is sponsored by FTXUS.

FTXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDX U.S. is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. The next big category comes from the upcoming Ethereum merge.

Around that event, Travis featured Ethereum CoreDeb set September 15th date for the merge. Polonex announces trading support for impending ETHPOWW4. fork, Bitmax launches derivatives for impending ETH POW fork. For most of the summer, the merge has been the only narrative game in town. That is partially on the strength of the merge narrative, but partially on the lack of other narratives to go around. This month, there were a few big moments around this. First of all, we got a date, September 15th.

Nothing catalyzes a narrative like an expectation around a specific event around a specific time. Second, however, we got a lot more discussion this month about the potential or reality of forks and all the risks they might hold. This is something that people like Kevin from Galwa Capital have been discussing for a little while now, but it's a discourse that's finally come to the mainstream. It's also been aided and abetted by the fact that there are active plans for an Ethereum proof-of-work fork. Miners like Chandler-Guo have been saying that they will support a fork, and you started to see this month the first financial institutions talking about supporting trading products around a forked version. Also, somewhat going back to the tornado cash piece,

that discussion got really wrapped up into merged conversations as well. One dimension of that is just the centralization discussion. USDC and Tether represent such a huge part of ETH volume, that they are effectively kingmakers as relates to which chain they support. Currently, there's no reason to think that they're going to move to a proof-of-work fork versus sticking with Ethereum's main new proof-of-stake merge, but the fact that they could potentially caused chaos by making that decision has again reinforced how important it is to have this discussion about centralization. There's also now a much larger question of censorship. Specifically, what happens if slash when, the U.S. government says, hey, major centralized staking platform like

Coinbase, could you please censor transactions from sanctioned sources? We're talking about a whole new level of compliance and the potential for another set of forks to be needed just to keep Ethereum neutral. Last week I read a piece by Nick Carter about what Ethereum should do in that circumstance. Finally, there is, of course, also technical discussions, technical risk discussions that the Ethereum community has been having, although they successfully completed the GORley merge this month, which was the third and final TestNet merge. Now, just wrapping up the merge part with Travis's take on how it impacts crypto markets, he writes, You might bet that with the upcoming merge for Ethereum, at least ETH could decouple from the chokehold of the NASDAQ,

but honestly, I don't love that bet. For as big of a narrative as the merge is, I believe it's the most significant catalyst in crypto history, if traditional markets are in turmoil, it would be my base case the positive price impact from the merge would be delayed at best and cancelled at worst. Crypto-native capital has been decimated in the past four months. C-Fi borrow lending businesses have pulled back nearly every dollar of loans they could, a fraction of the leverage from that once massive corner of the market remains in place currently. The crypto-native capital that still remains is mostly long-Eath, but I believe the aggregate capital base is insufficient to carry ETH price much higher in the near term, in the face of

significant multipronged macro risks. I believe there has never been more large pools of traditional capital ready, willing and able to buy ETH in size. But I do not believe much of that capital will be willing to step in and buy Eith leading into and after the merge if the macro backdrop is as ominous as it currently appears to be. We'll come back to that macro stuff in just a few minutes. A third theme from Travis's list is continued institutional adoption, something that I've called post-narrative institutionalization. He lists BlackRock partners with Coinbase to provide crypto access on Aladdin platform.

BlackRock launches private trust for direct spot Bitcoin access. Facebook launches NFT integrations with Coinbase wallet, dapper, and flow blockchain. Reddit integrates with FTX to allow users to pay gas fees using Fiat. Now, I think this one is fairly simple. Despite narratives of crypto being dead or institutions not touching it, we've seen over and over again that that's just not the case. Instead, during this quieter time, you're seeing the slow and steady move of both big institutions and Web 2 into this crypto space. These folks aren't necessarily making huge moves, but they're preparing themselves to be ready to react to changing market conditions when they come. And I think that foundation

creates a lot of opportunity when we do make it through the current macro moment we're in. Similar to that, and related to the theme of not being dead, the fourth theme that I pulled from Travis's piece is fundraising. He lists coin fund raising $300 million, Schema Capital raising $200 million, led by Paradig, Gabe Layden raising $200 million, led by a blockchain game, a metaverse avatar platform ready player me raising $56 million led by A16Z, NFT collective proof raising $50 million led by A16Z, AAA Game Studio Gunzilla Games raising 46 million led by Republic Capital, DFI-focused L1 injective raising 40 million from Jump Capital, BH Digital, and blockchain gaming platform Xtero raising 40 million led by Fund Plus and FTX Ventures.

Just on his list alone, this is $700 million in crypto funds raised and $232 million in capital deployed. That doesn't include the 100 million Temasek round for Anamoka, and it also doesn't include the nearly everyday announcement of $2 million, $4 million, $10 million round, for young companies. I've done this shtick a million times about why this matters, but in 2018 and 2019, fundraising was dead. There was no capital or very, very little capital available to be injected into people building things. And ultimately, as much as narratives are useful, it's the things that people can get their hands on and interact with, that ultimately keeps people

excited and brings new people into the space. One of the reasons that I believe that we're unlikely to see as protracted a bare market, at least holding aside the macro factors, is that there is still so much dry powder being moved into high potential startups that are built on top of Web3, Defi, NFT, and crypto infrastructure. Lastly, a fifth theme from Travis's list is legislation, regulation, and enforcement. He includes senators introducing a bill establishing CFTC regime for crypto exchanges, House Committee on Oversight and Reform asking five crypto exchanges for info on fraud protection, Robin Hood Crypto being fined $30 million by the New York Department of Financial Services for

AML KYC violations, Michael Saylor stepping down as CEO of Micro Strategy, and then the Washington, D.C. Attorney General suing Michael Saylor and MicroStrategy for tax fraud, and an Indian regulatory agency freezing $8 million in assets on the exchange Wasier-X. Now, Summer is generally kind of a low time for this sort of stuff, but I think a lot of this previews what might happen this fall. It seems like we're coming to a head on the CFTC versus SEC thing, and it's going to be Congress getting involved even further in that discussion. It also seems to me like we could be in for a fall of enforcement actions from multiple agencies across the government.

All of that said, relative to the crypto industry, this was kind of an incredibly boring and quiet month. The tornado sanctions were really the only game-changing thing, the only thing that has huge, huge implications. The merge stuff is obviously going to be significant, But right now it's still more future-looking speculation. What happens this month when the merge actually comes to bear, assuming that it does, will be much more significant in terms of understanding how the merge is going to affect

crypto in the near term going forward. Now, part of the quietness of this month is the fact that it's summer. And part of it is that we're all living in a market context defined by the battle between inflation and recession with the Fed as the chief negotiator. As you heard from Travis earlier, even the merge is unlikely to break us out of this. Greg Johnson, the co-founder and CEO of Rubicon Crypto, called it a market purgatory. And I think that's pretty accurate. And since we base this whole thing on Travis, let's give him the last word as relates to the macro scene

that is just shaping so much of what's going on. He writes, there is a pile of risk present at the moment. It's hard not to be bearish in the coming months given the macro backdrop, the weight of QT, a global recession, and a dollar wrecking ball could easily grind asset prices down through year-end. Or something more cataclysmic could happen suddenly, and it could be a vicious down move followed by the Fed stepping in and putting in a bottom. There's good reason to believe that the Fed tightening until something breaks is becoming increasingly more likely. That could mean asset prices may soon fight a bottom, but it could be a seriously rocky road to get there. Or we could

somehow thread a needle and avoid a half dozen distinct landmines and asset prices could head higher into year-end, crypto-included. At the moment, it's hard to have that as your base case, though. So there you have it. A fairly bleak but clear-eyed view of where we are headed into the fall. Thanks to Travis Kling for doing these great reviews each month. Thanks to my sponsors, nexus.com. Chainalysis and FTX for supporting the show. And thanks to you guys for listening.

Until tomorrow, be safe and take care of each other. Peace. I want to tell you about CoinDesk's new event. The investing in digital enterprises and asset summit or ideas. The event facilitates capital. flow and market growth by connecting the digital economy with traditional finance. Join CoinDesk October 18th and 19th in New York City for a 360-degree investment experience, where you can source, invest, and secure the next big deal in digital assets.

Use code Breakdown 20 for 20% off at General Pass. You can register today at coindesk.com slash ideas.