The Breakdown - The Debate Around the Bitcoin Reserve

Episode Date: August 1, 2024

NLW catches up on the debate around a US Bitcoin Strategic Reserve, plus looks at the indictment of Nader al-Naji. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

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. What's going on, guys? It is Wednesday, July 31st. And today we are talking through a slew of news and updates on stories that we have been covering for sometimes weeks now. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. So where we kick off today builds off of the conversations that came out of the Bitcoin Conference over the weekend. Specifically, Bitcoin discussions continue to be dominated by the potential of a strategic

Bitcoin Reserve. The merits and mechanisms have become a point of contention everywhere from crypto-Twitter to the pages of the Wall Street Journal. A lack of detail has hindered the conversation thus far, relegating it to mostly a discussion of hypotheticals. Yesterday, Senator Cynthia Lummis released a draft version of her bill which would set up the legal structure for a Bitcoin reserve. This isn't necessarily the direction a Trump administration would ultimately go in, but it provides enough detail to think through how a Bitcoin reserve might work.

Lemmas is calling her bill the Bitcoin Act. The bill declares that, quote, Bitcoin as a decentralized and scarce digital asset offers unique properties that complement existing national reserves, strengthening the position of the United States dollar in the global financial system. The bill would instruct the Treasury Secretary to, quote, establish a decentralized network of secure Bitcoin storage facilities distributed across the U.S. Valtz would be chosen in a way to distribute control across geographic regions with a focus on security and accessibility. This sounds a lot like the security design currently used by high-end custodians, where private key signing devices are physically distributed and kept under lock and key.

Unlike Trump, Llamas was specifically proposing that Bitcoin should be purchased by the government. Her bill would establish a Bitcoin purchase program targeting 200,000 Bitcoin per year over five years. This would bring the reserve up to a total of 1 million BTC. The Bitcoin would be held for at least 20 years and could only be sold for the purpose, of reducing the federal debt. No more than 10% of assets could be sold in any two-year period. Individual states can also maintain their own Bitcoin holdings as a part of the reserve. During her appearance at the Bitcoin conference, Lumice emphasized that the purchases would be funded out of existing resources. This statement seemed like it was designed to avoid the obvious

criticism that the government would be adding to its debt in order to buy Bitcoin in order to eventually reduce its debt. Lomas unfortunately used the term excess reserves, which has a very specific meaning in the banking world. It refers to the reserves of private banks that are kept on deposit with the Fed. Lemus wasn't actually suggesting that money should be expropriated from commercial banks. Instead, she was proposing to redirect government funds already within the Federal Reserve system. The first source of funding would be redirecting profits from the Fed. $6 billion per year over the next four years would be committed to buying Bitcoin rather than being remitted to the Treasury. Over the past decade, the Fed has typically operated at a profit of more than

$75 billion per year. However, the Fed has operated at a massive loss over the past two years for the first time in its 109-year history. It currently has more than a more than a more than a more than a more than $133 billion to pay back to itself before it can continue remitting profits to the Treasury. The losses were largely driven by the rapid rise in interest rates, so probably aren't structural. Still, the source of funding would be heavily restricted for at least the first few years. The second source of funding would be a reduction in discretionary surplus funds held within the Federal Reserve System. This is currently stipulated to be $6.8 billion, but would be reduced to $2.4 billion. The most interesting source of funds would be a repricing of gold

certificates held by the Fed to reflect their market value. In 1934, the Fed was forced to to transfer ownership of its gold to the Treasury in exchange for gold certificates. According to their most recent balance sheet update, the Fed values these gold certificates at $11 billion. The book value is set by law rather than market prices and was last revalued in 1973. That value is still at 42 per Troy ounce with market values around 50 times higher. Under the Lumm's plan, the Treasury would revalue the gold and issue new gold certificates. The Fed would then remit the difference in cash value between the old and new certificates to the Treasury. Basically, the proposal wouldn't actually sell any gold, it would only mark up an asset already on the Fed's balance sheet. The idea of repricing the

gold certificates is a little strange, but it has a long history as a thought experiment in some circles. It seems as though it would work from an accounting perspective, but we don't know what the impact it would have. Intuitively, this would expand the Federal Reserve's balance sheet and could act similarly to QE, but directed at Bitcoin instead of U.S. Treasuries. There's also the issue that gold certificates are really just a quirk of history rather than a valuable asset. They were used as an accounting fiction in 1934 to ensure the Fed didn't become technically insolvent when the gold was transferred to the Treasury. The certificates are non-redeemable and haven't played a major role in Fed accounting since the 70s, when the U.S. dollar transitioned to a purely fiat

regime. Lin-Alden dived into this topic in early 2023 and came to the conclusion that the Fed's gold certificates were, quote, basically the original meme coins. Still, on paper, this does seem to be a functional way to monetize the increase in value of the Treasury's gold reserves. George Seljan, director emeritus of the Cato Institute, was concerned that this plan could undermine Fed independence. Growing the Fed's balance sheet without adding interest-bearing assets could leave the Fed without enough revenue to operate independently from government funding. This is one of the major ways the Fed asserts its independence by being entirely self-funded. After spelling out his concern, Selgin spoke with Lemma's staff. They explained that the process would be a lot smaller than

Selgin had assumed, only enough to fund the purchase of a million Bitcoin. He said that this would, quote, only have a small effect on the Fed's bottom line, so the concerns I expressed in my previous threads are not valid. The scale of the reserve is worth keeping in mind. At current prices, a million Bitcoin is worth around $65 billion. That value will no doubt be higher if the government conducted its purchases, but to put it in perspective, the Fed's balance sheet increased by $3 trillion in the opening months of the pandemic. Beyond the wonky monetary theory issues, discussion is now raging over whether a strategic Bitcoin Reserve is even a good idea in principle.

The Wall Street Journal editorial board weighed in on the issue arguing that Trump's pro-Bitcoin stance was antithetical to Bitcoin principles. They wrote, freedom from government isn't what he's proposing. He wants all future Bitcoin to be made in America, which, is a limit on freedom and would require a much bigger electric grid since Bitcoin mining is energy intensive. Dealing with the Lumas proposal specifically, they added, she says the government could reduce the national debt by investing in Bitcoin. If cryptocurrencies really are a libertarian vehicle to invest free from political vagaries, then they should trade on their own without

government help. Nobel laureate economist Paul Krugman also had a view, writing in the opinion pages of the New York Times that, quote, The truth is that Bitcoin, which was introduced 15 years ago, an eon in tech time remains economically useless. A couple of exceptions to its uselessness are money laundering and extortion. He argued that a Bitcoin Reserve would be, quote, a government bailout for a scandal-ridden value and environment-destroying industry. Bitcoin Magazine CEO David Bailey seemed confident to fade Krugman, who notoriously said in 1998 that the internet would be no more impactful on the economy than the fax machine. Shocker, Krugman, who is wrong about the internet and wrong about Bitcoin for the past 12 years straight, thinks their strategic

Bitcoin Reserve is a bad idea. Could there be any greater endorsement? Lynn Alden's take seems to be something like, sure, why not? She tweeted, The case would be to hold a top-performing money that can accrue value to the government versus one that gets to based. Its volatility can be mitigated via position sizing. The U.S. had among the lowest reserves in the world as a percentage of GDP, so adding to it makes some sense.

Sheila Warren of the Crypto Council thought the details were less important than the big picture. During a podcast appearance, she said, I actually took that as a serious policy question that I do think has legitimacy. There's pros and cons to this, but I think the point politically is that it's real. You could see it being debated and being something that gets crafted over time and becomes policy. Pretty wild. Hello, friends.

Before we get back to the rest of the show, I want to implore you to join me at Permissionless. Permissionless is the conference for Cryptonatives by Cryptonatives, and the reason it's so important this year is that despite regulators' best attempts to push industry founders, devs, and executives out of the U.S., the United States remains the beating heart of crypto. Today, the tide is turning. Policymakers have pivoted from fighting crypto to embracing it. Literally now, we are in a major political parties platform, which will lead ultimately to the creation of new financial products, new applications, and ultimately new adoption. Permissionless is the conference for those using and building on-chain products. It's home to the power users,

the devs, and the builders, and perhaps more importantly, I will be there. The location is Salt Lake City, the dates are October 9th to the 11th, and tickets are just $499. If you want to get 10% off, use code breakdown 10. Go to the Blockworks website, blockworks.com. There will be links to register for the conference, and again, you can use code breakdown 10 to get 10% off. Next up, while the Lummus bill is presented at being about reducing government debt, you might have noticed that Trump's rhetoric about Bitcoin has been entirely framed in the context of geopolitical competition. So far, his focus has been on China, but Russia seems to be taking further steps towards regulating Bitcoin within their economy. On Tuesday, the lower house of the

Russian parliament, known as the state Duma, passed two new crypto. laws. The first would fully legalize Bitcoin mining beginning in November. Large miners will be able to register with the Ministry of Digital Development, while smaller operators can avoid registration by sticking below energy consumption limits. Several regions in Siberia have recently experienced electricity shortages attributed to Bitcoin mining. This new licensing regime would grant Moscow greater control over mining up to and including regional bans. However, this could also be viewed as a way to increase state control over the mining industry, with bureaucrats handing out licenses as they see fit. This law would also ban crypto advertising and allow the central bank to put in place a crypto transaction

ban if necessary to maintain financial stability. A proposed total ban on crypto trading was dropped from the bill before it went to a vote. The second law dealt with the use of crypto for foreign trade. Beginning in September, the Bank of Russia will commence an experimental regime to allow cross-border settlement of trade using crypto. Current regulations prohibit the use of crypto to pay for goods and services. Companies and crypto exchanges would need to apply to take part in the experiment. There is a lot more to dig into here, but I think it's mostly summed up by Alex Rucos, the CEO of Citizen X, who tweeted, Russia just passed a bill to legalize Bitcoin mining and crypto payments. Three days after Donald Trump announced a strategic Bitcoin reserve. Let the game theory begin.

Now, one of the most discussed pieces of news, at least on crypto Twitter, was the news that BitClout founder Nader El Naji was arrested on Saturday and has been indicted for wire fraud. The SEC has also brought a civil complaint for the sale of unregistered securities. According to court documents, El Naji raised approximately $257 million from the sale of BitClout's native token. He led retail traders to believe that Treasury funds wouldn't be touched to pay himself for his team, but would be used for quote-unquote something good. Instead, the SEC alleges that Al-Nagy spent more than 7 million worth of investor funds on a Beverly Hills mansion and, quote, extravagant cash gifts. Now, if you're not familiar with BitClout, it was one of the more

major attempts at a crypto-social media app. Launched in 2021, the app leveraged the likenesses of celebrities by creating profiles for them ahead of time in hopes of luring them to the platform. Later that year, Al-Naji launched a blockchain called DeSo, short for decentralized social. For a time, it was one of the hottest VC investments in the space, attracting 200 million in funding from Sequoia, A16Z, Chamoth's social capital, and Coinbase ventures among many others. The core of the SEC allegations are that Al-Naji took steps to present the platform as decentralized when it was nothing of the sort. They claimed that he promoted the project to something with, quote, no company behind it just coins and code.

Al-Naji also, quote, allegedly secured a letter from a prominent law firm opining, based on his mischaracterizations of the nature of his product, that the native tokens were not likely to be deemed securities under federal law. The SEC said in a press release, as alleged in our complaint, Al-Nagy attempted to evade the federal securities laws and defraud the investing public, mistakenly believing that being fake decentralized generally confuses regulators and deters them from going after you. Now, the criminal charge of wire fraud stems from fraudulently conveying investor funds to family members, including his wife and mother, who are named as relief defendants.

BitClout was controversial from the beginning. Many big names on crypto Twitter had profiles created for them without their consent. Shortly after the platform went live, lawyers from crypto law firm Anderson Kill sent to cease and desist claiming the project used their likenesses without permission. The profiles were immediately taken down, suggesting that the claims of decentralization were a little exaggerated. A pitch deck was leaked by Kobe, which described a scheme to buy into low-price creator coins ahead of them coming on the platform.

Kobe himself described it as a pump-and-dump-looking vehicle. Lastly today, one of the things we've been watching to see is whether as the Mount Gawks distributions happen, there would be a rush to the exit among long-term forced holders. Well, after waiting more than a decade in seeing 8,500% gains, it appears that most Mount Gox creditors are still holding on to their Bitcoin. A week after Cracken users receive their coins, Blastin has been unable to find any signs of increased selling. In a report published on Monday, they wrote, we can see a marginal uptick in cell pressure

following the distribution. However, this remains well within typical day-to-day ranges. Analysts noted that creditors fought hard over the years to receive Bitcoin rather than Fiat, so we probably shouldn't be that surprised. Around 41.5% of the Mount Cox Estate has now been distributed, around $4 billion worth. BitStamp users are still waiting on their coins to be unlocked, but a portion have already been received by the exchange. It appears as though a further 47,000 Bitcoin was sent out by the Mount Gox Estate earlier this morning, representing a further 3 billion in distributions. The Mount Cox estate has around 46,000 Bitcoin left, but we're likely getting close to the end of this round of repayments. The second round of repayments

is not yet scheduled, but will be made available to creditors who chose not to take a 10% haircut in exchange for early distribution. All right, friends, that is the story from where I'm sitting. Still lots of other things going on. We've got a circle IPO valuation. Goldman talking about Bitcoin is a store of value. But we will come back to all of that later in the week. For now, appreciate you listening or watching as always, and until next time, be safe and take care of each other. Peace.