The Breakdown - The Eerie Railroad of Crypto, Stablecoin Regulation, and the Cypherpunk Legacy

Starting point is 00:00:04 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 Sunday, July 20th, and that means it's time for Long Read Sunday. 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. All right, friends. Today we have something a little different for LRS. Regular listeners will know that

Starting point is 00:00:42 Blockworks recently combined their daily newsletter with this daily podcast, so it is all the big breakdown now, and the newsletter is written by Byron Gilliam and often has some of the best written content in crypto each week. Today, I am turning things over to the 11 Labs version of myself to read not one, not two, but three of Byron's pieces from this week. The first is called Crypto's Competitive Advantage, Saturday ICOs. Byron writes if Pump. Fun is a success, the New York Stock Exchange may have to return to a six-day workweek. In this century full of big tech successes, Europe's only big success is Spotify, whose shares are listed on the New York Stock Exchange. I mentioned this because New York is not

Starting point is 00:01:22 in Europe. Spotify was founded in Sweden, incorporated in Luxembourg, and keeps its accounts in euros. At the time of its 2018 IPO, half of its workforce and more than half of its customers were in Europe, but Spotify was one of 87 non-U.S. companies that chose to list its shares primarily in the U.S. that year. It's easy to see why. No market makes it easier to sell shares than the U.S. does, no matter where the company's from, and no market pays more for them. This is not a recent development. The U.S. has been a magnet for international investment capital for at least 200 years, in part because it was always easier to both start a company here and sell shares in it. In 19th century Europe, You needed a state or royal license to incorporate a company, for example.

Starting point is 00:02:07 In the U.S., you just filled out some paperwork and paid a processing fee. The U.S. had few restrictions on the issuance of stock at the time, so entrepreneurs could sell shares in those newly formed companies directly to the public with little, if any, regulatory oversight. Crypto-friendly readers may see where I'm going with this. The New York Stock Exchange required that companies be profitable and already have tradable shares, but there was an active over-the-counter market right outside the exchange where anyone could walk up and offer anything for sale to anyone. In Europe, by contrast, public share offerings were viewed

Starting point is 00:02:40 with suspicion and sometimes required ministerial approval. Perhaps most importantly, the U.S. developed a culture of small-scale shareholding far earlier than anywhere else did. The Erie Railroad was one of the first to do so, selling shares directly to retail investors in the early 1830s. Its relative success helped develop a culture of public equity investing. Retail enthusiasm for eerie shares inspired a wave of railroad IPOs, many of which were funded by European investors who had more capital than domestic investment opportunities. Europe also built railroads, of course, but these were mostly funded through government concessions or syndicates of banks. As a result, the U.S. finished the century with a much bigger railroad network than Europe did, despite having far fewer people.

Starting point is 00:03:24 American's enthusiasm for buying stocks has been one of the country's biggest competitive advantages ever since. Automobiles, aerospace, electronics, the internet, and AI. These capital-intensive industries all gravitated toward the place where it was easiest to raise capital, U.S. stock exchanges. But is there anywhere easier to raise capital than crypto exchanges? On Saturday, it took the Memicoin launchpad pump dot fund just 12 minutes to sell $500 million of tokens at a retail-friendly price of just $0.004 per token. Like the Erie Railroad, and unlike modern IPOs, much of this capital was raised from retail investors. Blockworks Jack Kubeneck reports that the median order size for Pump.com fund tokens was just $400, and that 20,000 accounts KYC'd with exchanges to qualify.

Starting point is 00:04:14 U.S. investors were excluded because of the still uncertain regulatory regime here, but the Pump. Pump. Fun ICO is a reminder that crypto markets are theoretically open to anyone with an internet connection at any time of day or night. The Pump. Dot Fun ICO alone raised more on a Saturday than the NYSE has raised on all Saturdays since at least 1952, when it stopped trading on Saturdays. This could prove to be a competitive advantage for the emerging digital economy. If crypto capital markets become the easiest place to raise money, that's where companies will go to raise it. And like non-U.S. companies raising capital in the U.S., non-crypto companies may someday raise capital in crypto. There are risks. Crypto's lack of regulation has attracted

Starting point is 00:04:55 projects more interested in avoiding oversight than in doing anything genuinely innovative or productive. The jury's still out on Pump. Fun, in my opinion. That might have to change. In the U.S., investing in equities didn't go truly mainstream until the SEC was formed, giving retail investors confidence that the market wasn't rigged against them. There is no such confidence in crypto markets, but 19th century capital markets were largely rigged against retail investors and productive industries. Banks, railroads, canals, managed to get funded and built anyway. Similarly, if the current crypto industry, for better and worse, was built by the Ethereum ICO of 2014, the Pump. Fund ICO of this weekend could be the start of the crypto

Starting point is 00:05:36 industry's next phase. In a best-case scenario, crypto capital markets could become to the 21st century what the U.S. equity market was to the 19th, a more flexible, more inclusive, and more speculative system of capital formation that out-competes the rigid incumbents of traditional finance. If a tech company as important as Spotify ever chooses to raise capital in crypto markets, pump.combe will go down in history

Starting point is 00:06:01 as the Erie Railroad of crypto. Today's episode of The Breakdown is brought to you exclusively by Grayscale. gray scale is almost certainly a name you know. They've been offering exposure to crypto for over a decade now and offer over 20 different crypto investment products ranging from single asset to diversified to thematic exposure to crypto and the broader crypto industry. They have long been innovators at the intersection of tradfi and crypto. And one of the benefits for a lot of us is that grayscale products are available right through your existing brokerage or IRA. Now, of course, investing involves risk,

Starting point is 00:06:40 including possible loss of principle. For more information and important disclosures, visit grayscale.com. Go to grayscale.com to explore their full suite of crypto investment products and invest in your share of the future. Next up, this was obviously crypto week in the house, and of course that was a big focus for Byron as well. He asked, can the Genius Act save banks from stable coins? Stable coins are yes a new form of money, he suggests, but an old kind of limit. money market funds, the world's most boring financial product, terrified bankers as soon as they started to catch on in the 1970s. When interest rates soared beyond what banks were legally allowed to pay on deposits, money market funds, which faced no such restrictions, suddenly looked like a threat to the

Starting point is 00:07:22 entire banking system. None other than Paul Volker called money market funds a regulatory arbitrage that weakens the financial system because they suck deposits out of banks. The problem was that banks couldn't compete with the higher interest rates on offer from money market funds because of Regulation Q, a 1933 rule explicitly designed to prevent banks from competing on interest. In the 1920s, banks engaged in a ruinous rate war, offering ever-hire interest rates to attract deposits. To pay these rates, banks had to make increasingly risky loans, creating a dangerous cycle that ultimately destabilized the banking system. Regulation Q sought to avert such competition by banning banks from paying any interest at all on checking accounts and

Starting point is 00:08:07 capping what they could pay on savings accounts and CDs. This is why banks became famous for giving out gifts in return for new deposits. They couldn't offer a higher interest rate than their competitors, so they offered toaster ovens and televisions instead. In 1979, for example, depositing $1,475 with the Republic National Bank for 3.5 years earned you a 17-inch color television, and the same amount deposited for 5.5 years earned a 25-inch one. Want an even better deal? Depositing just $950 for 5.5 years earned you a stereo with built-in disco lights. But even disco lights weren't enough to keep bank depositors from fleeing to unregulated money market funds. Money market funds were able to pay those higher interest rates because they didn't pay

Starting point is 00:08:53 interest. They got past regulation queue by paying dividends instead. This was and remains a distinction without a difference, but regulators chose to allow it in the name of financial innovation. Banks warned that this regulatory arbitrage would siphon away their deposits and impair their ability to make loans. They were right, too. In the decade or so after money market funds were introduced, retail savers moved hundreds of billions of dollars out of their local banks and into the new shadow banking system of money markets. As forewarned, this impaired the regulated banking system's ability to serve its core purpose of creating the money that the U.S. economy needed to grow. To their credit, regulators recognized the problem and, as early as 1970, began offering banks

Starting point is 00:09:38 various exemptions to Regulation Q. By 1986, interest rate caps had been almost entirely phased out. But it wasn't until after the great financial crisis, caused in part by a panic over unregulated money market funds, that lawmakers decided to fully repeal Regulation Q. The bell could not be unrued. However. For better and worse, the decision to allow money market funds to pay interest, while banks could not shift the foundation of the U.S. financial system from bank loans to capital markets. Now, the government's decision to allow stable coins into the U.S. banking system might do something similar. The Genius Act, expected to be signed into law any moment now, legalizes stable coins as a new form of money. Specifically, stable coins become non-bank money

Starting point is 00:10:23 that looks eerily similar to the money market funds that were de facto legalized in the 1970s over the objection of the banking industry. Lawmakers, however, appear to have long memories. This time around, the new form of money they're allowing will not be interest-bearing. The Genius Act prohibits issuers from paying interest on stable coins in the hope of protecting the banking system from the same kind of ruinous rate war that Regulation Q was designed to prevent. Interest-bearing stablecoins, it's feared, could further drain the banking system of demand, deposits, making it even harder for your friendly neighborhood community bank to give you a loan. It might happen anyway. If money market funds were able to innovate their way around regulation

Starting point is 00:11:03 Q, is there any doubt that crypto will be able to innovate its way around the Genius Act? Stablecoin issuers will likely figure out an equivalent of rewarding their users with toasters instead of interest. And even if they don't, DFI protocols will figure out ever more ways to pay interest. You can already get over 5% yield on stablecoins by taking a slimilar of smart contract risk with a protocol like compound. Tellingly, that might represent less risk than what bank depositors were initially willing to take with money market funds, and stable coin deposits are nearly as accessible too. Money market funds demonstrated that U.S. savers were eager to accept a little counterparty risk and a slight delay to withdrawals in return for higher

Starting point is 00:11:44 yields. So much so that today, money market funds are effectively risk-free because they've become too big to fail. The Genius Act may prove to be Stablecoins' first step in the same direction. Third and finally, we have a reflection from Byron at the end of a week which honestly was fairly significant in Crypto's history. The piece was called Anarchy, Crime, and Stable Coins. The House embraces crypto, but keeps the fences up. What would Timothy May think of Crypto Week? If the OG cypherpunk and author of the Crypto Anarchist Manifesto were here to read the statement from the House of Representatives, itself a kind of manifesto, declaring this to be crypto-week, I expect he'd have mixed feelings about it.

Starting point is 00:12:24 He'd certainly object to the idea of a crypto-gzar, appointed by the president of the very government whose authority he hoped to undermine. Cryptologic methods, he believed, would undermine government interference in economic transactions. On the other hand, he'd be pleasantly surprised, if not shocked, to learn that the U.S. government is banning itself from issuing a central bank digital currency. But he'd be most surprised to learn that the U.S. government's stated aim is to accelerate the adoption of cryptocurrency. The state will, of course, try to slow or halt the spread of this technology, he wrote in the manifesto. I guess not. He'd have reservations, sure. Markets, he thought, should self-police via mathematics, not laws, and that's not what's being promoted this week.

Starting point is 00:13:08 The Clarity Act, for example, applies the Bank Secrecy Act, public enemy number one for financial cypherpunks and other KYC-A-ML rules to most intermediaries. But intermediaries is the key word there. The Act also preserves the right to hold and use digital assets in personal wallets. May's vision was that two persons may exchange messages, conduct business, and negotiate electronic contracts without ever knowing the true name or legal identity of the other. Insert an intermediary, though, and even May might think the government is right to regulate. What might shock him most, though, is some of the rhetoric. Ensuring the future of the digital economy, Representative Tom Emmer says in the official House statement,

Starting point is 00:13:50 reflects our values of privacy, individual sovereignty, and free market competitiveness. Privacy and individual sovereignty are crypto-anarchist values, too. In that sense, CryptoWeak feels like a surprising vindication for May and the community of cypherpunks he inspired, bitcoins included. He would, however, take note of the multiple mentions of protecting consumers in the House statement and see that as evidence that the state is not surrendering its surveillance powers anytime soon. May ends his manifesto with a vivid image, governments fencing in citizens like livestock on a barbed wire ranch. Even after Crypto Week, I'm sure he'd say the fences remain up.

Starting point is 00:14:29 All right, friends, and with that, we are done with our whistlestop tour of the breakdown newsletter. If you are interested in subscribing to this and hearing more from Byron, go to blockworks.com slash category slash the dash breakdown or just go to blockworks.com and click newsletters. You can find it from there. Thanks to Byron for as always insightful thoughts. And thanks to you guys for listening. Until next time, be safe and take care of each other. Peace.

The Breakdown - The Eerie Railroad of Crypto, Stablecoin Regulation, and the Cypherpunk Legacy

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