The Breakdown - Will Withdrawals Drive a New Institutional Ethereum Narrative?

Episode Date: April 15, 2023

This week on the “Weekly Recap,” NLW looks at the Shapella upgrade, including emergent narratives around institutional investment, as well as checking in on the FTX bankruptcy estate and previewing the House Financial Services Committee oversight hearing with Securities and Exchange Commission Chair Gary Gensler next week.  - “The Breakdown” is written, produced and narrated by Nathaniel Whittemore aka NLW, with editing by Michele Musso and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Join the discussion at discord.gg/VrKRrfKCz8.  

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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 produced and distributed by CoinDest. What's going on, guys? It is Saturday, April 15th, and that means it's time for the weekly recap. A quick reminder before we dive in, the breakdown is expanding to be common. the Breakdown Network. We've launched a new show, Bitcoin Builders, which you can find pretty much wherever you listen to podcasts. And most importantly, if you are listening to this, the main breakdown show on the CoinDesk Podcast Network feed, you will need to switch over to the breakdown-only feed,

because after April 23rd, this show will only be on that breakdown-only feed. All right. So there has been a lot of macro and big picture thinking this week around things like AI. So for the weekly recap, I wanted to shift back and catch up on the big, crypto news. And obviously we need to start with the biggest protocol level event of the week, which is Ethereum's much-anticipated Chappella upgrade, which is actually kind of two upgrades and one, that went live on Wednesday night after months of work. This was in many ways the culmination of Ethereum's transition to proof of stake. The key feature added in this upgrade was enabling staked Ethereum to be withdrawn. Some of the earliest stakers have had their tokens

locked up for years at this point, so there was rampant speculation around whether these investors would withdraw their stake to realize any gain or loss. Now, it should be noted that over the last year, the rise of liquid staking options like Lido and Rocket Pool have allowed investors to maintain liquidity while still receiving their staking yield, which you would think somewhat reduces the need to withdraw to access liquidity for at least some investors. Also worth noting that withdrawals are limited by a queue system, restricting the number of stakes that can be withdrawn per day.

Going into the upgrade, the data seemed to indicate that the demand for withdrawals would be fairly minimal. Last Sunday, Ave founder Mark Zeller pointed out that the concerns about a long line of stakers waiting to get out just hadn't materialized. He wrote, one thing they won't tell you. You can withdraw now. If you're afraid, you can voluntarily exit right now. Meaning you'll be first in line to grab your ETH post-Shanghai. With Shanghai in three days, the empty withdrawal cues tell you everything you need to know. Zero real stakers panic. What happens if you exit now? You don't earn around two days of staking revenue. So around 450 per node. Then when Shanghai hits, your exit is proceed and you get your 32-Eath back,

and all yield when it's your turn on partial withdrawal queue. Anyone can do it, no one is doing it, end quote. CryptoQuant noted that 60% of stake deeth supply around 10.3 million eth is currently sitting at a loss compared to when it was staked. Some analysts suggest that large selling pressures tend to form around realizing profits rather than locking in losses, so this unrealized loss among stakers could in fact cause investors to hold their positions even though withdrawals are available. Another theme that was discussed frequently in the lead-up to the upgrade was the concept

of de-risking the Ethereum staking mechanism. When the merge happened in September, it was an open question when withdrawals would be turned on. Developers gave a vague timeline, but nothing was known for sure. Now that the Chapella upgrade has been completely successful and the withdrawals are available, staking is de-risked. Many think that this could incentivize more investors to participate, which is something we'll get back to in just a moment. In a research report last week, Bank of America, who have increasingly been providing crypto research, said that the Chapella upgrade was only an incremental improvement. Their analysts wrote that the upgrade does not address scalability issues, but, quote, acts as a precursor for future upgrades, providing a small

step forward. They view Ethereum upgrades as, quote, significant technological accomplishments, but not necessarily more significant or advanced than those implemented by next generation blockchains that have emerged as viable alternatives. End quote. The report said that Ethereum's long-term viability relies on successfully addressing scaling issues through the implementation of protocol upgrades, such as sharding, which is on the roadmap to be implemented in the next few years. Now, these Bafa analysts also dismiss concerns about people mass withdrawing ETH, saying, noting that the withdrawal process is designed to, quote, prevent a short-term mass exodus of validators and the resulting security risks. All right, so this was all the conversation in the lead-up to the actual event, which happened on Wednesday night.

So what actually happened on Wednesday night? In short, not much, really, which I think is pretty much exactly what the Ethereum community was hoping for. The upgrade came online without any major problems, taking 15 minutes to complete around 642 Eastern Time. Vitalik Buterin told a live stream watch party, We're in a stage where the hardest and fastest parts of the Ethereum protocols transition are basically over. Very significant things still need to be done, but those very significant things can be safely done at a slower pace. Looking at the future of the Ethereum roadmap,

Vitalik also spoke about the scaling solutions which would be next on the agenda to make Ethereum faster and cheaper. Quote, if we don't fix scaling before the next bull run, we know people are going to be stuck paying $500 transactions. But what about this question of whether there would be a mass wave of withdrawals? Well, it just seemed not to materialize. Ethereum traded relatively flat following the upgrade and jumped by about 3% the following morning.

Overnight on Wednesday, the withdrawal queue filled up to sit at 19,000 validators waiting to withdraw. However, 79% of that withdrawal queue was filled up with requests from Cracken, who agreed to shut down their staking product in the settlement with the SEC in February. What's more, the withdrawal queue represents less than 3% of the total ETH validators, and currently validator count is rising at a modest pace. In other words, more new validators are coming online than are exiting the protocol. On top of that, Nansen's Andrew Thurman noted in a Twitter post that, quote, The majority of withdrawals are addresses withdrawing their rewards, not their rewards plus full stake.

At current pace, it's reasonable to assume the total amount of staked Eath will trend down, but there remains strong inflows as well. Now, on Thursday, with the upgrade finalized and fears of a massive withdrawal having failed to materialize, Ethereum went on a bit of a tear, rising more than 10% for the day and pushing well past the 2000 mark. The number of tech skies that I got that said $30,000 Bitcoin, $2,000, ETH, Ain't It Grand, was just wonderful to see. I don't think you have to care that much about prices to still feel the joy of there being a little less pressure in that area, right?

So where does Ethereum go from here? One of the burgeoning narratives is that this opens the door to institutional actors. Crypto-Yutuber that Martini guy says, the Ethereum-Shanghai unlock, as expected, did not result in a sell-off. In fact, what it did was open the doors to institutional investment in Ethereum staking. Prior to the upgrade, private and public wealth funds could not offer Ethereum staking as an option to clients because the unlock period was undefined, meaning investors didn't know if and when they could access funds. After the unlock, now many funds buy Ethereum

so they can offer this service to their clients as it is in high demand. Unless you think that this narrative is only coming from the YouTube set, Rich Rosenblum, co-founder and president at GSR, a crypto market making firm, said something pretty similar, that the upgrade should reduce risk for potential investors. Lower volatility, he said, plus a yield. makes for a more familiar and less risky asset to hold long term. Once the POS network is fully operational, more institutions will feel comfortable holding ETH, especially once the staking yield becomes more accessible. Now, overall, this leaves Ethereum in a really interesting spot.

On the one hand, the big parts, as Vitalik said, of this transition to proof of stake are behind them. They went off from a technical perspective about as flawlessly as anyone could have wanted. There's clearly a strong community who's not interested in just getting out now that withdrawals are available. and I think that the point that withdrawals are available makes the asset stronger is absolutely the case. There is, of course, a big hitch, though, when it comes to how much this will drive institutional investors in. One is the question of overall what the institutional investor profile looks like anymore in the wake of FTX.

I think that's something that we maybe have some idea of, but not really not yet. The second challenge that Ethereum faces is, of course, on the regulatory sphere. Let's not forget that in their suit against Ku-coin, the New York Attorney General accused Ethereum of being a security. Of course, the CFTC in action after that made their position that ETH is a commodity quite clear as well, but this remains a battle. And even if it's super clear to you that in the long run, Ethereum will be not considered a security, to the extent that we're talking about this institutional investor narrative, even just having questions around it could be a challenge. Now, speaking of the FTX collapse, let's go to some new news from that front for the second part of this show. We got a bunch of updates this week, and the TLDR headline is that lawyers for the FTX estate are claiming that the

quote, dumpster fire is out. With four former executives now located and charged and the lengthy asset recovery process now showing signs of significant progress, the FTCS legal team put forward the impression that a fairly full picture of the situation had been formed and they were ready to move forward. Last Sunday, the exchange filed its first interim report

about control failures at FTX. Frankly, nothing in there is all that new. It's just more details on what was clear right from the beginning following the failure. One quote that did get a lot of traction came from former CEO Sam Bankman-Freet, who said at one point to colleagues, quote, Alameda is unauditable. I don't mean this in the sense of a major accounting firm would have reservations about auditing it. I mean this in the sense of we were only able to ballpark what

its balances are, let alone something like a comprehensive transaction history. We sometimes find $50 million of assets lying around that we lost track of, such as life. Now, lawyers for FTCS summarized the lack of corporate controls at the exchange in a blistering tone during the court hearing. Quote, Mr. Brankman-Fried repeatedly, pervasively, and often persuasively lied to stakeholders and customers and creditors in order to maintain a digital con game. FTX was a facade, a digital Potemkin village, or perhaps more apt, a video game. Behind the user interface, there was no correspondingly sophisticated reality, no equivalent process for segregating assets or reconciling trades,

no reliable relationship between the positions reflected in the online game, and the underlying positions held in the real world. So like I said, more colorful language, but nothing really new here. No one detail that might have been more of interest, especially for people who were affected by the bankruptcy. As part of the update, FDX revised the amount of liquid assets recovered up from $5.4 billion in January to $7.3 billion currently. The additional $1.9 billion recovered is broken down into $300 million in cash and $600 million in settlements and receivable investments. The additional billion dollars is accounted for as price appreciation in the existing

$3.7 billion crypto and securities portfolio already recovered prior to the January hearing. In other words, as Rookie XBT tweeted, FT recovered $7.3 billion not because they found it in their couch, but because Bitcoin is up 2x since they went into bankruptcy, LMAO. Still, the thing that really captured everyone's attention, at least on crypto-Twitter, was the possibility that the FTX lawyers are floating of a restart. Exchange CEO, John J. Ray 3, has floated the idea in an interview in January, but had not yet presented it before the court. The move would need capital, which the bankruptcy team suggested could come from fundraising

or from allowing creditors to convert their claims into equity in the relaunched exchange. FtX lawyers explained, quote, there are possibilities that customers could have an option to take part of their proceeds that they would otherwise receive in cash from the estate and receive some kind of an interest at the exchange going forward. The lawyers, however, went to pains to note that the idea is a long way from being ready, having not even reached a consensus within the bankruptcy team. Ray said, there are as many opinions on this, I think, as there are professionals involved in the case, and that is a lot. Now, this has the crypto community pretty mixed, and of course

people have been talking about it for a while, but it's now getting a little bit more momentum. On the one hand, you have the perspective represented by Autism Capital, who wrote, It's insane that opening FTX would even be a consideration. The brand has been irreparably damaged. Sam's shenanigans were the only thing giving it hypergrowth, and new customers will be wary of being exit liquidity for the debtors. There must be colossal outside pressure. Lundart, on the other hand, said to anyone new to the bankruptcy,

most of this is nothing new. But yes, FTX 2.0 is probably going to happen, which is awesome, since it lets creditors get a piece of an exchange they can all rebuild. Finally, make an exchange buy traders for traders and turn a horrendous fraud ordeal into something positive. Now, Travis Kling, who was deeply affected by the FTX collapse, took a kind of middle path, saying, lots of conjecture about the likelihood of an FTX restart being successful. It will come down to the management team, strategy, and transparency. If those three boxes get checked, it's highly likely the exchange will be successful,

and recoveries for creditors will be high and entirely whole. I don't know, man. I will admit that I have not spent very much time thinking about the possibility here. My first instinct, though, is that it's a real challenge. What the idea has going forward is that it seems that not too many people have tried to imitate the type of derivatives infrastructure that FTX had for international customers, and maybe that's something that traders actually want. Although at the same time, go listen to my interview with Checkmate James Check from Glassnode

from Thursday on Bitcoin Builders, as he talks a lot about how much healthier the market seems post-FTX, so I'm not necessarily sure it's something we should be rooting for. I also think that there are real big brand challenges. I'm not exactly sure what combination of team and narrative it would take to overcome them, but for now, count me in the not particularly optimistic field. I am, however, glad for all the creditors that the legal team is at least considering it because it should be on the table as one of the options for the best possible outcome for creditors. All right, one last note as we wrap up this weekly recap,

and this is really more of a little bit of a preview for next week. SEC Chairman Gary Gensler will finally be testifying before Congress at an oversight hearing on Tuesday. This will be the first time Gensler has appeared before the House Financial Services Committee since Republicans claim control of the House in January. Pro-Crypto lawmaker, Representative Patrick McHenry, is now chairman of the committee and has been at odds with the regulator's dismissive attitude towards Congress. In February, McHenry and Representative Bill Huizengo

requested information from the SEC regarding the arrest of SBF the night before he was set to testify before the House Financial Services Committee. This week, Gensler responded after the deadline and in a manner that the lawmakers found on Saturday. factory. In a subsequent letter sent on Wednesday, the two House Republican leaders were irate. They wrote, quote, ignoring the deadline, the SEC actively impeded committee staff from discussing the request with anyone in the office of the general counsel until Chairman Huizenga formally requested a conversation with the SEC General Counsel. The subsequent staff level conversations have yet to yield any of the requested documents. The letter threatened to use a, quote, compulsory process,

if necessary, to obtain the requested information. Now, there are three major topics on the agenda related to the crypto industry. First, a March rulemaking proposal, which would broaden the definition of a securities exchange to cover, quote, communication protocol systems, which is a move widely seen as an attempt to expand the SEC's scope and to cover crypto trading platforms as well as some private trading venues. Second, a staff accounting bulletin also released in March, which tightened the rules around how custody digital assets are accounted for bypassing the rulemaking procedure. And finally, the change is proposed in February, which would require SEC registered investment advisors to custody their client's digital assets with a registered custodian. This is a rule

which caused consternation in the industry due to a lack of clarity around which existing institutions would qualify under this rule. One financial services committee member unlikely to mince words on Tuesday is Republican whip Tom Emmer. In an appearance on Unchain last week, Emmer called Gensler a bad faith regulator, accusing him of, quote, blindly spraying the crypto community with enforcement actions while completely missing the true bad actors. Get your popcorn ready, friends. This should be a good one. For now, though, I want to say thanks, thanks as always for listening. I hope you have had a wonderful week. Go check out Bitcoin Builders. If you haven't, I've got three great episodes up there now with more to come next week.

If you want to talk more about AI, which I got into in a couple of the episodes this week as well, check out the YouTube channel. YouTube.com slash at the AI breakdown. And for everyone who's here, just hanging out and listening to Big Picture Power Shifts, I appreciate you endlessly. Until tomorrow, be safe and take care of each other. Peace.