In This Newsletter
Industry Developments
Global Developments
Industry Developments
Ethereum’s Update
Ethereum made big cryptocurrency news this month with the implementation of its London hard fork on August 5, which included the much-anticipated EIP-1559 update, as reported by Decrypt. EIP-1559 represents a major change to the gas fee structure on Ethereum and aims to eliminate congestion on the blockchain, which is usually caused by a backlog of transactions. The resulting blockage on Ethereum affects the number of transactions per second that the blockchain can process and increases the gas fees charged to transacting parties. It’s a simple case of supply and demand in the crypto market: As the demand for transactions increases and processing capabilities remain the same, gas fees rise. To avoid the resulting queue from the buildup on the blockchain, some parties have paid higher gas fees in their pitches to miners, according to Bitcoinist. The London hard fork aims to avoid this situation by instituting an algorithm that automatically calculates the gas fee at the time of the transaction, thereby avoiding the bidding activity to miners to speed transactions up. The base fee charged for the transaction won’t go to miners but will instead be burned to remove the supply of ether from circulation to keep prices stable. There have already been deflationary verified blocks approved after the hard fork, which means the amount of ether created from a transaction was less than the amount being destroyed. For those interested in live updates on Ethereum’s burn rate, you can check out this detailed live tracker developed by etherchain. The true effect of this new protocol remains to be seen, but it does address the criticism of ether’s unlimited supply compared to Bitcoin’s hard cap of 21 million coins. Could this new scarcity and deflationary pressure give even more momentum to ether’s rise over the past year? Regardless of whether EIP-1559 has a positive effect on ether’s price in the long run, the new upgrade to the network is a feat of its own. The London hard fork sets an important precedent for future upgrades on other networks and proves that blockchains can adapt to new demands and problems as the digital asset ecosystem evolves.
The Stablecoin Landscape
Circle, a digital payments infrastructure company that manages the second-largest stablecoin USD Coin (USDC), has filed for a federal commercial bank charter. The announcement from CEO Jeremy Allaire represents the firm’s move into traditional banking to capitalize on the $27.5 billion worth of USDC circulating in the economy. According to Deloitte, a federal commercial bank charter would grant Circle stable Federal Deposit Insurance Corporation (FDIC) protection on deposits, emergency borrowing from the Federal Reserve, and a more efficient and navigable regulatory framework for cross-border activities.
This move is a direct attempt to become the poster child of the stablecoin market and operate within the good graces of the federal government, considering its primary competitor finds itself in hot water with regulators from the New York Attorney General’s Office (NYAG). In February, the NYAG fined Tether over $18 million for misleading customers in its claim that its stablecoin was fully backed one-to-one by dollar reserves, demonstrating evidence that the company periodically had no on-demand access to cash holdings. Even after releasing a more comprehensive report detailing its assets and liabilities, Tether is still being scrutinized for its investments. As The Wall Street Journal reports, Tether’s asset mix consists of commercial paper, secured loans, treasury bills, corporate bonds, digital tokens, repo notes, and, of course, cash. What’s concerning here is that what Tether files as “other investments and digital tokens” accounts for $2 billion of the total $63 billion in assets, still showing a lack of transparency.
Circle’s most recent attempt to self-regulate wasn’t its first, as its divestiture from Poloniex set a compliant tone back in 2019. A recent Securities and Exchange Commission (SEC) filing shows that Circle posted a net income of almost $4 million in 2020 after significant losses and expenses absorbed by the company after selling off its assets related to Poloniex. Compliance didn’t come cheap. The company took on a realized loss of $156.8 million as a result of this divestiture, after originally acquiring Poloniex for $400 million in 2018, according to Coindesk. However, it seems that Circle’s decision paid off, as the SEC charged Poloniex for operating as an unregistered digital assets securities exchange platform. In short, Poloniex pursued an aggressive growth strategy and allowed users to trade risky assets that were actually investment contracts. It didn’t work, and the SEC determined that the platform failed to comply with Section 5 of the Exchange Act.
The Cryptocurrency Crackdown
The SEC crackdown on Poloniex ties into a larger conversation about what will happen with regulation in the crypto world. Firstly, it is important to recognize the situational irony resulting from the rapidly increasing institutional involvement in the digital asset space. As Bloomberg notes, cryptocurrencies started as a movement to remove institutional intermediaries from finance in favor of software protocols and new self-executing “smart contracts.” The blockchain would be an immutable, transparent, decentralized public ledger recording and validating transactions that typically flowed through big banks. But now, the very financial intermediaries that crypto and blockchain sought to eliminate are pivoting and taking advantage of the ecosystem. Investment banks and wealth management firms are becoming active crypto traders, payments companies are leveraging crypto as a medium of exchange, mutual funds are looking to establish cryptocurrency Exchange Traded Funds (ETFs), and an increasing number of banks are vying for cryptocurrency custodial service approval. All this adds up to crypto no longer being the niche space it once was, which Gemini co-founder Cameron Winklevoss noted in a tweet on August 8, writing:
“#Bitcoin and crypto is no longer a niche group. We are a movement of tens of millions and growing. Our industry will be the dominant economic growth engine this century. We care about the future that we are building and we're determined to have a seat at the table.”
This is good and bad news for crypto enthusiasts. On one hand, it shows collective buy-in into the intrinsic benefits of digital assets, distributed ledger technology, and the potential of decentralized finance. But it also means regulation is incoming, as the risks have permeated to a wider range of retail investors, mutual funds, pension funds, etc. This is why SEC Chairman Gary Gensler and his agency are expanding their oversight over crypto markets. Exchanges like Poloniex can no longer fly under the radar as both the benefits and the risks become distributed across the new digital economy.
Cryptocurrency Valuation
The curious part about institutional involvement is how banks value digital assets as they would with other asset classes like equities, bonds, and real estate. Common metrics for public equities are Price/Earnings, Enterprise Value/EBITDA, EV/Revenue. However, there is still no consensus for what equivalent metrics exist for digital coins and tokens, which aren’t companies that generate revenue. So, the question arises: What makes one cryptocurrency fundamentally more valuable than another cryptocurrency?
Coindesk attempted to take a crack at understanding crypto valuations and concluded that the value of a cryptocurrency depends on its underlying blockchain. Additionally, not all cryptocurrencies will be able to be valued with the same metrics; Decentralized Finance (DeFi) tokens can have Price/Earnings ratios because of the interest that is generated for token holders from the lending protocols, but the same metric wouldn’t apply to Bitcoin, for example. As more institutions and investment funds start investing more heavily in digital assets, it will be interesting to see the crypto equivalent of a discounted cash flow model or a comparable companies analysis.
Global Developments
Governance Tokens and Messi’s Transfer Deal
Lionel Messi, the longtime soccer star for FC Barcelona, is on the move to France to play for Paris Saint-Germain (PSG), and he’s blazing a new trail for the intersection of sports and crypto along the way. According to Reuters, Messi will receive a considerable quantity of PSG’s fan tokens, which are essentially governance tokens fans can purchase to maintain a say in minor votes and decisions related to internal club operations. The fan token hit an all-time high of $61.23 following the announcement of Messi’s transfer to PSG on August 10 but has since fallen back to its normal trading range between $30 and $40. These tokens are an ingenious way of bringing in revenue for the club while also giving fans a chance to participate in what is usually a closed-off institution. As such, these new partnerships between the sports world and crypto could open new opportunities where we see tokens leveraged to give the public insider access to their favorite teams, artists, and organizations.
India’s e-Rupi
India recently revealed its own government-backed “e-RUPI” digital payments platform that will allow money transfers in the form of QR codes and SMS strings, according to The Indian Express. While this initiative is separate from India’s CBDC studies, it maintains much of the benefits of a national digital currency, like financial inclusion and seamless welfare payments. According to PwC, the e-RUPI is primarily a voucher-based payment-to-merchant (P2M) system that enables the government to disburse money to individuals and entities with the help of issuing banks and the National Payments Corporation of India’s United Payments Interface. The vouchers will not be transferable in a peer-to-peer format, meaning the receiving party must spend the money at an approved merchant that is part of the e-RUPI program. As such, the hope is that e-RUPI will develop into a system that enables efficient transfers of agricultural subsidies, education subsidies, health insurance, and other services that can be used to stimulate local economic growth and promote general welfare.