February 10, 2023

Exploring transformation of value in the digital age

By Michael J. Casey, Chief Content Officer

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After the FTX debacle, many wondered how quickly and how big a show of force U.S. regulators would put on to demonstrate they’re on top of things. Well, this week, we got a response confirming everyone’s worst fears: over-reaction and enforcement-without-guidance are to be the order of the day. In this week’s column, I look at two fresh cases of what I see as ill-thought regulatory actions, ponder why they had to be so brutal, and consider what it means for U.S. leadership (or lack thereof) in Web3 innovation. 

This week’s Money Reimagined podcast sees my co-host Sheila Warren and I reunited after a month of not working on a show together. We talk to Colin Butler, head of institutional capital at Polygon, about the wave of real-world-asset tokenizations coming to market.

Have a listen after reading the newsletter. 

(Rachel Sun/CoinDesk)

Call me naive, but I’ve always resisted the conspiracy theory that the anti-crypto stance adopted by certain U.S. regulators is meant to strangle this industry and protect the financial establishment it seeks to disrupt. I’ve preferred to see it as a wrong-headed but well-intended effort to protect consumers.

Recent events have me wondering if something more sinister isn’t afoot. (And that maybe I am naive.)

First, all indications are that the Securities and Exchange Commision will outright prohibit companies from providing staking services to retail customers, products that give investors an opportunity to share in the token rewards that proof-of-stake blockchains deliver to validators. Following a hint from Coinbase CEO Brian Armstrong Wednesday that such a ban was coming, news broke Thursday that, in response to an SEC lawsuit, Coinbase competitor Kraken is indefinitely abandoning the staking service it offered to its customers, and paying a $30 million fine.

Second, per observations from Castle Ventures general partner Nic Carter and Blockchain Association chief policy officer Jake Chervinsky, and evident in other signs, such as Binance’s problems with USD bank transactions, it seems regulators are pressuring U.S. banks to stop servicing crypto companies.

These latest moves will make it even harder for small U.S. citizens to participate in this industry, limiting it to large institutional investors, while various innovative startups looking to disrupt those same rent-seeking intermediaries will struggle to access liquidity. It’s hard to understand how these actions serve to protect consumers or further other policy objectives such as expanding financial inclusion. It feels as if government agents are deliberately trying to force this industry into the hands of Wall Street fat cats.

But here’s the thing: making it hard for Americans to invest in and build crypto projects won’t stop people outside of the U.S. from doing so. Hardline actions here will just push activity overseas. And while the U.S. might continue to generate business in “institutional crypto,” it will miss out on the true innovations occurring at grassroots levels.

To be fair, SEC Chair Gary Gensler has been warning for some time that staking services could constitute unregistered securities, which would mean that exchanges such as Coinbase could be barred from listing them.

The argument hinges on the income-like earnings that validators of proof-of-stake blockchains earn in the form of new tokens and transaction fees when they lock up pre-existing tokens, putting them  at stake in a mechanism intended to keep them honest. It could be argued that the promise of fresh token income meets one part of the all-important Howey Test, which posits that for an investment instrument to be a security the investor needs to have an expectation of return. And from the complaint against Kraken, it appears that the exchange’s role as an intermediary managing the pool of staked token investment meant that, in the SEC’s eyes, it tripped up another Howey prerequisite: that the expected returns are “derived from the effort of others.”

Fine. In a letter-of-the-law sense, the SEC’s backlash against staking may have some standing. But why do this now, and in such a brutal way, shutting down a well-functioning program without offering a company get its program into an SEC-compliant structure?

Off the Charts: Wither Long-Term Yields?

This chart is inspired by a tweet from Realvision Founder Raoul Pal in which he queried whether the recent spike higher in 10-year Treasury yields “is just pandemic-related noise and the [long-term] trend remains?” 

It’s a vital question for investors, since the recent rise in yields has cut into the cost of borrowing, which has harmed markets, including that of bitcoin and other cryptocurrencies. 

Pal used a logarithmic chart. I spun up one based on nominal rates. In both cases, the long, 40-year secular downtrend is evident, followed by the recent disruption from that trend. 

Over time, the key drivers of a secular trend of this nature are inflation expectations, which in turn dictate expectations for the short-term rates the Federal Reserve sets. That’s why there was a runup in yields during the high-inflation 1970s and a spike higher again in the 1980s, when Fed Chairman Paul Volcker jacked up rates to cool the economy and break the back of rising prices. 

After that, major shifts in the global economy led to a large amount of deflationary pressure on prices, most notably the rise of the internet, which slashed information and coordination costs across the global economy, and the rise of globalization, which greatly widened the available supply of goods and flooded world markets with low-priced Chinese products. 

Now, there’s a belief that globalization has reversed and that, maybe, the internet has outrun its usefulness, given the missteps of some of the online platforms and a crackdown against Silicon Valley. That might mean that the yield downtrend has indeed bottomed. 

However, another viewpoint expressed by Pal could open the door for a return to the lower yield trend. In a separate tweet thread last week, he suggested that the surge in artificial intelligence could be one of the biggest deflationary shocks in all history as the “cost of expertise in many, many cases has just collapsed to zero, near instantly.” AI’s cost-savings could flip yields back lower in a few years time. 

The Conversation: Lone Wolf

The single, unwavering crypto-supportive voice on the SEC, Commissioner Hester Peirce, penned a powerful dissent to the Commission’s case against Kraken. She again railed at the SEC’s failure to offer guidance while resorting to a complete shutdown of a “service that had served people well.” 

She wrote: “A paternalistic and lazy regulator settles on a solution like the one in this settlement: do not initiate a public process to develop a workable registration process that provides valuable information to investors, just shut it down.”

Check out the responses, mostly supportive, from Crypto Twitter:

Relevant Reads: Kraken Crackdown

The story of the SEC crackdown on staking unfolded quickly, and CoinDesk was all over it. 

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