June 1, 2022 | Issue #222

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FTX Wants To Make Sweeping Changes To The CFTC

Last Wednesday, the Commodity Futures Trade Commission (CFTC) gathered leading representatives from traditional finance, crypto firms, and academia in Washington to debate a proposal from FTX to decentralize the trading of derivatives.
This all started in March when FTX US released a proposal that would modify their CFTC license to allow retail traders to trade crypto-derivatives on their platform.
Although all of this might sound boring on face value, the truth is that the consequences of the CFTCs decision are highly impactful in ways which we will get to below.
The Backdrop
Without going through the long (and yes, boring) history of the derivatives market, it's worth understanding that the industry, supported by Futures Commodity Merchants (FCMs), has consolidated significantly over the past 15 years. Starting with 171 firms in 2007, there now only stand 61. Much of this, like the consolidation of the banking industry, is due to the fact that the derivatives industry is slow to change.
Meanwhile, the approval of regulated bitcoin futures trading at the Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange (CME) proved that institutions had a large desire to trade crypto derivatives with billions of dollars being traded. That, plus the fact that international exchanges such as Binance are engaging in derivatives while being unregulated in the US.
But why should traditional and unregulated exchanges have all the fun? Why shouldn't US based crypto exchanges have the opportunity to also offer derivatives products on their platform? That's the question that FTX has, and is the leading reason why FTX and Coinbase acquired the CFTC-regulated derivatives exchanges, LedgerX and FairX, respectively.
The main difference in FTXs proposal vs the existing model is that it would remove banks and other financial intermediaries from the market completely (aka put some companies out of business).
How Would They Do This?
The proposal would allow FTX (as well as other firms with similar Designated Clearing Organization licenses) to offer derivatives trading without the involvement of the FCMs which we covered above.
FTX would do this by removing the buddy-buddy nature of the current marketplace and replace it with an algorithm that makes decisions around margin requirements and risk management. The idea here is that it removes a lot of unneeded steps as well as potentially leads to less systemic blowups. It would also allow the trading to happen 24/7.
So, Whats the Big Deal?
Honestly, when it comes to crypto-derivatives, market participants and the CFTC seem fairly open to FTXs model concept, with the caveat that they delay approval so traditional participants can prepare and compete.
The main issue arises when the discussion moves into the idea of trading traditional derivatives products (think cotton, corn, or oil) on crypto exchanges.
You see, when traders are taking positions on crypto derivatives, it's one thing if they get margin called or knocked out of a position over night. But if farmers, who take futures positions to hedge their inventory, get margin called while they are sleeping due to a 24/7 market and an algorithm, it could cause major issues around physical goods.
Our Take
We agree with FTX that by offering a 24/7 derivatives market it doesn't automatically mean that people HAVE to trade there. Farmers could still rely on the old methods.
At the same time, theres something nice about markets closing... The ability for people to take a break in their day and to have time to internalize information and make long term decisions, is probably beneficial.
We have a 24/7 news cycle. We have a 24/7 social cycle. And with crypto, we have a 24/7 trading cycle. Are all these things net positives? We don't know, but for our physical and mental health, they might not be.

Chanos Shorting Coinbase?

On a recent podcast from Crypto Critics' Corner, legendary short seller Jim Chanos, explained why he believes Coinbase (COIN) is an interesting case of a stock to short.
Chanos, who made a name for himself successfully betting against corporate frauds like Enron, explained that he was making a bet against what he calls "Coinbase's predatory business model."
Chanos is referencing a fact that we have pointed out multiple times in this newsletter, that Coinbase's existing fee model is significantly higher than its peers, and that eventually it will have to come down.
He also notes that, at the same time, the company has to reduce their fee structure... and that the overall crypto market is slumping which is leading to less transaction revenue. In fact, just today we learned that FTX surpassed Coinbase as the second largest centralized crypto exchange in May.
All of this is a one-two punch in Chanos eyes. As he put it:

“Money-losing broker dealers, if you witness Robinhood, generally trade at one to one and a half times tangible book value [per share].”

Coinbase's current figure is in the high teens to low 20's, meaning that in his eyes, there is a lot of room for the stock to drop. Now, we don't claim to be even in the same universe as Chanos when it comes to trading and investing, but we would like to make a few points.
Point #1: Coinbase isn't shy to discuss their fee structure and why it is justified
As Brian Armstrong discussed on the company's latest earnings call: "We're not seeing competition on fees. We are seeing that we want to experiment with different price structures." Simply put, the company believes their fees are justified for the ease of using the platform.
Point #2: Coinbase is actively diversifying their revenue
In Q1, subscription and services revenues accounted for more than $150 million in revenue (13% of total net revenue). This was an increase of 169% YoY. As new products such as staking, NFTs, and more are launched, the revenue should begin to diversify. Simply put, as adoption grows in crypto, fee rates can be made up for in volume and a bet on crypto exchanges is a bet on worldwide crypto adoption.
Now to be clear – for the above two points – although Coinbase has said the right things and has, to date, backed them up... that may not be the truth in the future. Regardless, as Kraken's CEO Jesse Powell points out...
Point #3: Traditional brokers and crypto exchanges are different beasts
In a traditional exchange, such as Robinhood which Chanos used in his example, there are dozens of other legacy infrastructure providers that are each taking a cut of a trade. Coinbase and other crypto exchanges have centralized the model so that they are a one stop shop. Therefore, it may be unfair to compare the two different models on a tangible book value per share basis as Chanos is trying to do. As Powell tweeted, "It's Borders as a comp for Amazon all over again."
Who's right? Time will tell.

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DEEP DIVES

The Terra Revival

By now, we're almost all aware of what happened last month with Terra's UST/LUNA crash and its rippling effect across the entire market.
But here we are, almost one month since Terra's initial decent, and the drama continues...
Last week, in a dramatic turn of events, the Terra community approved the CEO of Terraform Labs Do Kwon's proposal to revive the collapsed cryptocurrency, Terra (LUNA), and abandon the blockchain’s failed stablecoin, TerraUSD (UST). Put simply, instead of letting the project die, Do Kwon made a successful last ditch effort to revive the protocol by forking over the blockchain.
The Birth Of LUNA 2.0
The passed proposal outlined a new fork as well as a 21 million token airdrop distributed amongst both LUNA and UST holders impacted by last weeks crash. The first tranche of the airdrop occurred this past Friday, on May 27th.
Along with the airdrop, the original collapsed blockchain/token, Terra (LUNA) was renamed to Terra Classic (LUNC). The naming convention for the new forked-over blockchain/token, however, was confusingly given the previous name, Terra (LUNA). The relaunched Terra ecosystem will now include the UST stablecoin, also now known as TerraClassicUSD (USTC).
How Did The Market React?
Despite exchanges like Binance, FTX, Huobi, Bitfinex, Bybit, Gate io, Bitrue and Kucoin pledging their support for the modified version of the Terra blockchain, confidence in the project remains at an all-time low.
Since the new blockchain launched on Saturday, May 28th, prices of LUNA 2.0 tokens fell from a high of $19.54 to $3.93 within hours, indicating that investor faith in the new protocol is almost non-existent. Original investors are essentially taking whatever reimbursement they are getting via airdrop and are running for the exits. As of this writing, LUNA prices sit at $6.43.
Do Kwon, Do Klost
While the new Terra ecosystem tries to regain its footing, Terraform Labs and its founder, Do Kwon, are still being plagued by controversy and accusations.

Hold My Beer Moment
Considering how big and popular Terra was just a month ago, its downfall has left gaping hole in the crypto economy. As a result, DeFi projects such as Justin Sun's TRON have reaped the rewards. TRON is now DeFi's third-largest blockchain in terms of Total Value Locked (TVL). According to DefiLlama, the TVL across TRON's nine different apps currently stands at $6.14 billion, up 43% over the past month.
TRON's resurgence has been apparently driven by the launch of its new algorithmic stablecoin, USDD (USDD), promising "double-digit returns."
Sound familiar?

Summer 2022: NFT Winter?

With stocks and crypto tanking over the past couple months, many have been left wondering: what will become of the NFT market?
Lisa Xu dove into the market data and spoke to NFT creators and builders about their outlook on the space.

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REGULATORY FRONT

DOJ Charges Former OpenSea Exec in ‘Insider Trading Scheme’

OpenSea CEO Devin Finzer previously stated that some suspicious NFT trades made by a former executive had been “misframed” as insider trading. Today, the Department of Justice (DOJ) called those trades “insider trading.”
The FBI and DOJ arrested and charged Nate Chastain, a former OpenSea product manager, with wire fraud and money laundering for alleged trades he made using insider knowledge of which NFT collections were going to be featured on the marketplace’s homepage.
Each charge carries a maximum sentence of 20 years in prison.
How "Insider Trading" Happened On OpenSea
The DOJ alleges that between last June and September, Chastain secretly purchased dozens of NFTs right before they were scheduled to be featured on the homepage of OpenSea, the largest NFT marketplace.
As part of Chastain’s role as product manager, investigators said, he was responsible for selecting which collections would be featured. Once those NFTs had been featured and appreciated in value, he sold them for “two- to five-times his initial purchase price,” and used anonymous accounts and crypto wallets to conceal the transactions, according to investigators.
The question remains if Coinbase employees (as highlighted by @cobie) are next in line...

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