Health, Wealth, and Happiness

March 10, 2023

"You can’t be a good value investor without being an independent thinker. You’re seeing valuations that the market is not appreciating, but it’s critical that you understand why the market isn’t seeing the value you do."

- Joe Greenblatt

In today's issue: To crack down on banking fraud and money laundering, the Obama administration launched an initiative in 2013 called Operation Choke Point.

Originally reported by the Wall Street Journal, the operation consisted of asking banks to identify customers with activity the government didn't like, then cutting off those customers from the banking system.

It's a page straight out of The Art of War.

Today, a similar operation is happening in the world of crypto.

We'll unpack how crypto companies are gradually being cut out of the banking system, Art of War-style, and what it means for the future. Read on.

Must Read

Today's most important story for crypto investors.

User Segmentation and Distribution Across DEXs(Messari)

It's not the sexiest title, but this research piece from Messari has a meaningful takeaway for Uniswap (UNI) investors... Uniswap is dominating the other decentralized exchanges.

You already knew this, since we talk about Uniswap frequently. In fact, UNI is one of the core holdings of our Future Winners portfolio. What you may not realize is just how large Uniswap's lead really is:

Nearly half of all Ethereum users also use Uniswap. By contrast, only 6% of Ethereum users use Sushiswap, the next largest DEX.

The Messari research report shows how DEXs typically build their userbases by rewarding new users with tokens for switching. Unless the product is better though, the users will leave as soon as the token rewards stop coming (and you can't give out free tokens forever).

To compete with Uniswap, the report recommends these other DEXs "should focus on improving their offerings and creating a more compelling product to attract new users."

In other words, they should make better products, not just give away free tokens.

Uniswap is winning the market share without bribing users with tokens. What's more, Uniswap is achieving similar gains on other chains as it expands beyond Ethereum.

Investor takeaway: One of the most important numbers for any crypto investor is the number of users. If it's large and growing, a company's got a product that's working. In the crypto world, one hit product is worth a dozen startups.

The Future of Token Offerings

by John Hargrave

In the Netflix series Money Heist, a gang of thieves break into the Royal Mint of Spain. Through meticulous planning and clever negotiation, they keep police at bay as they start up the money presses and print one billion euros for themselves.

(Warning: spoilers ahead.)

I love heist movies, but I would never watch one that lasted ten hours. However, Netflix carves it into one-hour episodes... And here I am ten hours in.

I’ll save you the ten hours and tell you the thieves have dug a tunnel to get the billion euros out of the Royal Mint. The police, who are sick of waiting, are going to send one team to storm the Mint (which they could have done in episode 1) and a second to storm the sewer.

“We’ll flush ‘em out,” growls the head cop, “and be waiting for them in the sewer” (the series is in Spanish, so my translation may not be 100%).

I’m reminded of this show as I look at the U.S. strategy to flush out crypto.

Why the U.S. is Flushing Out Crypto

After the well-publicized crypto failures of 2022, U.S. regulators are concerned financial contagion could hit the traditional banking system.

This concern kicked up a notch with the troubles at Silvergate Bank, one of the few traditional banks that serviced blockchain and crypto companies. As crypto clients began to pull their money, Silvergate suddenly found it was not well-diversified (for finance nerds, there's anexcellent analysis here).

Remember that the government doesn't need to make crypto illegal. If you’ve studied Sun Tzu’s The Art of War, you know the battle can be won without ever fighting. Just cut off the enemy’s supply lines and let them slowly wither.

Instead of sending “one team in the front” and “one team down the sewer,” like in Money Heist, the government is cutting off crypto access to banks and labeling all tokens securities. It's part Money Heist, part Art of War.

First, Cut off Crypto Access to Banks

It’s already been difficult for crypto companies to establish banking relationships, but banks are critical. Companies like Coinbase need on- and off-ramps to convert traditional money to digital, and vice versa. They need to pay employees. They need to establish traditional lines of credit.

There are only a handful of banks remaining that can handle payment and custody services for crypto clients, and they’re under increasing regulatory pressures to diversify their deposits so they're not overly reliant on crypto companies. Translation: it’ll be harder to open an account.

From the government’s perspective, you limit financial contagion by limiting financial exposure. You limit the number of banks serving crypto, then limit the amount of business they can do.

As they're shutting off crypto access, banks are going under for completely different reasons. First, Silvergate Bank. Then, Silicon Valley Bank. The government may soon have much bigger banking problems on its hands.

Then, Label All Tokens Securities

I'm an OG in this industry, so I’ve heard the phrase “regulatory clarity” like 10,000 times. It means, “Tell us what the laws are.”

Well, we’re finding out what the laws are, and nobody likes them.

The SEC is labeling all tokens securities and aggressively flushing them out. This means that potentially every token you own is an unregistered security. You’re not in any legal trouble, just the people who issued those tokens.

As the SEC issues Wells notices by the truckload, we can complain that there are many problems with this interpretation of securities law. Saying "every crypto is a security" feels like shaving down a square peg to fit in a round hole.

The SEC's Chief Peg Shaver.

Wait! There’s Hope!

There is, of course, one way of legally issuing tokens to the public. Treat them like registered securities.

The traditional way of doing this is through an initial public offering (IPO), but that’s at least $4 million in fees. Too expensive for most crypto projects (and ultimately, most companies).

The Obama administration saw the exorbitant cost of IPOs and created several alternatives for smaller businesses to raise money through public offerings. Under Regulation A, for example, companies can raise up to $20 million from ordinary investors.

In our recent workshop on Stacks, the Layer 2 solution for bitcoin, I discovered something incredible. STX did a Regulation A+ offering back in 2019, issuing tokens instead of traditional shares of stock.

Translation: STX is a token that’s fully licensed and SEC-approved.

STX proves it'spossible to work within the system, but this comes with steep costs. The company estimates it spent $2 million on its offering. Muneeb Ali, the co-founder of Stacks, joked to the Wall Street Journal, “The $2 million is our gift to the crypto industry."

It may have been a generous gift, indeed.

If Reg A is the new standard for crypto companies wanting to issue tokens, STX provides a roadmap. It’s not cheap, but neither is launching a token the current way. It’s also not easy, but neither is launching a business.

It's one thing, however... Fully legal.

Offering fully-licensed, SEC-compliant crypto tokens is possible. You just have to do it old school through Reg A, meaning you’ll need $2 million... And a bank.

History Repeats Itself

In the early days of the U.S. banking system, so-called “wildcat banks” cropped up to print their own money. This currency would be accepted in one's local region, but some of the banks would suddenly collapse, leaving the money worthless.

The U.S. found it hard to outlaw wildcat banks, so it just created a strong central bank and levied an exorbitant tax on wildcat money. Over time, this brought the wildcat banks to their knees, and the U.S. won again Art of War style.

Regulators are Art of Warring the crypto industry big time. They’re Money Heisting this mofo. One team through the front (all tokens are securities), and one team through the sewer (cut off banking access).

I want to preserve the financial system (I’ve got a lot of money there), but I also want to help it evolve using blockchain and crypto technology. Our challenge is how to integrate these new technologies responsibly.

At the end of the day, it falls to the U.S. Congress (not the regulators) to write new laws that help integrate crypto responsibly. Please write your Senator and offer your support for responsible crypto legislation.

Health, wealth, and happiness,

John Hargrave

Publisher, Bitcoin Market Journal

ICYMI