What do they mean, "The worst of crypto is yet to come"?

Innovation at internet-scale is messy. But it's also really valuable.

THE WEEK

In this issue

Dispatches: Almost all of the news this week is about the major market gains triggered by Tuesday’s election results
Framework: A rebuttal to a recent piece in the Atlantic that oversimplifies the crypto industry’s dynamics.

DISPATCHES

News from the frontier

BTC hits $80k: Bitcoin just hit the $80k mark. As a reminder, the year’s low (on January 23) was $38,505.
Big business: Meanwhile, the rest of the market is also surging. Ethereum is up over $3k and has surpassed the market cap of Bank of America.
Where are the retail investors? While the crypto market is popping, some interesting elements are missing from this run compared to previous bull markets.
Sunday Funday: If Sunday’s market moves are any indication, maybe retail investors are coming back.
Adoption in Motown: Detroit to accept crypto for tax payments.

OPEN MONEY

Rumors of its demise were greatly exaggerated

In the last days of October, a reported essay titled “The Worst of Crypto is Yet to Come” appeared in the Atlantic.

The main premise of the piece is that regardless of the election outcome, big changes are in store for crypto policy and regulations. And, as the title implies, those changes will trigger a resurgence of crypto’s shady side.

Recently, most mainstream media pieces have been critical of crypto. On some levels this makes sense. After all, a lot of crypto’s problems of perception are self-inflicted.

Over the past year more than one crypto executive was hauled off to jail for crimes ranging from fraud to non-compliance with anti-money laundering laws.

In 2022 and 2023 people lost a lot of money when big companies and projects failed. By now, the list of spectacular failures is so long that it’s hard to remember them all.

But the risk here is that we start to view all of crypto as “bad.” Or that we start to think that the status quo, which, by the way, has its own cast of characters and underbelly, is somehow the standard that we should maintain.

We can learn from history: Imagine if, back in the day, when the earliest use cases of the internet were watching porn and cat videos, we just scrapped the whole thing because we couldn’t see the full potential?

That’s generally the vibe coming from the glossy critiques of the current state of crypto.

But, of course, the the reality of what's happening is way more complex.

Are there significant issues within crypto that need to be addressed?

Yes, absolutely.

Is crypto used in crime?

Yes, but so are cash, cell phones, and the internet itself.

But back to the Atlantic piece.

I think it raises some valid points or issues to pay attention to (mainly the growing power of the crypto lobby and how crypto quickly went from a fringe issue to a major political issue).

At the same time, I think it makes a few big assumptions that we are seeing repeated often, and which are not helpful in terms of moving the conversation forward.

On wanting regulations

For context, the crypto industry’s repeated requests for clarity from financial regulators (especially from US government agencies), is not a new trend that suddenly appeared with this election cycle.

While the regulatory conversation has gotten more intense recently, people working in crypto have been trying to get clarity for the better part of a decade.

It’s also important to note that there is a misunderstanding about the need for regulations. From the outside, the need for updated regulations is portrayed as crypto upstarts trying to figure out the latest legal way to enable crazy behaviors.

Here’s a passage from the article that demonstrates what I mean:

“The industry’s message now: Make crypto normal. Regulate us, please. All we want is to know the rules of the road. They highlight the most mundane, inoffensive applications of crypto while condemning the scammers who tarnish the industry’s reputation and avoiding mention of the “degens,” or degenerate gamblers, who represent much of crypto’s actual demand.”

A more nuanced perspective is that the crypto industry occupies a weird place.

Many crypto companies are building new technologies and infrastructure for handling financial information.

Right now, the limiting factor on innovation isn’t so much what’s possible technologically, but what’s permitted under the current financial regulations.

It’s important to note that some of the laws governing big regulatory discussions about whether a digital asset is a security or a commodity in the eyes of the law are based on policies written generations ago.

The SEC’s Howey Test, for example, which the agency uses to figure out if something is a security or not, including digital assets like Ethereum, is based on a 1946 decision by the Supreme Court with regards to citrus orchards.

What is the new normal?

One of the biggest issues facing the crypto industry is the awkwardness involved in defining crypto assets.

Quoting here again from the Atlantic:

“The main plank of crypto’s bid for normalcy is that tokens should be considered commodities, not securities. What could be more boring than a commodity? Wheat, orange juice, coffee beans, livestock: Commodities are interchangeable, and you can trade them with other people directly. The crypto lobby says tokens are clearly commodities, since they’re fungible like bags of corn and do more than just go up and down in price. For example, users can spend tokens as “gas” to interact with a blockchain or participate in the governance and upkeep of the blockchain; they don’t merely rely on “the efforts of others.” (The SEC agrees that bitcoin is a commodity, since unlike almost every other crypto asset it has no central issuer.)”

In some regards, this is the crux of the entire regulatory debate. One element that continually gets overlooked is that crypto assets are native to the internet.

Put another way: crypto assets are not native to public markets, physical goods producers, or corporate structures as we traditionally understand them.

This means, among other things, that it’s hard to call crypto assets either an apple (security) or an orange (commodity).

Sometimes they are both, sometimes they are neither. Regardless, the issuance and governance of crypto assets is different from anything that’s come before in any kind of market.

The most obvious approach to finding a solution to the security versus commodity debate is to come up with new structures that can capture all of the mechanisms, economic activity, and risks associated with the creation and distribution of crypto assets.

After all, it’s 2024, and the internet is a thing, and the financial regulations should probably be updated to deal with market speed and global networks.

Deeper in this section of the Atlantic piece, there’s a quote from the CEO of a nonprofit called Better Markets.

The gist of the quote is something like: blockchain companies don’t want digital assets to be called securities because then they would need to file disclosures.

This is a great example of how the thinking about digital assets hasn’t caught up to the reality of how the technology works.

Public companies need to file disclosures because oftentimes public data showing things like basic performance (like profit and loss, capitalization tables, or shares outstanding) won't exist otherwise.

But the thing about crypto assets is that all of that data is publicly available from day one.

The public-facing data doesn’t mean all blockchain-based projects are legit, but it is possible to use tools like block explorers, and analytics programs to get real-time data about what is happening with blockchain-based assets.

At this point in the Atlantic article, it would have been a great time to remind readers, that the fall of FTX wasn’t the consequence of a financial watchdog or from enforcement measures by traditional regulatory bodies.

Instead, the revelation that the FTX business model was based on fraud was the result of a reporter noticing some weird dynamics on a public ledger (a blockchain) and asking questions.

Over time, as the crypto sector matures and more tools become easier to use and more people become familiar with using all of the public data available for crypto asset systems, the legacy system of disclosure filings and earnings calls will likely feel archaic and quaint – like waiting for a letter to arrive in the mail.

We could go on, but hopefully the point is clear: innovation at internet-scale is messy.

But it's also really valuable.