Dispatch #19 -2021
June 11th, 2021
This week the Dispatch will dive deep into three stories, as they are nuanced subjects that require a thorough analysis. We start with the Colonial Pipeline bitcoin ransom payment and recovery, which saw the narrative flip quickly: It went from Bitcoin enables malicious actors to the Bitcoin blockchain is visible to all, including law enforcement. Next, El Salvador made Bitcoin legal tender in the country, which could have far-reaching ramifications for Bitcoin in the coming years. Finally, the proposed fundraising by utility protocol Solana is a good example highlighting the bitcoin network’s differentiation from most of the other digital assets.
- Colonial Pipeline bitcoin ransom payment & recovery breakdown
- El Salvador makes Bitcoin legal tender in the country
- Solana blockchain fundraising – is a blockchain decentralized if it raises capital?
- Interactive Brokers to offer cyrpto trading by summer’s end
- BITCOIN SCHOOL – School’s out as summer starts!
Colonial Pipeline hack’s bitcoin ransom and recovery
Most Americans know the the recent Colonial Pipeline hack that disrupted fuel supplies to the East Coast. What is less known is the ease with which the bitcoin ransom was tracked as the ransom-coins moved wallets. Here’s an analysis of the coin movement by blockchain compliance analytics firm Elliptic.
At the start of the hack/outage, most coverage was negative. This Bloomberg Editorial on the event is a good example of that coverage. It is really a meandering summary of all that they believe ails Bitcoin, rather than coverage of the ransom payment. The government, too, was raising its voice and this WSJ article covers the Biden administration’s effort to trace ransomware crypto payments following the pipeline attack.
bitcoin is easily tracked
However, the tone has changed since the Department of Justice/FBI announced that they had recovered a substantial portion of the ransom. This incident will hopefully educate the larger public, and media alike, about the open nature of decentralized blockchains. These public blockchains are not the ideal vehicle for criminal entities that try to minimize exposure. This WSJ article and this Coindesk article provide details of how the coins were recovered.
The two articles speculate how the FBI may have gotten access to the private keys that controlled the hackers’ bitcoin wallet address. These reports even caused bitcoin to sell off briefly as worries spread that the US government had cracked Bitcoin’s cryptography. This is highly unlikely given the computing power that secures the network at present.
Illicit activity on the Bitcoin network can be reduced further
Bitcoin usage on the Hydra darknet has been rising according to this Elliptic analysis. The article’s title, “How tightening regulation is forcing criminals to go to extreme lengths to cash-out their crypto assets,” and the FBI action last week, further reinforce some of the benefits of open blockchains. Might we be better off in the long run, having an open blockchain rather than cash that is not trackable?
In the future, hackers will be more vigilant about their private keys, and it won’t be as easy to recover future ransom payments. However, the Dispatch hopes this event will better educate the public about open blockchains and how tough it is to cash out bitcoin ransoms except within rogue nations. This Elliptic blog post looks into the many unorthodox channels used to move digital currency ransoms back into national currencies.
The takeaway for readers of the RockDen Dispatch
Do not make digital asset transactions in peer-to-peer venues or put coins through any service that tries to obfuscate ownership. It’s quite likely that the coins you received are “tainted” and will not be accepted into regulated US exchanges. Worse, you could be flagged for suspicious activity. This is Elliptic’s marketing pitch to clients.
Every US-based entity is using screening services similar to this pitch.
Note: MSB stands for Money Service Business, which most crypto exchanges are
El Salvador makes bitcoin legal tender in the country
This is likely to have significant long-term ramifications because, via El Salvador, Bitcoin could be directly connected to the global financial system. This WSJ article provides more background. Many uninformed pundits will dismiss the action claiming that El Salvador is a tiny economy, run by a naïve 39-year-old leader. However, El Salvador’s decision can have a global impact as financial systems are interconnected.
Additionally, El Salvador’s decision may also impact how the rest of the world treats bitcoin as it impacts the legal definition of “money”. The explanation below by law professor Andrea Tosato, is likely to make bitcoin “money” in the US and the rest of the world too.
This twitter thread from financial service veteran Caitlin Long goes into even more detail and ramifications. The Dispatch is out of its depth on legal matters, but is confident that the OECD + EU will fight to prevent bitcoin elevating to legal “money”. All governments want to maintain a monopoly on issuing an effective currency. Bitcoin is a challenge to the “effective” aspect of fiat currency.
El Salvador and its banks will face stiff resistance
And…surprise, surprise! The Basel Committee that sets bank capital requirements just released preliminary plans to impose high capital requirements for banks’ crypto exposure. Here’s the 25-page consultative paper, for you finance geeks! This WSJ article provides a good summary of the Basel proposal.
The capital rules under discussion would require 100% reserves for bitcoin exposure. Therefore, banks in El Salvador that hold bitcoin will have lower returns if they adhere to Basel rules. El Salvador appears to be anticipating this issue and has proposed a government entity to hold coins for those that don’t want to keep coins on a company balance sheet. The tweet below from PwC’s head of Crypto practice sheds further light on the issue.
Source: Twitter
To add a global spin on the announcement, we have a US Congressman cheering El Salvador’s action. Sure, it’s an outlier view in Congress, but it just illustrates the growing network effect. Warren Davidson is the Congressman representing Ohio’s 8th District.
Source: Twitter
Crypto protocol Solana raising capital illustrates Bitcoin’s genuine decentralization
Solana is the 9th largest blockchain with a $35bn market cap. These two Forbes articles on June 9th and June 7th provide the details behind the capital-raise and how the new funds will be used to grow the protocol. The new investors received the Solana’s native token SOL. It’s worth considering the nature of blockchain decentralization if a central entity is able to issue new tokens to raise capital. This sounds like a company raising equity, doesn’t it? The contrast is most notable compared to Bitcoin, which has no central governance committee of any sort.
Just to be clear, this is NOT a debate about if one is better or worse, it is merely about the stark contrast.
Conclusions and questions following this fundraising
- Large pools of external capital are flowing into utility protocols. What does this do to the long-term fragmentation of the market and the market share of current incumbents?
- The capital infusion should lead to faster innovation that could rapidly change market share within the segment. This invariably makes the outlook for each protocol more difficult to predict. Incumbents could be under constant pressure from upstart, especially if capital remains easily accessible.
- If you are investing in utility protocols for their scarcity, the fundraising suggests that’s the wrong lens. Ethereum bulls would argue that the upcoming network upgrade would make ETH scarce. However, Ethereum network participants ability/desire to change the issuance schedule in 2021 is red flag. What if they decide to increase issuance in the future?
- This further distinguishes the Bitcoin network’s unique value proposition and market position, plus the lack of any serious alternative as a store-of-value.
Market size for utility protocols is larger than store-of-value protocols
However, we should not ignore the fact that the total market for utility protocols could be multiple times larger than the store-of-value market. This Bankless article estimates a rough $28 trillion opportunity to replace trust functions in society, which is primarily in financial services. It’s unclear to the Dispatch if the utility protocol market will be heavily or lightly fragmented. Will that $28tn estimate be captured by 20 protocols or 2,000 protocols? If it’s lightly fragmented and incumbents like Ethereum maintain share, then the outlook for Ethereum will be bullish. If the segment fragments more aggressively and share is lost to better protocols, current incumbent values may be challenged. Accelerating fundraising would point to greater fragmentation is how the Dispatch leans.
In contrast, the Bitcoin protocol has a monopoly on store-of-value protocol. As a global digital asset, there is no need for a second store of value. The network effect will preclude one, not to mention the bitcoin network’s notable lead on security. This store-of-value characteristic (possibly morphing into money) may justify operating on a more secure, but energy intensive, Proof-of-Work cryptographic algorithm. That is clearly NOT the current narrative.
The debate on store-of-value centers around the potential market opportunity. Is it digital gold? In that case the market size could be some percentage of the physical gold market estimated at $10-12 trillion. Or, is it the much larger value stored in financial assets like fixed income? Can an inherently noncash generative digital asset replace a cash-generating fixed income instrument, however mispriced the latter might be? These are questions worth considering and debating.
The store-of-value proposition brings additional risks as it may challenge governments’ monopoly on issuing effective currency. This risk will be tested if the value of the Bitcoin network continues to increase, challenging monetary policy effectiveness. Government may attempt to curtail private-money blockchains, as they become larger. El Salvador’s legislation to make bitcoin legal tender will accelerating this tension.
Interactive Brokers to offer crypto trading
Interactive Brokers is one of the largest brokers in the US, where more sophisticated investors go to buy overseas stocks, individual bonds and futures contracts. The Dispatch will eagerly await IBKR’s solution as they are a mainstream traditional asset custody provider.
BITCOIN SCHOOL – out for the summer!
Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.
Asi
Important Disclosures
| This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results. |