In this issue:
The EU and the EO
The end of Inside Money
Terra is the Korean TITAN
Apes 🤝 Punks
The EU and the EO
On Monday morning the Committee on Economic and Monetary Affairs (ECON) of the European Union (EU) voted on the Markets in Crypto Assets (MiCA) draft legislation, first introduced in 2020. Throughout that time some legislators and activists have been pushing to include language in the bill intended to address the environmental impact of crypto mining - specifically by banning proof-of-work currencies from being used in the EU.
Ultimately the committee voted 32-24 not to include the language around mining as they moved it forward to the next stage in the process. That wasn’t because the committee rallied to support proof-of-work, but more because there was a rough majority consensus that MiCA was better suited for regulating financial instruments and that environmental harm should be addressed separately.
Supporters of the proof-of-work ban can still potentially intervene and re-introduce their language into the bill before it becomes law, or they may decide to refocus on more targeted legislation to address proof-of-work mining directly. It seems unlikely they will stop pushing to place environmental regulations on crypto networks.
I’ve written before about why I think fear of Bitcoin mining is misguided, but the more interesting questions to me here are practical and strategic. There are no significant mining facilities located in the EU so nobody will stop mining if Europe decides to ban it. The EU can’t really ban crypto mining, they can only ban themselves from benefiting from it. It’s the legislative equivalent of closing your eyes and shouting "You don’t exist!"
The rule as written also effectively bans any decentralized assets, since only a central authority could "set up and maintain a phased rollout plan to ensure compliance" (emphasis mine). Requiring a phased rollout plan is not a way of preventing environmental harm, it is a way of ensuring state control. The rule would prevent EU citizens from transacting in any neutral, uncontrolled asset regardless of how it operated. The result isn’t an environmental regulation but rather a complete ban on European participation in Web3.
In contrast in America last week Biden signed an executive order (EO) calling cryptocurrency "an opportunity to reinforce American leadership in the global financial system and at the technological frontier" and directing various federal agencies and regulators to work together to develop formal policy recommendations for the space. The order seeks to "address the risks" but also "harness the benefits" of digital assets.
The EU is working up the courage to ban cryptocurrency while America is working up the courage to embrace it.
The end of Inside Money
We talked in the beginning of March and then again last week about how the decision to freeze Russia’s foreign reserves has started to force the world to confront the difference between money (something you own) and debt (something someone owes you). It has been somewhat fashionable for a while now to claim that debt is money and so watching that narrative unravel has been startling for some.
Credit Suisse analyst Zoltan Pozsar published a note predicting an end of the current monetary global order specifically in response to central banks moving away from inside money (i.e. foreign reserve debt held at other banks) towards outside money immune to seizure (i.e. raw commodities like gold, oil and bitcoin). As I mentioned on the Techonomics podcast recently, I think the death of the dollar is easy to predict and hard to achieve — but this isn’t exactly fringe commentary.
Credit Suisse openly predicting the end of the dollar as the reserve currency is a wildly different world than the one we were in a few weeks ago.
Terra is the Korean TITAN
"@Knifefight have you written about Terra Luna yet? I am wondering if could be the stablecoin that I need for yield: i.e. cheaper than Ethereum and not BSC." — PS
That’s a great question and I will answer it - but first, let’s found a bank.
Our bank will do all the usual bank things like take deposits, pay interest, enable payments and make loans. Obviously we could restrict ourselves to only loaning out money we actually have but that is tedious and unprofitable so like any bank we will make more loans than we receive in deposits and keep only a fraction of our customers deposits available as cash to withdraw when customers need it. The percentage we will keep available as cash is 0%.
It will be fine! Since we are loaning out 100% of our reserves we will be very profitable and since we are very profitable we will be able to pay very high interest rates. No one will want to withdraw! If we ever do need money we can sell stock in our very profitable bank. When demand for our deposits is growing we can use the new money to do stock buybacks. Since everyone is confident in the value of our stock they will know we can back up our deposits and since everyone is confident in the demand for our deposits they will value our stock. Nothing could go wrong.
OK, one thing that could go slightly wrong is that this is all illegal for a variety of reasons, so we’ll need to run our bank on a blockchain and issue our deposits as stablecoins — but that’s fine. The difference between a bank deposit and a stablecoin is mostly regulatory optics.
That’s roughly the business model behind the Terra/Luna ecosystem. Terra is the name of the protocol itself and also the family of stablecoins pegged to various traditional currencies, most notably TerraUSD (UST) for the US dollar and TerraKRW (KRT) for the Korean won. Luna is the reserve token that the Terra protocol uses to stabilize the price of Terra coins.
You can think of the Terra protocol as something like a decentralized bank where the various Terra tokens represent deposits at the bank and Luna tokens represent shares of ownership in the bank itself. Terra promises stablecoin depositors ~20% APY to create demand for Terra coins. The protocol allows arbitrageurs to create more Terra by destroying Luna or create more Luna by destroying Terra at a fixed rate.
When more people are buying Terra the arbitrageurs can create more Terra by destroying Luna, making sure the supply of stablecoins rises to meet the demand and the price stays steady. When more people are selling Terra arbitrageurs can do the opposite, destroying Terra to create more Luna — effectively creating and selling new shares of stock to raise money for customers who withdraw their deposit.
TerraUSD (UST) is only about ~8% of the USD stablecoin market but it is growing fairly rapidly (UST is the lavender section of the graph below). TerraKRW has essentially cornered the market for Korean won pegged stablecoins.1
If this all sounds a bit familiar perhaps you are remembering TITAN the fractional reserve crypto bank that collapsed spectacularly last June. Or you may be noticing the similarities to the (3, 3) mechanics that power OHM and HEX. Or maybe you are OG and you remember NuBits, BasisCash, the Empty Set Dollar. This is a structure that keeps reinventing itself in crypto.
The trouble with this arrangement (and with algorithmic stablecoins generally) is that people tend to lose faith in the deposits (Terra) and the collateral (Luna) at the same time. When you most need the value of Luna to prop up the value of Terra they may both be collapsing — like offering panicking customers in a bank run shares in the failing bank instead of cash.
Terra is aware of this risk/critique, of course. Terra development is lead by the Luna Foundation Group (LFG), a Singapore based non-profit dedicated to the Terra protocol. LFG recently sold $1B worth of Luna tokens in a private OTC sale to raise a forex reserve for UST — essentially a pile of reserve assets they can use to step in and defend the price of UST during market shocks. As they put it:
“The reserve assets can be utilized in instances where protracted market selloffs deter buyers from restoring the UST peg’s parity and deteriorate the Terra protocol’s open market arbitrage incentives”
Translation: if the market goes haywire we can use this money to step in and keep things under control until the market goes back to normal. Part of the goal here is literally to have the firepower necessary to step in in case of emergency, but an even larger part of the goal is to avoid any emergencies in the first place by giving the market so much confidence it never feels the need to test the peg.
Will it work? Probably not forever. A ~20% APY interest rate for Terra deposits requires a growth rate of >20% in demand for Terra deposits to be sustainable. Eventually that interest rate will need to level out to whatever the natural growth rate of the Terra economy turns out to be, otherwise even a large reserve set aside for defending the price will eventually be depleted. On the other hand there is plenty of room for them to grow and plenty of reasons to believe overpaying for market share now could be a reasonable long term strategy.
So depending on your perspective Terra is either a ponzi scheme or an under-capitalized bank with an aggressive growth strategy. I’m not sure that UST scratches the itch you describe in your question either way, though. It is cheaper to transact with than Ethereum but it isn’t really any more decentralized than BSC.
Terra is cheaper than Ethereum because it runs on its own proof-of-stake network, where the asset that being staked is Luna. That means anyone who controls the majority of Luna controls the system, and as recently as February the LFG was able to arrange a private sale of ~$1B worth of Luna tokens. The SEC certainly thinks Terra is centralized — they served Terraform labs CEO Do Kwon2 a subpoena earlier this year.
The stablecoin market has grown quickly but has also attracted a lot of regulatory heat and a lot of competitive pressure. There is certainly a lot of value to be captured in the stablecoin market and I have no idea how much of it Terra will be able to capture. But it is probably better to think of it as an upstart online bank than a trustless, decentralized platform.
Apes 🤝 Punks
The most expensive NFT collection for most of the year has been the Bored Ape Yacht Club, which we last mentioned in January when we talked about all the celebrities that were buying them. BAYC is a kind of streetwear fashion brand that is actively maintained by the company Yuga Labs. That makes BAYC fairly different from the #2 most expensive NFT collection, the CryptoPunks, which were made in 2017 by Larva Labs and have been mostly dormant since.
On Friday Yuga Labs announced that they had spent some of their enormous war chest to acquire the intellectual property of CryptoPunks (and also Meebits, another LL collection) from Larva Labs. Even more interestingly they announced plans to pass those commercial rights on to token holders, just as they have for BAYC and the other Yuga Labs collections. Until now BAYC token holders could license their apes and build commercial properties with them but CryptoPunk holders could not. Now all the projects will have the same privileges.
Yuga Labs is a master of strategic largesse. In some sense this is an expensive free gift to CryptoPunk holders — but it is also a brilliant way to position their own collections for long term success. The Ape/Punk rivalry used to be the main competitive storyline of the NFT markets but now both projects are Yuga Labs IP. The Bored Apes acquired their only serious competition and the CryptoPunks shed one of their biggest handicaps (restrictive licensing).
Both projects rose in the wake of the announcement, but Bored Apes actually rose considerably more — CryptoPunks got improved licensing terms but the Bored Apes cemented their market leadership and secured a historical legacy. The market is clearly more impressed with the cleverness of the Yuga Labs strategy than they are with the commercial rights to Punks themselves.
The acquisition also puts Yuga Labs in control of 4 of the top 6 projects by total traded volume. If they decide to launch a competing NFT marketplace they would probably bring a large portion of the NFT market with them by default — maybe even the majority. If I was OpenSea I would be pretty concerned.
Disclaimer: I own a number of Yuga Labs NFTs. You can learn more about my personal holdings / biases on my disclosures page.
Other things happening right now:
Someone spent ~$50 buying bitcoin in 2010 and held them all the way until last week when they were worth ~$20M. Honestly not a bad trade.
This graph of crypto adoption (from a long and interesting thread of generational data trends) puts crypto at right around the same stage of adoption as the internet in 1998, the year Google was founded and the year after WiFi was invented. For most people at that time the internet still made a sound. Note to my younger readers: it wasn’t a good sound.
The Terra protocol originates in Korea, which is why the second most prominent stablecoin on the platform is the Korean won. We’ve written before about how Korean banking laws create a cryptocurrency ecosystem that is thriving but surprisingly isolated from the rest of the global cryptoeconomy.
Eagle-eyed viewers will note that I actually quoted a tweet from Do Kwon at the top of the newsletter but that’s just a coincidence. There is no obvious connection that I am aware of between those two stories.