Macroeconomics, Fintech, Emerging Markets, Derivatives | Director @ STS | Seen in TheStreet, INC
In this progress report, we revisit the issues highlighted in last year’s review of the Bitcoin ecosystem and see how things have improved, and also highlight completely new developments.
I’ve been studying bitcoin since its second year of existence, and treat it as a distinct asset class to highlight how it fits into a broader macroeconomic picture. I have been an advisor to several financial technology firms and employ quantitative analysis for information gathering and trade execution with asset management firms and hedge funds like State Trading Society (STS Capital Group, simply STS) or its subsidiaries like Pareto Network or Blockchain Development Company, which allow the hedge fund to vertically integrate trade data.
When it comes to this asset class, there are still people that argue against the concept of Bitcoin, mostly in reaction to one of its sales pitches without ever noticing what this really is. For example, people are likely to debate about the “-coin” or “currency” nomenclature of “bitcoin” and “cryptocurrency” respectively. Ultimately, what we have is an asset with a fixed known supply, which has some attributes of all other asset classes, some improvements, is continually updated to have more attributes and improvements, in a world with massive inflation. This is the macro story of bitcoin, the big picture.
There are no commodities with a fixed known supply, only estimates that are continually disproven.
Part of the growth comes from the reality that people who are not fans of Bitcoin becoming one of Bitcoin’s largest advocates as they have to battle the extreme ignorance of their followers with factual information. Educated arguments against Bitcoin usually result in contributing to make it better, as there are no fundamental limitations to the concept. Uneducated arguments are usually not nuanced enough, and for people that represent large wealthy institutions, Bitcoin simply had not been large enough for it to be worth their time in taking an educated look at it.
There are also still people that will make stock market analogies to Bitcoin, exacerbating their cognitive dissonance, when the commodities markets have always been more similar. People request stock market influencers to opine on Bitcoin and use their abysmal answer as validation or lack thereof. Warren Buffett was not a commodities trader. Others compare Bitcoin’s market cap against JP Morgan’s as validation for or against its CEO — Jamie Dimon’s — misplaced thoughts on something out of his wheelhouse. Basically, the market cap of a publicly traded company is not ever worth mentioning in comparison to Bitcoin. The desired behavior of stock prices — always going up, controversial when they go down — is not relevant to in the commodities markets, where cyclical prices in response to cyclical demand is expected. Volatility is not an argument amongst commodities traders. Permanently hopeful buyers (Perma-bulls) practically do not exist in the commodities markets, outside of some rare metals. Yet, with many observers and traders of Bitcoin, they buy it as if it stock that they hope to go up in price forever, with their confidence shaken when it decreases in value, validating the “it has no revenues, it is backed by nothing” arguments of detractors. The utility and scarcity function well enough, just like any commodity, and bitcoin enforces the scarcity better than any other commodity.
Bitcoin has 7 distinct account types, some of which cannot send funds to each other. You can have bitcoin and be unable to send bitcoin to some other users.
Good news! The incompatibilities seem to be gone, and Segwit version 2 (bech32) transaction types take up over 50% of the block space, which suggests most people are using it. This is the desired transaction type, requires the desired address/account type and this is up from 1.4% last year.
Lightning Network invoices are still not common, use of the Lightning Network has not improved. There are some new developments here that are a clear market signal, more on that later.
Pictured: A little over One Thousand Bitcoin locked in the Lightning Network ($17 million), not growing well.
Lightning Network required Segwit addresses and transaction types to proliferate. Segwit has proliferated, Lightning Network has not. Press F to pay respects.
Lightning is Bitcoin’s attempt at a Layer 2 technology, to provide scaling, Segwit provides some benefits for scaling on Layer 1 which have helped.
The market has chosen other scaling solutions, and those solutions don’t really involve developments on the Bitcoin blockchain.
Pictured: Cognitive Dissonance on Bitcoin messaging
There is a Cambrian explosion occurring on the Ethereum blockchain and ecosystem called “DeFi” or decentralized finance. It welcomes Bitcoin as a digital asset, yet “Bitcoiners” are often too stubborn to admit it while using it anyway. Conflicting messaging has emerged, where DeFi is another thing for Bitcoiners to villify and deter capital from going towards, but simultaenously they want to attract capital using the trendiest messaging because not much else is going on in Bitcoin.
So without much fanfare, nearly 100,000 Bitcoin is used on the Ethereum blockchain, where it is traded faster (12 seconds to confirm a payment instead of 10 minutes), for more assets on permissionless decentralized exchanges, and where that Bitcoin inherits better functioning Layer 2 technologies on Ethereum.
WBTC is a custodial way to get Bitcoin stored on the Bitcoin blockchain over to the Ethereum blockchain, it requires KYC (regulatory compliance and questions on the source of funds) to transfer between blockchains. If there are any fees, the custodian earns them.
RenVM is a permissionless, no questions asked way to get Bitcoin stored on the Bitcoin blockchain over to the Ethereum blockchain. Its security is currently on par with an Exchange’s cold wallet system while acting like a hot wallet system, people trust exchange’s with orders of magnitude more money, while Ren’s system is a new entrant to the market, coming live as of late Spring 2020 and growing very quickly. RenVM aims to be much more secure and decentralized than an Exchange’s cold wallet, and people that help through a system of “Darknodes” earn fees.
WBTC, a wrapped Bitcoin solution
renBTC, a separate leading wrapped Bitcoin solution
Unlike what is prevalent in the Bitcoin community, these third-party projects are not married to the Ethereum blockchain and ecosystem, or the idea of a single distributed ledger technology to rule them on. They are ready to integrate into any blockchain that provides growth in user base and activities.
The final note about Ethereum developments in direct contract to Bitcoin developments is the permissionless innovation and healthy competition. Both systems need scaling solutions. Bitcoin has a Layer-2 scaling solution called Lightning Network and a permissioned sidechain called Liquid with private transactions. Implementing Lightning Network required a highly contested consensus change that took 15–18 months, fracturing the ecosystem and currently it is mostly in vain. Ethereum has about 8 competing Layer-2 scaling solutions, none of them required consensus changes and grow without the gracing of any “core” developer.
This is important to understand because Lightning Network has some of the same pros and cons as a single ONE of the Layer-2 scaling solutions seen on the Ethereum Network. Lightning Network would fit in the category called “state channels”. And that’s the point, Layer-2 on bitcoin is playing out as a classic state-capitalist system versus free market competition, with a lack of competition showing its weaknesses 9 out of 10 times, waiting for that one brief period of time where the free market system produces errors and economic harm by simply being allowed to exist and innovate. It is impossible to have a nuanced discussion of Layer-2 technologies on Bitcoin because there is only one, called Lightning, to choose from. The limitations of state channel technology like Lightning cause it to just not penetrate the market. People do not like “liveness assumptions” and do not want a “watchtower”. Regarding sidechains, people do not like the idea of a quorum being able to freeze funds, or the ability for them to be compelled to freeze funds.
As with all state-capitalist systems, they worked too hard to get where they are, and they have to keep marching in the direction they are going, partially by promoting unity and ostracizing dissent. There is a future for Lightning Network, but there is a better future for Layer-2 technologies that don’t require liveness assumptions.
Pictured: Comparison of six live and competing Layer2 technologies on Ethereum, all of which have competing versions. Compared to one solution on Bitcoin that is barely live.
There is an interesting story with exchanges this year and they have fallen out of favor for a new concept called Automated Market Makers (AMM) which operates completely onchain. But not on Bitcoin’s chain, but Ethereum’s!
Remember all that “wrapped Bitcoin” that was being referred to earlier in this post, people are wrapping their Bitcoin so they can trade it amongst the financial infrastructure on the Ethereum blockchain.
AMM’s are quite a bit different than other “DEX’s” or decentralized exchange, they do facilitate decentralized exchanging, but in a much more collaborative way. Whereas other DEX’s had centralized administration and were just worse versions of companies like Coinbase that run centralized custodial exchanges.
The big news occurred when the leading AMM, called Uniswap, had trading volume that grew larger than Coinbase’s! Now, they typically rival each other in trading volume daily.
This is definitely an area to revisit next year, as the limitations of AMM’s are set to go away. AMM’s — like all DEX’s — are bound by the Layer 1 capacity or bandwidth of their network, in this case the Ethereum blockchain. On Ethereum, both Layer 1 and Layer 2 are upgrading and will increase bandwidth by up to 5 orders of magnitude, exponentially.
The other interesting story is that Paypal allows people to buy bitcoin now. After a decade of being aggressively hostile towards people tangentially associated with cryptocurrencies, banning their accounts, they have done a complete 180.
With the entrance of Paypal expanding access to cryptocurrencies, the headlines here were that more bitcoin is being bought daily than new issuance of bitcoin. The macro story of bitcoin is heating up! In fact it touched its all time high again, last seen in late 2017!
Another interesting development is that the relevance of Bitcoin has changed. When buying activity increases in other digital assets, while the price of Bitcoin doesn’t rise, people assume that it is the same money already inside of the crypto space being moved around, reflecting no new interest from new people. In the past, Bitcoin was the only thing people would purchase that would allow them to access the crypto economy, where they would trade their bitcoin for other digital assets such as Ether or Ripple later on. This year, that perspective is challenged by noticing that people are buying stablecoins first. The issuance of stablecoins (DAI, USDT, USDC) has increased by an order of magnitude, suggesting people are using cash deposits on exchanges to buy stablecoins and then using those stablecoins in the digital asset economy, completely bypassing the use of Bitcoin or Ether except as a settlement layer.
I wrote about this reality in 2018 and people are accepting that utility.
Managing risk with Bitcoin futures and derivatives in a regulated arena has exploded and grown by orders of magnitude over the last year. Despite a modest launch, Bitcoin futures and options trading, in normal brokerage accounts regulated by the CFTC are working well, and do not garner international news every time there is a trade. As it should be.
Unfortunately, these are not “physically settled” contracts, where the actual asset of Bitcoin is acquired and used as collateral. This would do wonders for the scarcity of the Bitcoin continuum.
The one company that was aiming to do physically settled futures, Bakkt, has not grown in trading volume that much. Their bitcoin options are practically dead in the water. Despite ambitions, that organization seems to lack leadership. The original CEO of Bakkt, Kelly Loeffler, pivoted to being an acting Senator of Georgia, joining the subcommittee that regulates the CFTC which would be convenient for her business Bakkt, but even more convenient for her husband who is the CEO of the New York Stock Exchange. NYSE was the primary investor in Bakkt. You would be forgiven for merely assuming it was an incestuous business relationship, as yes, she was immediately accused of insider trading within 4 months of assuming her Congressional seat. An investigation which was promptly squashed alongside a million dollar donation from her husband to the Pro-President Super Pac, its only a 100% correlation. Expect more House of Cards-esque power moves from Kelly Loeffler and her husband Jeffrey Sprecher. Could be big for Bitcoin as their comical indiscrete background noise moves into the foreground over the rest of the decade.
Governments and supranational bodies like FATF, OECD, want to leverage the transparent ledger to expand tax compliance and anti-money laundering reporting. Although their proposals and demands are impractical, they are about a decade late as Bitcoin and other major digital commodities are upgrading their ledger’s to be less transparent. The power is being removed from the government just as they are noticing the power.
Although some Finance Ministers in major markets act perturbed by the concept of people having financial privacy, the irony is that private digital assets like Monero already comply with reporting regulations. Bitcoin has some upcoming aspirations that allow it to function more privately and would inherit the same compliance benefits.
People are free to transact with cash, or trade any asset for another. Governments relies on self-reporting of these transaction, if at all. To thwart behavior the state doesn’t like, it must identify the people transacting, identify the wrongdoing and convince a judge of it, get a warrant against certain physical property that it knows the location of and in many cases seize assets on premises. Or actually catch people in the action of doing something illegal or violent. This may seem familiar because it is in line with the social contract of many country’s constitutions. For the people, it is impractical and dangerous to transact with cash and barter in large amounts so they use banks and payment networks that connect banks.
The governments have essentially deputized banks and regulated the payment networks, creating automated information sharing with the government. This is necessary for banks if they wish to still be licensed for the ability to hold customer’s funds, or access the national and international payment networks to transfer funds to other banks. It is a nice trade for the government, as it gets information without needing a warrant for it, and is able to identify people, freeze their assets and make life inconvenient for whomever it pleases.
As people use banks a lot, the government has gotten use to this power.
Bitcoin allows people to transact like they would with cash in person, but across infinite distances in unlimited amounts. Therefore, it inherits the cash regime, as there are no financial institutions involved. As information about Bitcoin transactions becomes more private, it reverts government surveillance capabilities back to what it had in cash-based economies: reliance on self-reporting. Private digital assets — of which Bitcoin is not but will become — have a way for users to prove provenance and source of funds, it is just at their own consent. Such as during an audit. The governments can only regulate behavior after they have identified the people transacting, identified the wrongdoing and convincing a judge, and getting a warrant to inspect further. This is compliant with the existing system, governments just aren’t used to it in a long time, and yes it is likely impossible or prohibitively expensive to investigate this way.
Bitcoin privacy improvements come with the activation of two technologies, Taproot and Schnorr. These are marginal improvements which can be combined with existing best practices and new versions of those best practices.
The bad news is that it will take another year or two or three to activate, and it is yet again another account type, so it will be a while, and the other account types undermine the privacy gains of the new account type.
Bitcoin is not a leader in private digital currencies, and these improvements don’t make it so either. They just make potential obfuscation techniques built on top of Bitcoin indistinguishable from one-to-one transactions, and all other transaction types. So that will be huge.
The big picture story for Bitcoin is playing out, as governments are embracing the existence of the distinct asset class, and some are already clamoring to own more Bitcoin than others.
Although there have not been many innovations or upgrades on Bitcoin this year, this has helped its macro picture get clearer as the lack of change helps incumbents get more comfortable with bitcoin. This can be seen in the headlines and balance sheets of publicly traded companies who opt to store some of their treasury in Bitcoin, an action that could get an entire executive team and board dismissed in prior years.
Other blockchains are picking up the slack where Bitcoin has no consensus for innovation, but including Bitcoin in a collaborative way, even if the sentiment is only admitted in one way. Bitcoiner’s publicly do not want attention on the capabilities and welcoming playground that Ethereum offers, but many Bitcoiner’s use it in private.
Despite massive creation of new dollars and other fiat currencies worldwide, and pronounced bubbles in all asset classes, very little of that is making it into purchases of Bitcoin. This is not reflective of interest in Bitcoin and there are still limitations in the financial vehicles available to buy exposure to actual physical bitcoin. Corporations are not issuing debt in the exuberant credit markets and using those proceeds to buy bitcoin, their shareholders are not borrowing against their shares to buy bitcoin. It is still primarily retail traders buying bitcoin, a handful of non-crypto focused asset management firms, and a handful of publicly traded companies using their existing treasury for purchases. The credit markets are where the real spigot of fiat leaking into this economy has yet to be turned on.
Governing bodies that wish to use Bitcoin for mass surveillance and data mining under the guise of compliance are about a decade late as the network upgrades to thwart that capability. These upgrades were never about them, just improvements in the concept.
Everything is falling into place for Bitcoin.
For more insights into the macroeconomic picture in a way that includes digital assets, follow me on Twitter and LinkedIn. Also published at https://medium.com/coinmonks/everything-wrong-with-bitcoin-in-2020-68b14b858f0a
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