Was BlockFi Block-headed?

Headline: What the heck happened to BlockFi?

Date:

Body: 

Not so long ago, I walked through Union Station to take a train home.  It was markedly different post-pandemic.   Except for the occasional employee, or police officer, the only activity seemed to be the errant piece of trash blowing through.  (Pre-pandemic, there were hundreds of people gathering in the food courts, and there was even a bookstore, now gone.)  All of these changes took a while.   But, some changes come quickly.   Just a few months ago, when I had a reason to walk the station, I saw many large video billboards for BlockFi, some sort of credit card paid for with cryptocurrency, or so I thought.  Now, just on the heels of FTX, BlockFi is also going bankrupt.   What happened to make this fall so quickly from grace?   Can we learn anything from it?

Ok, so what happened?

Less than a week ago, BlockFi filed for a Chapter 11 Bankruptcy protection.  Chapter 11 Bankruptcy gives a company breathing room from creditors, and allows them to remain in business.  The company will work with creditors to re-negotiate payment schedules, either extending the time period for payback and/or lowering the interest rate of the debt.   (Half a loaf is better than no bread at all, right?)  They are still in business through this period so that they can make good on the most debt possible.  In fact, every plan is reviewed by the Courts and the best interest of the creditors must be reflected. (This plan will almost  certainly include some degree of layoffs.)   Interestingly, it appears that the legal counsel for BlockFi went to some pains to explain why it is so incredibly different than FTX

Different, yes, but related, well, kind of…

Several years ago, BlockFi loaned Alameda Research (the hedge fund associated with FTX) $680 Million.  Then, when BlockFi was on the ropes (roughly May of this year), FTX received a $400 Million credit facility from FTX, along with a pledge that FTX planned to buy it in the future.  As it turns out, each participant declined to honor its obligations to the tune of several hundred million dollars.  As if this were not bad enough, BlockFi used FTX for their trading platform and lost $355 Million in cryptocurrency locked up since FTX had their public insolvency. 

One other issue that is interesting is confidentiality.   A hallmark of an organized bankruptcy is transparency between the debtor and all creditors.   But, central to their business model is a long list of names and e-mail addresses of customers.  In the wrong hands, this intangible asset could be worth a lot.  The court is currently doing its best to weigh these 2 issues against each other.  For instance, we have learned through Court filings, that BlockFi’s largest creditor is the Ankura Trust.   BlockFi owes them $729 milllion.

In its bankruptcy filing, BlockFi said it owed money to more than 100,000 creditors. The largest creditor listed is Ankura Trust, a company that represents creditors in stressed situations, which is owed $729 million. FTX, BlockFi’s second-largest creditor, is owed $275 million.  The company estimates that they have a similar amount of cash on hand to deal with all creditors, and a total of $10 Billlion in total liabilities.   This one’s going to be interesting to watch (Most interesting is that the assets might actually be valued at only $1 Billion.   Stay tuned.)  For now, BlockFi has suspended withdrawals, so, the lawsuits coming out of this might also be interesting.

 The Verdict

“We are deeply saddened to see the devastation that is cascading across an industry that we love and believe in, touching the lives of so many people,”   This was written by a BlockFi official, and it rams home the need for appropriate regulation.  Now, unfortunately, the alphabet agencies of the Federal Government face 2 large problems:

1,  They are all competing with each other to be the agency in the lead of regulating this industry.   This is an old blood sport within the Federal Government, where each agency fights to regulate new areas of law, in order to garner the additional budgetary authority that will accompany that expansion.

2.  Not many people within the Federal Government really understand the cryptocurrency industry.     Education will be really important here.

But, as investors, this is interesting.   In the long-term, I strongly believe that some form of cryptocurrency is here to stay.   Whether it is Bitcoin, Ethereum or some other coin, I have no idea.  But, in the short term, I find it quite likely that  cryptocurrency will lose a lot of value as the federal government gets to know how to regulate this industry.  It would seem to me that this combination gives us an opportunity for careful investment.

REFERENCES

BlockFi tells U.S. bankruptcy court it is ‘the antithesis of FTX’ | Reuters

BlockFi files for bankruptcy as contagion grips crypto markets | CNN Business

BlockFi Files for Bankruptcy as FTX Contagion Spreads (coindesk.com)

BlockFi Files for Bankruptcy. What It Means for Investors (fool.com)

BlockFi declares bankruptcy in aftershock of FTX’s collapse : NPR

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

It’s Good to be a King!!

Headline: What is self-sovereign-identity?

Date:

Body:  Years ago, I was listening to an NPR article about a young woman in Texas, searching for her identity.     Many are thinking, “duh” because that’s what you do as a young adult.   But there was more to it.   The parents of this young woman saw to it that she didn’t have a birth certificate or a Driver’s License.  (She went to live with grandparents and the paperwork portion of her conundrum got straightened out, due to an action of the Texas legislature.)  I was feeling anger towards the parents, thinking that there could be no reason to do this but some form of child abuse.   But, there was another voice on the report, and that man suggested that this was a HUGE gift they gave her.   He referred to her as a sovereign.   He laid out an argument that had  the trappings of logic, but, reflecting upon it, I began to find holes in his logic.   Fast forward to today and I find a concept related to cryptocurrency, and this is called “self-sovereign identity.”   I wondered if this was the same concept I had heard of, or if this was something new.   Thus began this entry.

The idea of a self-sovereign identity (SSI) begins to make some level of sense when thinking of the Internet as it currently exists.   Want to do business with Amazon?  You have to give them detailed information and then, allow them to observe the products that you order.  Want to do business with Facebook?  You have to setup an account, and then you are trusting them with your pictures and occasionally very personal information.  The SSI paradigm (still very much in the sketch-pad stage of development) would introduce some type of passport that would allow you to reach out to anybody you’d like, directly.   If you are confused, please take comfort from the fact that EVERYBODY appears to be confused on this topic, even the evangelists. 

Is this a solution in search of a problem?

Well, I don’t think so.  In 2021, the average cost of a data breach was over $4,000,000.  But, if each person was effectively rrrr  But, think a little closer to home.   ( I don’t think I’m an outlier here.   Feel free to disagree.)  I live in a rather small apartment, but I still have a bunch of stuff that I could easily do without, and would love to  sell on E-Bay or some similar site.   Now, one problem is that I have mis-placed my password.   But, the second problem is that I don’t entirely trust my anonymous buyer.  The SSI system would go a long way toward solving this hesitation.

More importantly to me, is the robot testing that current websites use.  Whether it’s a CAPTCHA challenge (reproduce the letter string) or the challenge of “click on all pictures with a car in it” I have sincere problems since I am visually impaired.  If I had an SSI system, I could instantly prove my identity as myself, without the extreme frustrations caused by these tests.

Well, this sounds good.   So, what’s the problem?

There are a few problems that occur to me:

1.   Somebody has to issue this Master password.   If you accept that there is such a central repository, it seems to me that you are violating your own logic for SSI.
2. They claim that this would relieve us of the  problem remembering all of our 80 passwords.   They are correct here, but, having different passwords augments your security.  If somebody hacks your Facebook password, they do NOT have access to your banking records.   This problem would have to be fixed to make the SSI paradigm work.
3. Authors refer to the “post-truth society” and “fake newss I think this is an impossible goal within our society.   What MIGHT be possible is training our citizens how to critically think about the information they see.  There are some internet sources that are more credible than others, and if something is really important, people should go to 3-4 trusted sources of information.   If they agree on the larger outline of the issue, then it’s probably a good outline of the issue.   If details are disagreed upon , we should then consider why this person might feel this other way, and consider if we could learn something from this difference in opinion.
4. The author suggests that this system would be something like a combination of Yelp and Biticoin.  Well, if you are familiar with Yelp, you’ll know how easy it is to leave a savage bad review, in response to an imperfect experience we had there.     If this could be controlled, then, wouldn’t this be a GREAT thing?   I would argue  probably not.   For proof, look at any reports on the use of social scores in China.   This idea is very scary to me because now, one person can’t just destroy your reparation,  they can also impair your financial destiny.

Are there opportunities for you?

Yes, there are opportunities.  In fact, the SSI would allow you to monetize our memories.  For instance you could look at pictures and identify people presented as either a friend or an associate, and get paid for this, turning them into  a “data laborer.”   Or, if the SSI thing is truly thought out, there would be no reason why you couldn’t vote over the Internet.  Think of the participation rate if you could vote using your smart phone?  But the largest opportunity is that you could allow your SSI (which would essentially be an AI system) to become an executive assistant that can buy plane tickets or setup dinner reservations.

So, where are we now with this project?

Pilot projects are already being implemented.   The one we have the most information on is called MetaMUI.  It is an SSI system setup by an aboriginal group within Australia.  (Yeah, I had to look that one up myself too, no shame.)  The system allows members of the community to positively identify themselves when in the online environment, and the payment module (slowly coming online) allows the community members one single place to place all money, cryptocurrencies and other types of valuable assets.

A robust e-government system to digitize the entire government services, the MetaMUI SSID app can be employed by users to connect to other public entities such as banks, government organizations, shops, schools, etc, through Pairwise Trust authentication. Commercial sites that have a public identity on the MetaMUI identity blockchain can offer the Pairwise Trust login to their customers. The user no longer has to register the website and create an ID and password. Users can simply connect their SSID to the website through Pairwise Trust connection and login instantly. Users do not need to provide sensitive private information to every website they visit anymore. The MetaMUI SSID app provides seamless login capability without sacrificing private information. 

As exciting as this is, and it is, it is important to realize that this innovative product lives on one device at a time.   Most interesting is a future SSI system that will be interoperative with any device you happen to be on.   For instance, a personal story.   I was on a trip to Chicago when a job became open, but to get it, you had to take a test online.  If I had had  a portable SSI system, the IRS computer would have recognized my sign-on whether from my own smartphone or the hotel business center.  (And would have done so without any delay by asking verification questions.

The Verdict

SSI systems would go a long way to solving many problems related to the internet today.  The only thing that sticks in my craw is the authentication itself.  This whole discussion is wrapped around the idea of decentralized finance (DeFi) which suggests the unnecessary nature of intermediaries.   In its current  incarnation, in order for the SSI system to work, there MUST be a central authority to issue the SSI to begin with.  Perhaps in the future, somebody much smarter than myself will find a way around this issue, but for now, it appears to be quite intractable.  So, for right now, it seems to be a great thing to play around with the idea of, but, it doesn’t appear to be ready for Primetime.

REFERENCES

https://www.coindesk.com/policy/2020/10/01/self-sovereign-identity-explained/

https://www.ibm.com/blogs/blockchain/2018/06/self-sovereign-identity-why-blockchain/

https://cointelegraph.com/press-releases/metamui-and-sovereign-yidindji-government-launched-1st-self-sovereign-identity-based-national-id-system

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

That’s How We Roll(up).

Headline: ZK-rollups?  IDKY?

What is a Rollup in cryptocurrency?

Anybody out there hate doing math homework in grade school?   I did.   I developed a terrible habit of keeping my homework paper “clean” by using a piece of scrap paper to do the actual calculations with the attendant strikethroughs and other marks.  The result was that each problem would be either wrong or right, and it took me a while to understand the importance of “partial credit.”  I just thought it made the evaluation process faster and cleaner.   In a similar manner, there is a thought that an Ethereum transaction might be more efficiently validated off chain and then added to the main.   This is referred to as a “rollup.”

It is done because it is more efficient.   First, gas fees are much lower as rollups are one of the scaling systems, like sidechains and state channels.  These speed-ups are likely to be used as complements to the Merge, and the combination is supposed to make Ethereum blockchain much more attractive. 

I remember rollups in my lunchbox.  Are there different flavors of these rollups?

Yes, there are several different varieties of rollups.  There are 2 very important flavors, Optimistic and Zero Knowledge.   In an optimistic rollup, the transactions are verified (think of a very first-draft verification), but most of the data on these transactions are stored at a different location.  This allows verifiers to verify a block of transactions quickly, and minimize gas fees.  Zero knowledge rollups use a nifty piece of cryptology called zero-knowledge proofs, and these allow the particular transaction data to be rather scant/    Because it runs on thin data, the gas fees will likely be much less.   Said another way, the “block” of transactions might be  a thousand transactions, are executed off the main Ethereum net.   When done, a summary of these transactions is posted to the mainnet of Ethereum.   While both are more efficient in gas fees, they are also less secure as they have less frequent audits and rely on external tools for reliability.  ZK rollups are much faster because optimistic rollups require a “cooling off period” (my words) which gives people sufficient time to challenge the new transaction block.  Because the ZK rollups rely upon off-chain computation and on-chain posting, they are considered “hybrid scaling solutions.”  ZK rollups are likely to rotate the operator role by using a proof-of-stake system.     Their stake also keeps them honest because if incorrect blocks are posted, they lose their stake.

OK, with a little less hand waving this time, what is a ZK rollup?

The information concerning accounts and balances comprises a Merkle tree.    A cryptographic hash of this tree’s root (a Merkle root) is stored on-chain.   Since the root of the function is stored on-chain, the information encoded is easily derived, but stored off-chain.   This makes calculation much faster and serves to minimize gas fees.  A batch root can also be saved to recognize a series of related transactions.  Now, when a verifier wants to add the block to the blockchain, there is a validity proof demanded, which is another mathematical function for the verifier to prove, this one not related to the transaction.  Once this commitment is made and the function solved, the block of transactions can be added to the mainnet.

What is a ZK-SNARK v. a ZN-STARK?

These functions share the purpose of verifying the correctness of off-chain calculation.  First, there were ZK-SNARKs,  and these used a Common Reference string to aid the cryptography behind a block of transactions.   Later, these same functions were improved as they used “trusted individuals” in groups, to derive the cryptographic functions.   ZK-STARKs were an improvement on these, as they use publicly available data to aid in the cryptography, and the “trusted individual” problems are avoided.  Further, they are more scalable and can get exponentially more difficult to derive very quickly.

All of this techno-speak is giving me gas…

How much users pay for transactions on ZK-rollups is dependent on the gas fee, just like on Ethereum Mainnet. However, gas fees work differently on L2 and are influenced by the following costs:

First, there is something called “State write.”   This has nothing to do with the Constitution.    It is simply a fee charged to submit a transaction to the blockchain.  ZK rollups serve to spread this “pain” among a series of transactions such that each participant pays less than they might have alone.

Second there is a fee for data publication.   This fee will grow larger  as the size of data kept on the mainnet expands.  (This is why optimistic rollups might be a more efficient option because so little data is stored on-chain.

Third, there are L2 operator fees, and you can think of these as fees to pay the miners on the mainnet.

Fourth, and finally, there are proof generation and verification fees.   Operators of the ZK-rollups must complete validity proofs, and this is the fee to encourage them.

It should be stressed that all of these aggregated fees are minimal and a dwarfed by the fees charged by real banks.

.Pros and cons of ZK-rollups

Pros	Cons
Validity proofs ensure correctness of off-chain transactions and prevent operators from executing invalid state transitions.	The cost associated with computing and verifying validity proofs is substantial and can increase fees for rollup users.
Offers faster transaction finality as state updates are approved once validity proofs are verified on L1.	Building EVM-compatible ZK-rollups is difficult due to complexity of zero-knowledge technology.
Relies on trustless cryptographic mechanisms for security, not the honesty of incentivized actors as with optimistic rollups.	Producing validity proofs requires specialized hardware, which may encourage centralized control of the chain by a few parties.
Stores data needed to recover the off-chain state on L1, which guarantees security, censorship-resistance, and decentralization.	Centralized operators (sequencers) can influence the ordering of transactions.
Users benefit from greater capital efficiency and can withdraw funds from L2 without delays.	Hardware requirements may reduce the number of participants that can force the chain to make progress, increasing the risk of malicious operators freezing the rollup’s state and censoring users.
Doesn’t depend on liveness assumptions and users don’t have to validate the chain to protect their funds.	Some proving systems (e.g., ZK-SNARK) require a trusted setup which, if mishandled, could potentially compromise a ZK-rollup’s security model.
Better data compression can help reduce the costs of publishing calldata on Ethereum and minimize rollup fees for users

The verdict

All of this geek speak, (and trust me, I saved you from the bulk of it) is fine and good to hear, but I don’t understand all of it.   Confession: I don’t either, entirely.    I guess what we can learn from it is that cryptocurrency is an evolving concept.   The coders continue to improve the code underlying the currencies, and make the processes more efficient and faster.  So, the question is then, how is this knowledge valuable to me?    Well, I think that we are tracking some of the larger building blocks behind cryptocurrencies being added now, and into the near future (figure 1-2 years.)  After these larger blocks are in, I would begin to feel a little better about investing, even if the huge jumps in value are over.  Perhaps it’s just like the doctors tell us: everything in moderation.

REFERENCES

What Are Rollups? ZK Rollups and Optimistic Rollups Explained (coindesk.com)

Zero-Knowledge rollups | ethereum.org

Layer-2 Scaling: zk-Rollups and Optimistic Rollups | Gemini

Can the Optimism blockchain win the battle of the rollups? (cointelegraph.com)

 Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

If it Ain’t Broke, Don’t FTX It?

Headline: What is going on with FTX?

Date: 11/13/2022

Body:  Wow!!  It seems only yesterday I was watching the World Series!  Each official was in uniform, and prominent on each was a patch that read, “FTX.”   I don’t know what it cost the exchange, but it couldn’t have been cheap!  Now, days later, I read that they are in some serious danger of not being a going concern?   How does this compute?

In a nutshell…

FTX, an exchange owned by billionaire Sam Bankman-Fried was hemorrhaging money and oozing red ink.  Just one day after Binance announced that there was a deal to buy FTX (details not available) the CEO of Binance announced that they would not be following through with the non-binding deal for the $32 Billion company.  The reversal is apparently due to reports of mishandled customer funds and U.S. government investigations.  They are facing an $8 Billion shortfall.  Bankruptcy is not out of the question.  (Mind you, this is a very fluid situation and by the time you read this, things might have changed.)  One particularly bad sign was that the exchange began to sell off its own holdings in FTT, the currency native to FTX.  Also bad is that the CEO warned people of earnings that could drop nearly 60% from the year before.  Sequoia Capital, a major backer suggested publicly that their $213 million investment was considered to be worthless.   Add all of this to $6 Billion of customers demanding withdrawals, and things look quite bleak indeed.  They are not the only ones, as both Bitcoin and Ethereum have declined significantly in concert with FTT.

So, what did Binance say, in particular?

This is unusual, but I will append the entire published announcement, as it is pretty interesting.

“As a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged US agency investigations, we have decided that we will not pursue the potential acquisition of FTX.com.

In the beginning, our hope was to be able to support FTX’s customers to provide liquidity, but the issues are beyond our control or ability to help.

Every time a major player in an industry fails, retail consumers will suffer. We have seen over the last several years that the crypto ecosystem is becoming more resilient and we believe in time that outliers that misuse user funds will be weeded out by the free market.

As regulatory frameworks are developed and as the industry continues to evolve toward greater decentralization, the ecosystem will grow stronger.”

This sounds to me like Binance is suggesting that in the future, the information they have to deal with will allow them the ability to not be fooled in the first place.

What is the history of FTX?

Mr. Bankman-Fried’s rise began in 2017 when he founded Alameda Research, a crypto trading firm that made a fortune exploiting arbitrage opportunities in the Bitcoin market. He parlayed that success into the creation of FTX, which was based in Hong Kong before relocating to the Bahamas last year.  Until quite recently, Mr. Bankman-Fried could be seen striding around the Capitol building, creating friends among the leadership, and he personally made a $5 Million contribution to the Biden election campaign.  CZ, for his part, used to be an investor himself, but was effectively bought out by Mr. Bankman-Fried.   Along the way, the CEO of FTX made a very public joke, and CZ was the subject of it.  Though no official reaction was noted, there was certainly some bad blood engendered. Not long ago, CZ announced on Twitter that Binance would sell its holdings of FTT. He insisted that he was not engaging in a “move against a competitor.” But he later compared the FTT token to Luna, a cryptocurrency that crashed in May, setting off a broader crisis.“We won’t support people who lobby against other industry players behind their backs,” he added on Twitter.  Given this history, it would seem that these 2 billionaires were some type of frenemies. 

What are the Pros v. Cons of FTX?

Pros	Cons
Margin and futures trading is supported.  Some sophisticated investors would like to place bets on the future markets for cryptocurrency, and FTX allowed them to make these bets.	U.S. residents are excluded from this exchange.  Residents in the US can use a subsidiary, but the offerings are limited compared to FTX based in Hong Kong.
Access  to even more exotic bets on cryptocurrency.   Some of these  investors might wish to place a bet on volatility or other attribute, and FTX allows them to place these bets too.	There is no live chat support for the exchange.  This is standard on most exchanges, but on this one, finding information in the resources that are available can be very time-consuming.

FTX was pretty clear on what could prompt margin calls, but this policy appears to be important to the pros and cons.  A margin call requires the investor to provide enough capital to substantiate a portion of their entire bet in cryptocurrency.  Let’s assume that the “maintenance margin factor” is 5%,  When the leverage nears 20, the peoson could be challenged to offer collateral.

FTX and Binance appear to be puppies from the same kennel?

Yes, they are very similar, but there are a few key differences in how they function.   Chiefly, Binance has begun to offer an online chat feature, and Binance has slightly higher fees than FTX.

Could this”conflict” all be part of a strategic hit by competitors?

This may be true, but it seems unlikely. 

However, there are some experts who do give us a bit of context, which might be helpful.   The CEO of Binance is often referred to as “CZ.”   There is a cryptocurrency expert who works at Duke University at their Law School, Lee Reiners.   Per Professor Reiners, “CZ executed a pincer movement.  He surprised all of us.”  The CEO of FTX suggested that the concerns FTX floated publicly were never expressed to him before.

So, how does FTX compare to Coinbase?

 Ok, first thing to understand is that Coinbase is a centralized exchange, and FTX is organized as a decentralized exchange.  So, by their very organization, they are different.  Both offer custodial and non-custodial wallets for your cryptocurrency  and NFTs.  But, Coinbase makes the custody feature, a feature, as your cryptocurrency becomes a lot more useful since you can negotiate it  at will.  The downside of this custodial  approach is that Coinbase will also have to have your private key.   This always makes for a risk, when you give anybody your private key.  That said, Coinbase does have some excellent security (98% of cryptocurrency stored with them is in cold storage) and they do not believe in using leverage.

The Verdict

“This episode highlights the vulnerability of the entire crypto edifice,” said Eswar Prasad, a Cornell University economics professor. “Even large and apparently financially solid institutions turn out to have fragile and shaky foundations that crumble at the least hint of trouble.”  While Economics is widely known as the dismal science, perhaps we should take a look at what’s happening here.  Remember Prodigy Internet?  They also tried to offer a service that was notable because of its refusal to edit the comments its users made.  Perhaps that is akin to what is happening to FTX.    They are doing something new, and getting financially punished for it, but soon, there will likely be hundreds doing the same thing.   Then, it will be heralded as a model for decentralized exchanges.   Only time will tell.

REFERENCES

https://www.cnbc.com/2022/11/09/binance-backs-out-of-ftx-rescue-leaving-the-crypto-exchange-on-the-brink-of-collapse.html

https://www.investopedia.com/ftx-review-5219459

https://www.fool.com/the-ascent/cryptocurrency/ftx-vs-coinbase/

https://www.bbc.com/news/business-63577783

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

Avoid Scams: Click on This to Read More.

Headline: How Do You keep yourself from being scammed?

Date:

Body: 

Bad actors and fraudsters are always on the prowl for new ways to separate you from your money, and the massive growth of cryptocurrencies has to have them salivating.    According to a study done by Chainalysis, fraudsters stole $14 Billion in 2021 alone.  So, I offer the following to you in an effort to educate, and hopefully make you a harder target.

Fake websites

Fake websites are one really good opportunity for a fraudster, especially something like a fake cryptocurrency exchange site.  If they are able to setup a really good-looking site, they have the opportunity for both short and long-term cons:

Short term, they could take all of the personal information you put in to open an account at the alleged exchange.  They can then use this information to gain access to your banking information, credit cards, anything.

Longer term, if they have the wherewithal to give you a short-term win, they can encourage you to stick around and invest even more money.   Then, one day, they turn the lights out, and swipe all of the money that you put into that cryptocurrency wallet.

Phishing scams

Often used in conjunction with a fake website, a phishing attempt often starts as an alarming e-mail.  You might get an e-mail with the headline, “YOU MIGHT HAVE BEEN HACKED TOO.”  When you click on the link, it brings you to the fake website where they have you “verify” your private key and other information.

Pump and dump schemes

Everything old is new again.  In the past, people have purchased thousands of shares in a loser company, then hire dozens of college dropouts to call people to cajole them into buying thousands of shares in this loser company.  Then, the leader of this organization sells off their shares for a much higher price (due to the artificially created demand) and  the new investors are left holding the bag.  Nowadays, this is being done with some cryptocurrencies.   And in this way, the scammers don’t even have to find a boiler room anymore; Anywhere in the world with an Internet connection will do.

All of these schemes and more have caused many crashes and pileups on the information superhighway.  But, they seem to have a common thread of getting something for nothing.  Keep this in mind.

What are some of the red flags to be looking for?

So, how to spot a crypto scam? Warning signs to look out for include:

Promises of guaranteed returns: No financial investment can guarantee future returns because investments can go down as well as up. Any crypto offering that promises you will definitely make money is a red flag.

A poor or non-existent whitepaper: Every time a new cryptocurrency is launched, there should be a whitepaper behind it.  This document will explain how the currency is valued, and the reason that the cryptocurrency was launched.   The management team should be named.   The founders should definitely be named.  If there are lots of grammatical mistakes, it might be a sign of a rushed scheming scallywag.  Be careful.

 

An ounce of Prevention…

Ben Franklin could probably not have imagined the Internet, but, he was right on with his statement.  There are things you can do to protect yourself and your digital assets.

1. Protect your wallet.   Perhaps it might be a good idea to only put  a small amount of cryptocurrency into your Coinbase wallet online, and keep the bulk of it in a cold wallet that is not often hooked to your computer.
2. Only invest in things you understand.   Per Frank Drucker, you shouldn’t invest in a group unless you can draw their business model using a crayon.  This means that the logic of their business should be inescapable, and there should be no hand-waving.
3. Take your time to do your own research.   If it’s a Great deal now, it should still be a great deal in 2 weeks’ time.
4. When reading the whitepaper (You ARE reading the whitepaper, aren’t you?), the project that they are trying to fund should be very plainly stated, and it should be possible.

Sometimes, a pound of cure is needed.

What if you are taken by a crypto scam.   There are some definite steps you can take:

1.  File a police report
2. File a report with the CFTC at 866-366-2382.  Or file a report online with the CFTC.
3. File a report with the SEC and the FTC.

Remember, fraudsters depend upon the shame felt when one falls for such a scheme.   They rely upon this stigma to ensure that people don’t report.

 The Verdict

There is a lot that can be done to ensure that we don’t fall victim to a crypto scam, and if we do, there are steps to take to minimize the hit we will take.  The general rule seems to be that the faster we respond to a vulnerability or intrusion, the less damage will be done to us.  Certainly, we didn’t hit all the problems out there (we can’t) but, we did hit some of the biggest pitfalls.      Human beings are pre-disposed to  want to not show up weak in front of other people, and this is so important in dealing with these crypto-schemes.   Perhaps Shakespeare was right, so many centuries ago,

Whether ’tis nobler in the mind to suffer The slings and arrows of outrageous fortune, Or to take arms against a sea of troubles, And, by opposing, end them?

If you even suspect that you might be the victim of a crypto-scheme, I implore you to take up arms against your sea of troubles.

 REFERENCES

https://www.kaspersky.com/resource-center/definitions/cryptocurrency-scams

https://consumer.ftc.gov/articles/what-know-about-cryptocurrency-and-scams

https://www.investopedia.com/tech/how-identify-cryptocurrency-and-ico-scams/

https://www.aarp.org/money/scams-fraud/info-2019/cryptocurrency.html

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

Basic Training, DROP A FEW DOLLARS AND GIVE ME .00002 BTC!!!

Headline: Beginner Crypto-investing

Date: 11/5/2022

Body:  My buddy once wanted to buy a Ferrari.  Being a non-fool, the first thing he did was educate himself on all of the models available, and decided on the model he was looking for   Then, he looked for good ways to get a good deal on a Ferrari (no, he didn’t go to Italy.)   He discovered a few good auction areas, but he also read that if one is willing to do a little work (He’s a gearead, so, he really looked forward to this challenge) the government will often have auctions where they sell off cars seized in criminal busts.  He found a relatively local site for this, and waited until the next sale.  He got the program and looked for the Ferrari he was looking for, and learned that “garage kept” was a useful attribute to look for.   He found one and put a pretty strong offer on it.   He won!!  (Yes, I did get to ride, and placed my backpack in the storage compartment in the front, very strange.)  Point is, when he was interested in making a large investment, he educated himself first,  was patient, and then got precisely what he wanted.  With cryptocurrency, you should probably do something similar. 

Ok, the first decision is to see if you wish to invest in cryptocurrency at all. 

There are advantages and disadvantages:

Advantages of investing in cryptocurrencies.	Disadvantages of investing in cryptocurrencies.
Diversification—The idea here is that as some investments go up, some go down or stay the same.  Diversification allows you to take advantage of more market movements, and shields you from overloading on one particular investment.	Limited regulation—The protections offered to investors who invest in cryptocurrency are very thin on the ground.  It is the Wild West here.  Further, when regulation might take effect is highly uncertain, as it the effect it might have on pricing.
Return potential—Remember, this is return POTENTIAL.  And it is very high, as is the possibility that your cryptocurrency becomes worthless.	High price volatility—Prices can change A LOT, day to day, and hour to hour.  If you value your sleep, you might want to consider keeping your crypto investment relatively small.
Additional Utility—Egad, “utility!!!”  It simply means that you get something else of value too.  Let’s say that Bruce Springsteen starts “Boss bucks” when you invest, you might be invited to special parties, or given advance notice of other projects.

OK, cute story, and I too love Ferraris, but how do I do the nuts and bolts of cryptocurrency investment.

1. Decide where to buy it.   There are many places to buy cryptocurrency.   Some make it very easy and are relatively expensive.  Some offer other investments as well.   So, read some good articles and decide carefully where it is best to purchase.
2. Decide how you’ll pay.  If a beginner, this will likely be trading a fiat currency (e.g. USD) for the cryptocurrency, but, as you diversify, you might want to trade one cryptocurrency for another.
3. Add value to your account.  OK, it’s time to purchase a wallet.  Then you need to load it with currency.
4. Select a cryptocurrency.  This is a very personal decision.   Perhaps you want BTC because it has the longest track record.   Perhaps you want ETH because of its use within many metaverses.  Perhaps you want  to invest in a more speculative cryptocurrency, like Dogecoin or Cardano.  The choices are nearly endless.
5. Make the trade.

So, how much of my investable assets should be invested in cryptocurrency?

I have seen many answers to this question.   The key attribute of crypto, to my mind, is how variable it can be day to day and even hour to hour.  Given this volatility, I think it’s a  conservative estimate to limit yourself to 5-10% of your investable assets.

What should I do once I decide on a dollar amount to invest?

1.  Get the whitepaper.   Every time there is an initial coin offering (ICO) the management team will write a whitepaper explaining the attributes of this coin.  You should feel totally comfortable with the identities of the management team, the purpose of the offering, and the systems used to distribute the coins.  Be sure to take note of any major investors and their possible agendas.
2. Make sure that your exchange supports the currency you are investing in.  While you’re at it, make sure that there is indeed an active market for that currency.  If it is thinly traded, perhaps you might consider a different currency.
3. Be sure to understand how cryptocurrency is taxed.  If you are trading, then, you will pay a capital gains tax, assuming that you make money.  If you receive currency as a reward for mining or something similar, you’ll be taxed on the value at the time you received them.   So the bottom line here is to keep careful records on your own.  Back these up with documents from your exchange.

What if I am reticent about investing in crypto, but, I want to obtain some of the upside potential?

There are a number of options  here.  You could invest in an ETF which in turn invests in several cryptocurrencies.  You could also invest in a company that has a large investment in cryptocurrency, like Paypal.  You could also invest in a bitcoin trust.  These are offered through normal retail investment firms.

The Verdict

Cryptocurrency investing is very exciting.   Consider it like driving a seriously over-powered sports car.   Can it be a lot more fun than driving a Toyota or Honda?  Yes, it can be.   As you see valuations going up and up, quickly, it can be very exciting.   Can you get into much more trouble much more quickly driving that over-powered muscle car than when driving a Toyota or Honda?  Yes, you can find yourself in a world of hurt where you only wake up in a hospital.  This is why allocation is so important.  I think that cryptocurrency investing is a bit like Brill cream.   A little dab will do ‘ya.

REFERENCES

https://www.nerdwallet.com/article/investing/cryptocurrency

https://www.fool.com/investing/stock-market/market-sectors/financials/cryptocurrency-stocks/how-to-invest-in-cryptocurrency/

https://www.investopedia.com/tech/what-you-must-know-investing-crypto/

https://www.businessinsider.com/how-to-buy-cryptocurrency

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

Is California Dreaming?

Headline: What is the progress so far with California trying to regulate cryptocurrency?

Date: 11/3/2022

Body:  I remember when I was little, I loved watching gameshows, especially The Price is Right.  Whenever there was a car at stake, there would be a huge reaction from the crowd, followed closely by the announcer’s voice.  Rod Roddy would intone all of the features of the vehicle, and always, he would mention, “California emissions.”  So, even 30 or more years ago, California was in the vanguard of states trying to regulate pollution more vigorously than the federal government.  They seem to be continuing that progressivism, as they try to regulate some cryptocurrencies.     Perhaps we can profit by looking closely at their example.

The governor of California signed an order that calls for the state government to consider cryptocurrency regulation along a similar reasoning as the federal government.  (This was after 2 attempts at legislation were shot down or stalled.)  He also seems to want to explore the advantages of using the blockchain model for several state systems.  Per the governor, “Too often government lags behind technological advancements, so we’re getting ahead of the curve on this, laying the foundation to allow for consumers and business to thrive.”   Even prominent individuals disagree on the correct role of cryptocurrency.  Elon Musk supports cryptocurrency, and Warren Buffett opined that he would not pay $25 for all of the world’s Bitcoin.

Why is this so important?

As the Constitution was set up, all states were seen as laboratories of democracy, where things could be tried out in a relatively small area.  If the idea works out well for the state, the Federal Government can then consider whether Federal Law should be changed to match the state regulation.  Well, to put it bluntly, if California were a laboratory, it would be a laboratory that Gill Grissom would just salivate over.   It has 39,000,000 residents and boasts an economy of more than $3.1 Trillion.  More than 400 businesses in the state will take cryptocurrency in exchange for goods and services   It is clearly a big deal.  So, if we get good lab results from California, it seems likely that the Federal Government might try to cheat off of their paper, in an effort to craft reasonable regulation of cryptocurrency.

California is particularly important because of the technology culture that is native to the state.  Ohio tried to start a program where cryptocurrency could be used to pay taxes, but the program was discontinued because so few people used it, that it was prohibitively expensive.  Given that California is the home of Silicon Valley and many tech firms, it seems likely  that there will be more interest in utilizing cryptocurrency to meet everyday obligations like taxes.  In an effort to further these advances, the state of California has christened a Departmenet of Financial Protection and Innovation to supplement the findings of the California Blockchain Working Group.  The Department will take enforcement actions as necessary and create educational resources for the general public on how to avoid frauds within cryptocurrency.  The Working Group is tasked with aggregating ideas of how the blockchain model might be leveraged to help state agencies.

What specifically does this order do?

1.  They have to gain an idea of what state agencies and stakeholders want to see from the installation of the blockchain
2. Obtain Public comment and aggregate this into a report.
3. Begin enforcement of consumer protection laws relevant to cryptocurrency.
4. Develop, manufacture and distribute educational resources relevant to digital assets.
5. Aggregate, review and remediate complaints relevant to digital assets.

The Verdict

In so many different arenas, California is in front of many regulatory attempts.  Some might grumble about “granny states”  but to me, it seems that California might have gotten it nearly right.  Per a spokesman for the Department, “The consensus among staff is that the department and commissioner could regulate virtual currency, to some extent, under current state law. Consumers would be the prime concern of any regulatory structure we build—making sure they are fully aware of the risks associated with virtual currency and providing effective, reasonable safeguards against those risks.”  This seems to be a well thought out middle ground  to regulation: allowing investment, but requiring the buyer to carefully research what they are putting money into.

REFERENCES

https://www.usnews.com/news/business/articles/2022-05-04/california-moves-to-embrace-cryptocurrency-and-regulate-it

https://today.westlaw.com/Document/I3146dd75d5d111ec9f24ec7b211d8087/View/FullText.html?contextData=(sc.Default)&transitionType=Default&firstPage=true

https://www.coindesk.com/markets/2020/09/29/california-governor-signs-law-bringing-state-new-tools-to-regulate-crypto/

https://cointelegraph.com/news/california-becomes-second-state-to-try-regulate-bitcoin

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

The Music Industry Grows Back to its Roots.

Headline: How might NFTs change the music industry?

Date:

Body:  For decades now, there have been a relative few ways to get your music distributed.   You sign on to a label, and essentially, you sign away to the corporate owners all or nearly all rights in your creation.  In return, they leverage all of their relationships with radio stations and venues, and you get airplay and concert dates.   NFTs suggest a new way to distribute music.  When somebody purchases the NFT represented by your musical composition, it is recorded on the blockchain.  (Depending on how the smart contract is written, this is usually bragging rights, not ownership of the audio or composition.)   Otherwise, you give over your check to a record company, and you have very little left but the beginning of a GREAT country song, perhaps.  (Provided that you crash your pickup, and have your partner leave you.)

What is an NFT for music?

The NFT is essentially a receipt, granting you ownership rights to that song or composition, and this receipt is recorded within the blockchain, and this is essentially immutable.    Through the years, there have been countless court battles about who owns a certain song and this record-keeping makes court battles generally unnecessary.

Where can I find these music NFTs?

Opensea is the thought that comes to mind for NFTs.  But, music is different and there are music-only platforms that seem to be preferred. Examples include Zora, Foundation, Catalog and Sound.xyz.  In marketplaces such as this one, music NFTs can be paired with PDF documents that contain a transcript of the lyrics.  The appeal to music writers is that as the song is sold from person to person, the original writer will continue to get a small amount of the sales price, as original owners are recorded in the blockchain.  This is already happening.  Recently, Jacques Green sold the rights to a song, called “Promise” for 13 ETH, or almost $23,000.  Kings of Leon minted an NFT of an entire album, and paired it with a VIP experience to any concert the buyer might choose to attend.  In another development, Universal Music Group has partnered with the Bored Ape Yacht Club to develop its own band within a metaverse.

Most interesting to me, is a community called Anotherblock.   This  group minted an NFT in a song called “Weekend on a Tuesday” and each of the 250 investors in the NFT get a .02% share in streaming revenues.  In an issue of Cointelegraph, the CEO, Michael Traore was quoted as saying, “Music rights’ value is created by people loving and listening to the music, and doing things with it. Why shouldn’t [they] be able to own rights if they create the value by listening to it. They should be able to get some of the upside as well.”  When they polled their Discord community, Anotherblock found that the most interest in NFTs was for EDM followed closely by hip-hop.   Said one managing director of another online community, Shannon Heber,  “The ethos and focus of Web3 is identity, ownership and community.”    Maybe they’re on to something, maybe they’re on something, time will tell.

What’s the big deal here?

The big deal is 3-fold:

First, artists don’t have to pay off a huge record label for distribution of their music.   The fans, if they are ardent enough, can make a direct financial contribution to the bands they like.

Second, if there is a lesser-known artist, the owner of the NFT is motivated to do whatever they can to promote the artist, in an effort to make their NFT more valuable, should they decide to sell it in the future.  This benefits both the artists and the fans. 

Third, the NFT allows the artist to gamify the experience to encourage interaction.  As an example, one artist offered a cash prize of $50,000 for the best piece of content that could be created.   This  encouraged fans to create a lot of content that helped the artist, and helped them feel as if part of the team behind that artist.

OK, so what’s standing in the way of NFTs being very common in the music industry?

The technological learning curve for NFTs can be a “key barrier to entry,” said Lin Dai, CEO and co-founder of OneOf, an environmentally conscious NFT marketplace that champions emerging musical artists. “About 99% of all creators have not been able to really participate yet,” Dai said.  “Do your own research” (DYOR) is a standard piece of advice within the NfT community, and setting up your own NFT is no different.  You have to carefully consider which blockchain you wish to record your NFT, and then, which marketplace will be best to sell

The Verdict

When the Internet started, it took some time for people around the world to see the value of giving away information to others.  Blogs also took a while to catch on, but now there are millions of them worldwide, and some of the content is quite good.   On the other side of the coin, some of it is useless or even entirely mistaken in the information it conveys.  It has taken us some time to become societally comfortable with this arrangement.  Seeing this pattern, I don’t think it’s too much of a jump to presume that NFTs will also take some time to gain widespread public acceptance.  But, I think that for the truly devoted fan, the NFT will allow for them to qualify for truly unique experiences  that they might value very highly.    In time, we shall see.

REFERENCES

NFTs in Music: Why They Are Taking Off in the Music Industry

https://cointelegraph.com/news/nfts-democratize-music-industry-and-redistribute-song-rights

https://www.coindesk.com/learn/the-web3-guide-to-getting-into-the-music-industry/

https://www.binance.com/en/blog/nft/how-are-music-nfts-changing-the-music-industry-421499824684903380

https://www.npr.org/2021/03/04/973791982/a-small-choral-group-is-betting-big-on-tokenizing-their-art-with-blockchain

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

We put the “Ex” in “executive.”

Headline: Why are all the executives fleeing from the cryptocurrency firms?

Date:10/26/2022

Why are all of the cryptocurrency executives suddenly stepping down?

Body: Remember that old trick from college?  Just after dessert, just before the check arrives, you develop the sudden need to use the bathroom?  Then (ostensibly after washing your hands) you return to the table, and like magic, the check has been paid.  It seemed to always work (until you got a job.)   Well, something similar seems to be happening in the C-suite within cryptocurrency firms.  Like rats escaping a ship, they all seem to be jumping at the same time.   In my brief research, I found 6 of them leaving within a few months.  The question as to why has to be asked.

Is this REALLY a big problem?

It appears to be a real problem, because at about the same time as executives parachute out, the cryptocurrency seems to lose all value.   And this sequence of events is repeated.  Don’t believe me?  A few examples:

Name of Executive	Name of Cryptocurrency Concern	Details
Brett Harrison	FTX	Various M&A activity
Alex Mashinsky	Celsius	Filed for Bankruptcy, consequent to a $1.2 Billion shortfall on their balance sheet.
Michael Moro	Genesis	Various M&A activity
Jesse Powell	Kraken	He claims that he needs more time for “personal stuff.”  Timing is consequent to the firm being accused of traffic with Iran.
Michael Saylor	Microstrategy	This was related to bankruptcy of Three Arrows Capital.
Sam Trabucco	Alameda Research	“to prioritize other things.”
Changpeng Zhao	Binance

These are just a few of the cryptocurrency executives who have quit their jobs in recent days.   Given that the industry is so new, this gusher of governance leaving is a major concern.   The question we have to answer is , “Why?”   Particularly interesting would be, “Why now?”

To answer this conundrum, I might offer a few observations that come to bear on these questions.

Laissez-le-bon-temps-roulez!!

Apologies to anybody reading this who knows French.  But, the good times will roll, until they don’t.  When these CEOs took over 1-2 years ago, cryptocurrency was on a tear, and these CEO were raking it in, hand over fist.  Well, the good times have stopped for now, and the piano player is demanding to be paid.  Welcome to reality, indeed, as cryptocurrency values have almost universally tumbled.  Bitcoin, for example, lost 60% of its value.  This first major slap in their faces, could go a good way toward explaining the exodus  of cryptocurrency executives.  But wait, there’s more.  In the last decade or so, cryptocurrency has had to deal with attempts to regulate it.  Said one expert, “If there is a firm in complete crisis and meltdown, you need an adult in the room, and you need that adult in the room to understand regulation and compliance.”   This same professional seems to think that the shifting is not yet over.

Inflation

Yes, another mention of the “I” word, and I don’t mean, I-phone.   During the pandemic, the U.S. government was forced to make decisions in monetary and fiscal policy that made inflation a very serious threat.   Doubtless, you are aware that that particular bird has come home to roost.   Badly.   The resulting inflation is beginning to erode the confidence that buoyed valuations of cryptocurrencies.

Investors

The new regulatory environment is not the  only headwind to this industry.   Investors in these companies (or projects) are beginning to demand that they see profits.    These entities are not used to shareholder pressure, and this too is forcing top executives to consider stepping down.

The Verdict

The cryptocurrency firms are very new, and it’s logical that the leadership is too young to have much relevant experience.  But, that certainly makes it no less important that experienced people also be involved.   In an open bay with a light breeze and fair weather, almost anybody can handle the tiller.  But, it’s when the storm clouds roll in (and, they will) that you want an experienced hand on that tiller, and an experienced one in the bow too.

I did notice one thing that didn’t seem relevant to the discussion above, but seemed a salient point nonetheless.    Many of these cryptocurrency CEOs who are stepping down are often stepping into other roles.   Many are stepping into new CEO roles representing a different cryptocurrency.  This is important to your research efforts, because as you identify the management team, it is now very important to identify whether this team represented other cryptocurrencies before.   Would this be good or bad?   Good question: I would say it could be either:   It would be good if they made all of their learning mistakes with the former cryptocurrency and now had the requisite experience to enable their considered judgement.  On the other hand, a series of cryptocurrency projects in the past could denote a very poor management ethos for that team.  I guess the important thing to do is look at their behavior and ask if you would trust your money to a banker behaving in this manner.  Once again, it is a very individual decision.

REFERENCES

Crypto CEOs are leaving their jobs. Here’s why – MarketWatch

Crypto shakeout engulfs the C-suite as CEOs start stepping down | Pittsburgh Post-Gazette

Kraken’s Jesse Powell to Step Down as CEO of Crypto Exchange (coindesk.com)

Celsius CEO steps down amid bankruptcy proceedings | Reuters

Kraken CEO Jesse Powell steps down | Fortune

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.