G7 discusses cryptocurrency

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Headline: What has the G7 agreed upon in cryptocurrency?

Body:  OK, don’t yawn.   Unless, of course, you’re taking in extra oxygen to support you in a frenzy of extreme interest; That would be OK.  Cryptocurrency is an international thing (in a decentralized world, Banks and governments are not involved) so, it is natural that countries might try to regulate this product in concert with their international partners.    So, recently, I had heard that the G7, a major partnership, was trying to agree upon a rubric that could be used by all members.   So, what decisions were made, and why does it matter?    Let’s take the 2nd part first.  The G7 matters because it is so big, pure and simple.    So, let’s look at just what the G7 is.

What exactly IS the G7 and what is it supposed to do?

The G7 is an informal bloc of industrialized democracies—the United States, Canada, France, Germany, Italy, Japan, and the United Kingdom—that meets annually to discuss issues such as global economic governance, international security, and energy policy. Proponents say the forum’s small and relatively homogenous membership promotes collective decision-making, but critics note that it often lacks follow-through and excludes important emerging powers.  At first, this partnership was the Group of Eight, and included Russia, but Russia was suspended in 2014 after their annexation of Crimea in Ukraine.   The E.U. is a “nonenumerated” member, but all members in aggregate, represent 45% of the world economy.   So, what happens here , in no way, stays here.  (For its own part, the U.S. has experienced some rough waters in this group when former President Trump very publicly challenged the organization on both trade and climate change.)   Interestingly, China seems motivated to join the G7, but many members point out that the G7 umbrella is only for “stable democracies.”

So, the question that must be asked is, “who cares?”   The G7 is a very informal group lacking the central structures of NATO or anything similar.   I have read many different accounts of this, but at root, it seems that the big deal is that as part of the G7, your country can effectively help to promote a solution that would in turn, benefit your own country.  For example, take trade treaties between the U.S. and the EU; two very good friends.  By being a part of the G7, the Europeans would likely get to affect the language used in the treaty to be written.   In effect, they get  to be “in the room” as the U.S. first begins to consider what it most wants from this treaty.     Hence, when the final treaty comes out, the EU has already effectively ghostwritten the draft.  This is important to diplomacy.  Despite this, many diplomats point to the importance of the G20 to be much more salient in this environment.  Currently, there is no more vociferous debate than that around Ukraine.

What does this mean for cryptocurrency?

OK, first, understand that all countries involved, are deeply confused by the cryptocurrency debate;  They do want to take advantage of cryptocurrency, but they don’t want to be stuck with egg on their collective faces, if the entire crypto space just shuts down.  This is why it is so vital that the G7 hammer out a plan at their meeting in May, as collective action is the only realistic way to conquer these challenges.    As of now, Japan has quite a significant regulatory framework on cryptocurrency, and the EU has a regulatory framework ready to “go live” in 2024.  This is the pressure building behind the G7.   In response, one of the financial arms of the UN, the FSB, has volunteered to help develop a cryptocurrency rulebook.  The outfall of all this is that we might have a global policy as early as July 2023.

The Verdict

Einstein has a quote  that I always think of in this regard:  “We can not solve our problems with the same level of thinking that created them.”  I admit that they don’t yet have the specifics to share but, I am encouraged that this planning is happening within the G7.   Since NATO is such a formal group, the G7 allows for experimentation and breaks down fears that stall NATO and similar institutions into inaction.  To be clear, given the broad reach of decentralized finance, larger agreements within the UN or similar assemblies will be necessary to foster efficient   transactions that are easy to execute.  I will return to this topic later in the summer of 2023.                         i

REFERENCES

https://cointelegraph.com/news/g7-to-collaborate-on-tighter-crypto-regulation-report

G-7 Finance Ministers Call to Accelerate Global Crypto Regulations Following UST Collapse: Report (coindesk.com)

G7 nations set to push for stricter cryptocurrency regulations at Japan summit in May (yahoo.com)

G7 Countries Set a Date for Imposing Global Crypto Regulation After the Recent Banking Crisis (Report) (cryptopotato.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.

What the heck happened to Credit Suisse?

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Body:  So, if you can’t trust a Swiss banker, who CAN you trust?    This question has become some type of joke, appearing in any variety of action/comedy films of the 1980s and 90s.  The stereotype is of a very conservative business person, who keeps very quiet concerning the business of their clients.  So, is this stereotype justified?    I have never been to Switzerland, so I cannot say for sure.   But, with what just happened to Credit Suisse?   I’m not so sure the stereotype fits anymore.  You make the call.

OK, so what DID happen?

For many years, things were going well at Credit Suisse.  Credit Suisse (CS to the cool kids), was one of the few 800-lb gorillas on the Wall Street scene for many years.    Then, in an attempt to capture out-size dividends, they made some ill-advised investments, and received about $50 Billion loan from the Swiss National Bank, to help them address liquidity concerns.     They were scrambling for money, but as these withdrawals happened, the largest investors refused to pony up any more dough.    So, this was the need for the $50 Billion loan from the Swiss Nationqal Bank.   “This additional liquidity would support Credit Suisse’s core businesses and clients as Credit Suisse takes the necessary steps to create a simpler and more focused bank built around client needs,” the bank said in a statement.  The bank also used some of this money to repurchase many of its own debts.    At the same time, the Bank went on a severe “rightsizing”  (read, “firing spree”) of the company, shedding over 9,000 jobs.  At the same time, management went on a disasterous policy change campaign where they demanded that employees be on site 3 days per week.   Some other employees chose to leave on their own.

In an effort to soften the blow to other Swiss financial firms, the Bank made a statement.  In it, they said the following:

“There are no indications of a direct risk of contagion for Swiss institutions due to the current turmoil in the US banking market,” the statement continued.  The cynic that I am, we can already see why the Bank had to make this announcement.  Their shares dropped 24% overnight, and other large banks (e.g. Paribas, Societe Generale, Commerzbank et al.) dropped between 8-12%.   So, the question that must be asked is, what role, if any, did the failure of American banks have upon Swiss banks?  This remains unclear, and there is competent evidence on either side of this argument.   However, one expert on Swiss Banks said, “It’s unfortunate that the problems with some of the smaller U.S. banks in the last two or three weeks happened at the same time as this issue with Credit Suisse but the two are completely different and very largely unrelated,”  He went on to say that the financial body blows absorbed by Crediti Suisse started many years before the first of the American Banks began to fail.

The blows keep coming for Switzerland’s second biggest bank. On Tuesday, it acknowledged “material weakness” in its financial reporting and scrapped bonuses for top executives.  I read this line within the report, and I had to set my chair back up.  Let me explain.   First, CS is a bank and the largest issue they have to face is to keep the faith of their customers, so, finding them deficient in financial reporting is a HUGE black eye.  (Think of a Middle School Boxing Champ being accidentally scheduled to fight Tyson.  THAT  type of black eye.)  Second is a type of term of art within the auditing field.  When an audit firm finds a problem, it is a “reportable condition” and the company does something to mitigate it.   But,, when they find a “material weakness” it would be highly improbable that the company could institute a solution fast enough, and the prudent investor might change his or her investment decision on the basis of this material weakness.  Said another way, a reportable condition is an occasional migraine.   A material weakness is brain cancer.

Credit Suisse broke up.  Several of its components were legitimately profitable.   These went on to provide wonderful service to their clients.  The portions of CS that were bleeding red ink were purchased by UBS.  In addition to making less risky bets, UBS realized how important a hybrid work arrangement was to keeping the best people employed with them.

“In that sense I also see a prosperous future for the financial centre because we have hundreds of very well capitalized banks and very successful wealth management and asset management banks.”  Contrary to this expression of trust, it cannot be denied that number of banks has fallen from 356 in 2002 to 239 in 2021.  Over a similar period of time the industry has fired over 20% of its workforce.  Against this backdrop of decline, holding management accountable is nearly impossible in Switzerland (In the U.K. individual members of the Management Team can be held liable in these schemes, and might  face criminal prosecution.)

So, what lessons can we learn?

LessonComment
Acknowledge the changing landscape.Work/Life balance has been a buzzword for decades.   But, the shift has been accelerated in the aftermath of the pandemic.  The work situation (relationship between employer and employee) has irrevocably changed.
Embrace changeManagement should not exert themselves against changes (like the hybrid work paradigm) rather they should explore for evidence to see if they might help gain competitive advantage.
Prioritize employee well-beingEmployee well-being (Mental and physical health) IS the company, and it is much more profitable when this is kept in mind.
Communicate & EngageTransparent and consistent communication with the workforce is vital to productivity and profits.
Invest in Technology & Infrastructure.Sometimes, a new work benefit will require an investment in technology, and companies should be willing to consider this investment to help minimize retraining costs.
Implement training and support.Employees and managers both need resources and time to  adapt to new benefits and work situations.
Regularly reassess and adapt.The very definition of work is evolving constantly, and managers need to constantly assess whether or not their current interventions are having the effects they intended.

The Verdict

“If necessary, the SNB will provide CS with liquidity,”   The Swiss government said this of the future of Credit Suisse.  This statement struck me funny, given how proud the Swiss are of their banking industry.   But, stepping back a bit, this makes sense.  When Silvergate, Silicon Valley Bank and Signature went  down in the U.S., the FDIC went out of their way to express that all depositors would be made whole for their deposits.  This move was necessary to prevent others from running to other banks and withdrawing their deposits, and starting a bank run.   Apparently, the good people in Switzerland are little different  from the good people in the U.S.  I would guess that it hit me so hard because it strikes me as a little unfair that the government would be so willing to renumerate without apparent limit.  (They claim that taxpayers are not paying… How does THAT work?)  I think that the government is hoping that they can exercise “moral suasion” or use of an inexpensive form of jawbone control.    It seems to me risky that they are pinning so much hope to that technique.   Perhaps better regulation will evolve over time.   One can only hope.

REFERENCES

https://www.cnbc.com/2023/03/24/swiss-claim-the-us-banking-crisis-ultimately-toppled-credit-suisse.html
https://www.reuters.com/business/finance/credit-suisse-collapse-threatens-switzerlands-wealth-management-crown-2023-03-22/
https://www.cnn.com/2023/03/15/investing/credit-suisse-shares-saudi-national-bank/index.html
https://www.entrepreneur.com/leadership/collapse-of-credit-suisse-a-cautionary-tale-of-resistance/448183

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.

Privacy Should Retain Primacy?

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Headline: What are the privacy concerns when considering cryptocurrency?

Body:  Privacy concerns are paramount in the minds of many when you ask about cryptocurrency.   It is true: There is always a tradeoff between security and access.  I work for the government, and our major database is DOS-based.   When I asked my buddy in the deskside group, he sighed and noted that the government was cheap.  Then he shrugged and said that the DOS it is based upon is very secure.  (I think there is a very good reason: Most hackers are under the age of 30, and most of them haven’t even HEARD of DOS.)  But all jokes aside, my deskside guy is pretty good, so perhaps it might be useful to delve into the privacy concerns regarding cryptocurrency.

Is this really a big deal?

Yes.  In 2022 alone, the crypto markets were worth more than $2 Trillion.  Ever thrown a crust of bread up in the air at a beach?  Just how long was it before several dozen seagulls materialized?   If it’s more than 30 seconds, I’d be very surprised.  Online hackers and fraudsters are just like these aerial rats (sorry  to the membership of SOS, Save Our Seagulls), and will materialize in even great numbers even faster when there are Trillions of dollars involved.  That’s a lot of bread.

Why are there privacy concerns?

We already spoke of the tradeoff of security and access.  More to the point, there are slowly, being added regulations with which these cryptocurrency firms have to comply.  One such set of requirements is the Know Your Client (KYC) requirements where they collect a fairly broad array of data about the participants.   Well, in a bid to speed up the transaction time, sometimes there are compromises made to the securing of the customer data.  This is the crux of the concern.

What is de-anonymization of data?

This means that bad actors are trying to re-assemble different bits of publicly available data, and ting this to a single individual or group.  Let’s say, for fun, that you go to to look at Tik Tok on a regular basis.  Even if signed on as an anonymous person, the algorithm will quickly lean that I like dog videos a lot, especially the dog grooming videos (the best ones are the ones with the Huskies who are howling the whole time and blowing a coat.)  The algorithm might look at this and other data and conclude (wrongly) that I own a dog and would likely react positively to ads for dog-related products.  While I am a dog fan, owning one is fairly out of the question.  But the point remains that they pretty accurately described my behavior 

How De-Anonymization Works and how is it used?

Data miners can retrieve some information from each available data set they have access to, and some publicly available data (e.g. Census data)  to put together a person’s identity or transaction. For example, a data miner could retrieve a data set shared by a telecommunications company, a social media site, an e-commerce platform, and a publicly available census result to determine the name and frequent activities of a user.  We might all expect this activity to be entirely illegal, but, there are cases where it is not.  For instance, the FBI used de-anonmization tools and techniques to figure out who was behind Silk Road, and law enforcement agencies regularly track down child predators using similar tools.  Remember, no matter how good you think your privacy is, de-anonymization is always possible, given budget and equipment.

So, what are they doing to improve privacy?

In short, these cryptocurrency firms are innovating.   Two of the biggest improvements were the Lightning Network and Taproot.    The Lightning Network  is a much faster Layer 2 payment protocol (I think this is related to the sidechains post I had put together previously. )  Taproot is a program that associates several signatures together to make substantiation of transactions faster. 

I’ll See You in Court!!

This is the sign off for one of my favorite podcasts, Legal Eagle.  But, it is appropriate here too, because a group of 6 plaintiffs are taking the Treasury Department to court over their application of regulation.  In short, there was a service called Tornado Cash that allowed users to deposit cryptocurrency to one address and then withdraw the same funds from a different address.   The Treasury Department asserts that agents from North Korea and other places were using this functionality to launder money, and thus shut down this service.     The plaintiffs responded that there are legitimate reasons for doing this,   One person anonymously donated to support Ukraine, and another was using the anonymity to secure his private assets as he ran his Ethereum staking business.  Further, plaintiffs are saying that the Department exceeded its authority, granted by Congress.  The outcome should be interesting.

The Verdict

Anytime that there is a vast pool of data (and a good amount of money) floating around in the same place, you can rest assured that there are hackers nearby, preparing to try and exploit any security weaknesses that they can find.  But, the law enforcement angle makes this puzzle even more complicated.  Not too long ago, there was a mass shooting in California, and the FBI requested that Apple “crack” the phone so that e-mails can be read, and pre-meditation of this horrific act can be asserted.  Further, they asked Apple to program in a “back door” to their phones, such that law enforcement agencies could do this activity more easily in the future.   Apple said, no and the FBI countered with something like, “but we need it to keep the American people safe from terrorists.”   I am not making light of the seriousness of this debate.   I just think that we need to have the conversation as a country.

REFERENCES

https://cointelegraph.com/news/crypto-privacy-is-in-greater-jeopardy-than-ever-before-heres-why

https://www.coinbase.com/blog/defending-privacy-in-crypto

https://www.investopedia.com/terms/d/deanonymization.asp

https://www.coindesk.com/markets/2020/12/19/the-pandemic-turbocharged-online-privacy-concerns/

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.

I Thought Only Serial Killers left Signatures Behind??

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Headline: What happened to Signature Bank in NY?

Body:  OK, so if you have your scorecard handy, Silicon  Valley Bank and Silvergate Bank both were forced to close due to bank runs pursuant to a softening in the tech startup environment.  It would appear that we have a #3 on the podium now.   Signature Bank, situated in New York, is now shut down, due to many of the same issues.  Now, the most attentive amongst you (likely the left-handers in the group) might notice that Signature Bank rings a bell from a previous entry.  They are the traditional bank that agreed to partner with Binance to help them gain access to the international SWIFT network.  Now, they too have been shut down by state banking authorities.

What happened?

Scott Shay, Joseph DePaolo and John Tamberlane founded Signature in 1999 with backing from Israel’s biggest lender, Bank Hapoalim. On a personal bio page, Mr. Shay described himself as a “thought leader, and author of several widely read books on profound issues facing the Jewish community.”   One of Signature’s specialties was financing the purchase of taxi medallions, which authorize holders to operate cabs. It was known in New York for providing banking services to law firms and real estate companies, and for catering to wealthy families in the area.  The bank went public in 2004.

Things seemed to be going so well.  In September, almost 25% of its deposits came from cryptocurrency firms.   But, as the small-business market softened, the bank tried to decrease this amount by more than a third.   The bank also said its digital asset-related client deposits stood at $16.52 billion. Signature was one of the few financial institutions that had opened its doors to taking deposits of crypto assets, a business it entered into in 2018.   Then came February 2023, and the Bank announced that the CEO would become a senior adviser, and the COO would be promoted to the CEO role.    (This progression of events makes me have to ask if the outgoing CEO felt a disturbance in the Force.)

State regulators closed the bank down, and transferred control of $90 Billion of customer deposits to the FDIC.  Just like in the SVB default, US authorities claim that all customers will recover 100% of their deposits, and the taxpayers will not be charged.  Per the articles, this is possible, only because Signature Bank has been found to be under the systemic risk exception.”   Once again, I think this was done to encourage  belief in the US banking system.   Without this announcement, a much larger panic might have occurred.   In the meantime, the FDIC has established a “bridge” successor bank, with the objective of making their customers whole.    The designated bridge bank is led by the former CEO of Fifth Third Bancorp.    Sadly, shareholders appear to be out of luck, as the FDIC approximates the cost of receivership at $2.5 Billion.  Customers can call a hotline or find information on the corporate website.

The transfer of all the deposits was completed under the systemic risk exception approved earlier today. All depositors of the institution will be made whole. No losses will be borne by the taxpayers. Shareholders and certain unsecured debt holders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund (DIF) to support uninsured depositors will be recovered by a special assessment on banks, as required by law.

“This story has more to do with crypto, huge error in judgment by veteran bankers,” said Christopher Whalen of Whalen Global Advisors, which specializes in analyzing and consulting on financial institutions. “Result was the same in a deposit run.”

The Verdict

“Many depositors at these banks are small businesses, including those driving the innovation economy, and their success is key to New York’s robust economy,”  said the governor of New York.  This is interesting because it summarizes the conundrum facing so many municipalities and banking entities.    On one hand, they desperately want to help support and profit from the firms using cryptocurrencies, but, they are quite fearful of it, as the price variability is so great.  The outcome is something truly unprecedented.   Even though we have gone through transitions from coinage to checks to EFTs, there has always been a central authority of a bank, a government, or both.  Cryptocurrency ( and decentralized finance more broadly) will force us to all become experimenters and be a little patient for results.  New York certainly seems to be trying to foster a home for cryptocurrencies and digital assets, and London has invested billions into a similar exercise.  As unaccepting of delays as we are, we must develop within ourselves the patience and maturity to wait and see on this one.  Rest assured, if one is patient and logical, there will be a fabulous opportunity to make a few bucks.   But, as my father often told me, “If it’s a good investment now, it will be a good investment down the road, too.”  Perhaps the best use of the intervening time might be to become more educated about cryptocurrencies, and how we might approach the opportunity, while mitigating the risks.   Kind of like any other investment, huh?   Interesting.

REFERENCES

https://www.reuters.com/business/finance/new-york-state-regulators-close-signature-bank-2023-03-12/

https://www.fdic.gov/news/press-releases/2023/pr23021.html

https://www.fdic.gov/news/press-releases/2023/pr23018.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.

Goodness, Gracious, Great Banks a-FIRE!!

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Headline: So, what DID happen to Silicon Valley Bank?

Body:  OK, so I promise not to be too click-baity here.  But, in the most recent issue we went over what happened to Silvergate Bank.  At nearly the same time, Silicon Valley Bank also went under, and the natural question is, did they both succumb to the same malady.  Well, sorry to  hit you with this one, but, the answer is “sort of.”  Think of their relationship as a popular song, and then the parody song as written by Weird Al Yankovic.  The rhythms are the same, most of the notes are the same, the orchestration is often the same… just the story told through the song is sometimes completely different.  (I never thought I’d mention Weird Al in one of my columns, but here we are.)  Let’s dig in.

Who’s on First?

To get the basics of the case, I think we need to look at an authoritative source.   Relax, I will summarize the words of the FDIC and others, so as not to  make many fall asleep.  To my mind, the first significant quotation is as follows.  “Depositors will have access to all of their money starting Monday, March 13.  No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.”  So, with coverage by the FDIC, individual accounts are usually insured up to $250,000 each.  But, the Federal Government seems to be suggesting that they will backstop the defunct entity so that it can return 100% of the losses.  So, the question that must be asked is why is the government doing this?    This is my opinion only, but I think the federal government is trying to send a signal to tech companies that they are safe to continue expanding and adding jobs to the economy.   If they didn’t do something similar to this, these new companies might take a look at what happened to the bank, and decide to put off expansion of their labor force, or execution of projects.    The announcement also said the following.  “ Finally, the Federal Reserve Board on Sunday announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors. “  With these 2 statements, I think the federal government is trying to tell both new and existing small businesses that they will continue to be financially protected, even if their bank goes under.  If the Public began to have doubts about this protection, the entire economic system could be in some danger.

So, what DID happen?

Silicon Valley Bank executives took their eyes off the ball.   (This is a very human thing.   Akin to some of the Shakespearean tragedies.)   Deposits began rolling in, and then executives wanted to loan out that money with the goal of achieving the highest rate of interest possible.  To do this, they tended to back the projects with higher levels of risk, and these were usually newly minted tech startups.  Now, this is an acceptable business model if they also use a largish amount of available resources to also invest in safer, more short-term projects.  (Think of this as a version of hedging… the good type of hedging.)  Point is, with this mix of investments, the Bank would always have a significant amount of cash available to pay off customer demands.  Simply put: They didn’t do this.   (Like a fisherman, instead of being  happy with the 600 pound tuna, they had to chase the 50-foot shark.)  Everybody knows that ti is theoretically possible to exist, but nobody has seen it.  SVB was shut down by the California Department of Financial Protection and Innovation on March 10, with no specific reason offered behind the bank’s forced closure.  Interestingly, SVB was identified as “systemically important” to the US economy, and this designation did a number of things, including giving the FDIC a larger set of tools to settle these accounts.

Wait, didn’t we see this movie before?

Yeah, we did.   In the wake of the 2008 financial market meltdown, the lawmakers tried to enact onerous new paperwork requirements upon banks having more than $50 Billion in deposits.  Then, there was an Army film inspired barrage of lobbyists air-dropped on Congress, and the threshold was reset at $250 Billion of deposits.   SVB studiously stayed  below that threshold, reaching $220 Billion in deposits at its apogee.  This situation was made even more dire when, in 2019, the liquidity requirements for banks under this $250 Billlion threshold were significantly softened.  Many suggest that this combination of policy changes set the table for these current issues

So, who’s to blame?

In short, everybody.   We could blame regulators for being too soft on these entities.   We could blame the executives for taking on too much risk.   We could blame venture capitalists for  actually starting this run on SVB.     There is a lot of people who could be credibly blamed.  We could also blame Twitter for helping to spread news of the liquidity crisis that SVB was having    In the past, rumors and other information had to travel from individual to individual.   But, in the world of social media, thousands of people could see the article and then decide to withdraw their funds also, “just to be safe.”

In this light, the SVB saga is just the latest episode of the American tech industry struggling through three overlapping transitions. First is the macro transition from an era of low interest rates that supported cash-burning consumer-tech companies to an era of high interest rates that require discipline and unit economics. Second is the existential transition from tech’s dominance of attention economics and cloud computing to its expensive struggle to figure out the next mountain to climb, whether it’s crypto, the metaverse, artificial intelligence, climate, or something else. Third is the cultural transition from “tech” as a metonym for high-growth start-ups to “Big Tech” as a description of the largest companies in the world. All three transitions are contributing to a scarcity mentality in Silicon Valley, where, as Thompson observed, “tech has been shifting away from greenfield opportunities and expanding the pie to taking share in zero sum contests for end users, from their attention to their pocketbooks.” This is the cultural climate that explains a crippling run on SVB followed by a call for national bailouts.

The verdict

On Monday, the tech writer Ben Thompson wrote that the collapse of SVB pointed to a broader rot in Silicon Valley itself. “I assumed that the venture capitalist set knew about Silicon Valley Bank’s situation [and] I assumed that Silicon Valley broadly was in the business of taking care of their own,” he wrote. “Last week showed that both [theories] were totally wrong.” Far from the familiar metaphor of Silicon Valley as a symbiotic ecosystem, where investors, mentors, and collaborators benefit from a culture of trust and faith in progress, the SVB collapse makes the tech world seem more like an actual jungle, where everything looks lovely and peaceful until a jaguar comes along and lays waste to some capybara.

This evocative quote was pulled from one of the commentary articles, and I think it is very important.  It indicates to me that even an expert in the industry thinks that the industry is “growing up” and developing.  Consider the media industry.   At first, there were newspapers, and they would often work together to ensure that they all had information to write about: ?They started as colleagues.   Then there were radio stations and TV stations and they competed to get the best interviews first.  Now there are competing interests so serious, there ase photographers who drive around urban centers at 3AM on the off chance that their police scanner might reveal a crime in progress, and they might get a picture or video that nets them millions of dollars.  Admittedly, the media example is rather extreme, but it does seem that most industries mature in a similar manner.  Now banks are over-extending themselves to help support the tech companies.   This is one reason that I think the tech sector is maturing, and I think this is a good thing.   But, every child needs an adult to guide them on their way.  One who is strict, but not too strict.   The government has this role and, like parents, they will likely take a while to find their balance.

REFERENCES

https://www.wsj.com/articles/how-silicon-valley-bank-avoided-oversight-fdic-systemic-risk-midsize-greg-becker-dodd-frank-reporting-lobbying-5b3ff837

https://home.treasury.gov/news/press-releases/jy1337

https://www.theatlantic.com/ideas/archive/2023/03/silicon-valley-bank-collapse-banking-crisis-wokeness-venture-capital/673394/

https://cointelegraph.com/news/fdic-to-attempt-another-auction-of-silicon-valley-bank-report

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.

Silvergate, Meet the Pearly Gates.

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Headline: So, what DID happen with Silvergate Capital?

Body:  OK, I am going to ask you to step in the Wayback Machine with me here, and set the destination for the later 1930s.    Ok, see that long, long line of people, all queued up before that substantial looking building?  This is likely NOT an architectural appreciation society.    This is a  bank run.  In short, there were some challenging economic conditions… and then contagion took over.   One neighbor went to talk to another, “You know, Shirley down the street, she barely got out all of her money.”  Then neighbors #1 and #2 spread the word further, as they both sprint to the Bank to get their savings out.   Multiply by a few thousand people, and this is the crux of a bank run.  Yes, nowadays, the FDIC will serve to manage this, somewhat, but please note the word “manage.”   Largely, this means that the contagion will not spread to many other banks.  For the ones directly affected, FDIC can only do so much.

So, why am I telling you about bank runs that were happening about 100 years ago?  Well, they provide a decent intuitive model for what happened to Silvergate Bank.  Only, this time, Silvergate was not just a bank.   And then again, cryptocurrency was involved.  (I will tackle Silicon Valley Bank in a future article.  That one’s kind of interesting too.)  So, let’s get started.

OK, who’s on first?

As happens so often, the media has generally gotten some things wrong or, at least incomplete and somewhat confusing.   The entity that went into “voluntary liquidation” was Silvergate Bank.   In turn, Silvergate Bank is owned by a holding company, Silvergate Capital Corporation.

What happened?

Things were good, at first. In 2013, Silvergate Bank began to help the first companies within the cryptocurrency industry.   In November 2018, it filed to go through an IPO, and they revealed that they had just under 500 cryptocurrency clients.   By the time the IPO was accepted, they had over 750 cryptocurrency clients.

Just a cursory view of the news would suggest that there are multiple headwinds buffeting the cryptocurrency industry.  In response to these confitions, Silvergate Bank took a $4.3 Billion loan from The Federal Home Loan Bank in San Francisco.   These loans themselves, did not seem to unduly concern the FDIC.

Just a few weeks ago Silvergate Corporation announced that its annual financials would be delayed due to questions from its independent auditors.   (Score one for the good guys?)  Just after this, Silvergate announced that they would be hiring a law firm and a different accounting firm to help guide them through its transition.   According to Silvergate management, all depositors would receive full and complete refunds of their deposits.  (I have to wonder how they’re going to do this, given the FDIC limit of $250,000 per customer account.) ,

Within this announcement, Silvergate admitted to concerns that Silvergate Bank might have “going concern” issues.   No, this is not something that should llead to a conversation with a friendly urologist.   “Going concern” is a term of art within accounting, and when you see that phrase on an Audit Report, it means that there are things going on that concern them so much, that they believe that the company being audited will not be surviving the next 12-month period of time.   Silvergate said that they would be “voluntarily liquidating’ its assets in response to “recent industry and regulatory developments.” One of the major industry developments is the bankruptcy of FTX and its conjoined corporate twin, Alameda Research.  Silvergate (SI) sold securities and derivatives at a loss of $718 million as customers withdrew about $8.1 billion of digital deposits during the fourth quarter. This amount is far in excess of the bank’s profits since 2013, the Journal reported.

Shares of Silvergate Capital Corp., a crypto-focused California bank, lost almost half their value after the Wall Street Journal reported it spent the equivalent of a decade’s profit and fired 40% of its workers after investors scrambled to redeem $8.1 billion in the wake of crypto exchange FTX’s collapse.  Now, the FDIC has forced them to stop operations and help make good on as many of the customer demands as they can.

Is this different from what happened at other cryptocurrency-adjacent companies?

This is a very good question.  At the beginning (of the end) FTX tried to say that the problem was a “bank run” when actually, the crux of the issue was fraud being perpetrated upon unsuspecting clients.    Silvergate appears to be more of a bank run, one caused by and made worse by external factors.

Why was Silvergate at such enhanced risk?

Mainly because they held a substantial amount of their assets in cryptocurrency.  But, have faith; things can get MUCH worse, even at a traditional bank.   One main issue is how banks report bonds that they hold.   Most bonds are traded actively and are considered to be “trading  investments.   The value of these must be tested, regularly to see if their value had declined in value within the market.    If so , they have to be “written down”  to reflect market values.  But, if a bank reports them as “Held to Maturity” investments, this “mark to market” protocol does not have to be used.   The outfall of this is that the bonds held by the bank can be massively over-valued, and the bank itself can now be described as “under-capitalized.”  Silvergate was involved in a lot of this investment activity, so when the bank run began, they had very little liquidity cushion to use to satisfy customer demanded withdrawals.

What’s the outfall likely to be?

I think the predicament of the marijuana growers and retailers is comparable.   Even though these products are legal under state law, no traditional banks will touch them.  I think that a similar situation faces crypto firms.  What they do is legal, but getting financing from “TradFi” (traditional Finance, I had to look it up too) is becoming more and more complicated.  This will likely lead to a very few cryptocurrency financing companies with a lot of power.   (Think OCP for cryptocurrency.)

The Verdict

According to industry expert a Mr. Bianco, “I still think crypto is going to win the day at the end of all of this.”  I have opined on this before, and in short, I agree with him.  Within the marketplace, there are many evolving metaverses which each have their own native currencies.    But, the “on-ramp” to playing in these metaverses appears to be purchasing cryptocurrencies to trade for the native currency.   Because of the draw of these metaverses (which are getting more and more immersive each day,) I believe that cryptocurrency in some form is here to stay.  So, if cryptocurrencies are here to stay, what happened to Silvergate?   I think it comes down to a human failing.  Greed.

Time after time (especially FTX), hedge funds have worked to get people into cryptocurrency, and other firms provide marketplaces where these cryptocurrencies can be traded.   The kiss of death appears, once again, when the hedge fund works through the same corporate structure as the cryptocurrency exchange.   In the case of FTX, they began making loans to Alameda, and trading their requests on a prioritized schedule. Silvergate started providing services to the industry in 2013, with no apparent problems.  Then they instituted their own “internal settlement tool” the Silvergate Exchange Network, and now, they are defunct.   Same rhythm, same chord structure.  Not a melody I like to hear.

REFERENCES

https://www.coindesk.com/business/2023/03/09/silvergate-bank-had-to-be-perfect-but-now-pays-a-heavy-price-strategist/

https://www.coindesk.com/policy/2023/03/08/crypto-bank-silvergate-announces-voluntary-liquidation/

https://www.investopedia.com/silvergate-plunges-45-7091740

https://www.forbes.com/sites/genegrant/2023/01/25/silvergate-shows-what-may-happen-if-community-banking-crisis-arrives/?sh=213ed9b63744

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.

Keep Mama Safe. Data, too.

Uncategorized,

Headline: Is data theft a real problem in cryptocurrency?

Body:  For as long as there have been human beings on this Earth, there has been theft.   As time went on, and our systems of scrip and other physical tokens turned to 1s and 0s on a screen, theft did continue to be a problem.   Only, now, instead of an unobservant watchman making a pile of silver or gold vulnerable, it is physically easier to break into a computer and steal the data that underlies that account.   In this case, there was the Federal Government backstopping the banks, in the guise of the FDIC.   Now, there is cryptocurrency, and people are worrying that the blockchain and the organizations that control it might inadvertently open up people  to additional scams.  Only, this time, there is no Federal Government to insure (at least part of) your account balance.  So, this leads us to a question.

Does investing in cryptocurrency place my personal data at risk?

To be frank, yes, you are more at risk.  Just a few illustrative examples:

Just recently, a French cryptocurrency firm fell victim to a hacking exploit, and as a result, e-mail addresses for many of their customers were compromised.   Reportedly, 9,500 of these customers also had their physical addresses, phone numbers and names exposed as well. 

Intuit is accused of “failing to take adequate and reasonable measures to ensure that its data systems were protected.”  In a subsidiary of Intuit, one employee clicked on a link they didn’t know the source of, and POOF thousands of accounts were potentially exposed.  (It appears that several hundred were exposed, but only a subset of these have been maliciously used.

In 2022, a very organized extortion gang (Lapsus$) started to become very active by stealing source code and other data from world-renowned companies.   At its height (depth?) they leaked a significant amount of Bing source code and compromised a contractor important to their authentication standard.  After the 7 arrests, the group has gone underground.

Also in 2022, Conti, a Russian cybercrime gang launched ransomware attacks against the government of Costa Rica, and as a result, the president declared “national emergency” as a result of the attack.  Some say that these attacks were merely a diversion, allowing the gang time to loudly down=play their association with the Russian government.

Decentralized Finance Platform Hacks

As the cryptocurrency ecosystem has evolved, tools and utilities for storing, converting, and otherwise managing it have developed at breakneck speed. Such rapid expansion has come with its share of oversights and missteps, though. And cybercriminals have been eager to capitalize on these mistakes, frequently stealing vast troves of cryptocurrency worth tens or hundreds of millions of dollars. At the end of March, for example, North Korea’s Lazarus Group memorably stole what at the time was $540 million worth of Ethereum and USDC stablecoin from the popular Ronin blockchain “bridge.” Meanwhile, in February, attackers exploited a flaw in the Wormhole bridge to grab what was then about $321 million worth of Wormhole’s Ethereum variant. And in April, attackers targeted the stablecoin protocol Beanstalk, granting themselves a “flash loan” to steal about $182 million worth of cryptocurrency at the time.

Why are these cryptocurrency firms having such difficulty with security?

There are a lot of ideas about what makes these cryptocurrency firms so vulnerable to these attacks.   But, they all seem to boil down to inexperience.  Most of the firms that are selling cryptocurrencies are directed by people who are very young.  Given their youth, they have energy  but lack the longstanding experience that confers upon older companies some ability to display wisdom.   For instance, many cryptocurrency concerns were started in 2021 and 2022, at a time when the economy was doing pretty badly.  Because of this, they have learned how to behave in these market conditions.   But, as the business cycle goes, there are bound to be other times when fortunes change.   Given the realities of this new market condition, they might not have sufficient resources to adapt to the new reality.  Furthermore, security seems to be less of a priority, because of an organizational culture emphasizing FOMO, or “Fear of Missing out.”

The Verdict

Data theft is a large problem as it relates to cryptocurrency  But, it seems like we should be more able to wrap our arms around it.  Each cryptocurrency seems to have an excellent “why” as spelled out  in their whitepaper.  But, it seems that the questions of “how” are rarely answered.   How are you going to protect the cryptocurrency not yet sold?  How are you going to handle your ICO?  How are you going to keep fraudsters from hawking counterfeit versions of your currency?  These are all valid questions and if not answered to your satisfaction, perhaps you would reconsider your investment.

REFERENCES

https://www.coindesk.com/markets/2020/07/29/crypto-wallet-maker-ledger-loses-1m-email-addresses-in-data-theft/

https://www.thestreet.com/investing/cryptocurrency/intuit-sued-after-hackers-stole-crypto-from-customers

https://www.wired.com/story/worst-hacks-breaches-2022/

https://www.forbes.com/sites/forbestechcouncil/2022/07/11/how-to-protect-your-cryptocurrency-from-cybercriminals/?sh=9e6b90849c3d

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 the SEC up to Monkey Business?

Uncategorized, ,

Headline: Why is there a class action suit against Yuga Labs?

Date:

Body:  Oh boy, oh boy, oh boy, lawyers everywhere are about to go, well…er…um… APESPIT!!!  Here’s why.

In a nutshell…

In a nutshell, there are a whole lot of people who are, as a class, suing Yuga Labs for having “inappropriately induced” this group into buying their Bored Ape NFTs and the associated ApeCoin token.  Their claim is that Yuga Labs used famous promoters to artificially inflate the value of both the NFTs and the APE coin.  A further claim is made that Yuga Labs waved the prospect of huge returns in front of “unsuspecting investors” claiming a loss of more than 87% since the end of April 2022.  In an interesting twist, one community member brought p the point that Yuga didn’t create APE coin.   Rather, APE coin was started by a DAO, which was then adopted by Yuga Labs.  It will certainly be interesting to see the outcome of this fight.  When in court, the class will have to prove that Yuga Labs engaged in a “pump and dump” scheme where they artificially inflated prices.    This is often quite difficult to do.

Making their case even trickier, the class might  have to convince the jury that both product lines were sold as investment contracts which constitute unregistered securities.  These have to be registered with the SEC, in most cases.  For now, though, Scott & Scott face the arduous task of finding the entire list of potential plaintiffs.

Well, at least they all seem to agree…

Nope, not really.   The class is small when compared to the number of people who have purchased Bored Apes.  Many within the broader community feel that the class suing Yuga are essentially whining because they made their own bad financial decision.   One of these is Kevin Wu.    “Extremely ridiculous! Take responsibility for your own actions, people.”

Is this really a big deal, worthy of interest by the SEC?

It conceivably might be.   Even on the individual level, this might be worth considering.   Just one year ago, a Bored Ape sold for $3.4 Million USD.  Even now, the average price of a Bored Ape is over $115,000. “I see very, very, very little likelihood that the SEC is going to want to step in there and… characterize that [Bored Ape NFT collection] as a security,” said professor of law at the University of Kentucky Brian Fyre.

The Verdict

Once the case is filed, the court’s determination on whether NFTs are securities and their similarities to a company share would be a key factor to winning.  We have hit upon this topic in a previous blog post, but really, this is a very important question.  On one hand, because the different agencies of the Federal Government vie for larger portfolios (and budgetary allocations), I could see why the SEC would take the stance that  these are investment contracts.  As such, they need to be registered, and there are dozens of required disclosures that they have to tender to potential investors.   On the other hand, Law Professor Brian Frye opined differently.  “I see very, very, very little likelihood that the SEC is going to want to step in there and… characterize that [Bored Ape NFT collection] as a security,” said the professor.  He felt that if the NFTs were considered securities, then the SEC would be forced to regulate a lot of things that they don’t want to regulate. I think this makes sense.

 REFERENCES

https://cointelegraph.com/news/yuga-labs-inappropriately-induced-bayc-investors-class-action

Yuga Labs faces massive class action lawsuit from aggrieved investors

https://cryptonews.com/news/law-firm-trying-organize-class-action-lawsuit-against-yuga-labs.htm

Yuga Labs Faces Potential Class Action Lawsuit

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.

 

Did Solana Fly Too Close to the Sun?

Uncategorized,

Headline: What are the problems with Solana?  And are “hot wallets” and “blockchain bridges” partially to blame?

Body:  Just like so many other firms, Solana is beginning to have its own problems.  Solana decentralized finance (DeFi) platform Friktion is shutting down its user interface and urging customers to withdraw their assets from the protocol, according to a statement on Jan. 26.   Only withdrawals will be permitted and new money cannot be invested.  (I note, with interest, that their cryptocurrency is abbreviated  SOL.)

So, what is a “hot wallet”?   Are they sold with hot pants?

No, they are not.  A hot wallet is a place where you can store digital assets, but they are always connected to the Internet.   This is advantageous and disadvantageous.  On one hand, it does mean that your entire balance of cryptocurrency is always available for trading.  Given the price volatility, this accessibility of your assets is likely good.  On the other hand, it also means that hackers have constant access to the defenses guarding your cryptocurrency investments.   Let’s be honest, sometimes they do get lucky.    To access them, there are both public and private keys.   To send money to a hot wallet, one needs the public key.   To get money out of a hot wallet, one needs the private key.

Some people prefer hot wallets because of their constant connection with the Internet.   Some prefer to use a particular hot wallet because it synchs so well with the web applications for a particular cryptocurrency.  Common wisdom seems to be to place a small amount of cryptocurrency in a hot wallet, and the majority of your digital assets should be kept in a very secure cold wallet.

 What is a blockchain bridge?

A blockchain bridge is a tool that lets you port assets from one blockchain to another.   Say, you open up an Ethereum wallet, and then purchase some Cardano coin.  There is a bridge between these 2 blockchains (making them inter-operable) but, the asset resting in your Ethereum wallet is essentially a derivative instrument.  There are unidirectional and bi-directional bridges that allow you to make the transaction and reverse the procedure.  Bridges are either custodial (centralized thru something like Coinbase) or non-custodial.

Trusted BridgesTrustless Bridges
Depend upon a central entity for their operations.These bridges operate using smart contracts.
Users have to rely upon the reputation of the bridge operator.The security of the bridge is the same as the security of the involved blockchain.
Users need to give up control of their assets.Users maintain sole control of their digital assets.

One might want to use a bridge because denominating a transaction in a different cryptocurrency might be far more profitable.  (Think of exchange rates between countries.  Due to exchange rates, it might be cheaper to pay for goods in Euros as compared to USD.)  Further, these small pieces of code used to be difficult to use, but they are becoming increasingly user-friendly.  Currently, the largest bridge is the “Wrapped Bitcoin” bridge with $10.2 Billion in assets.  Like any bridge, it provides opportunities, but entails risk.  The opportunities entail the easy cross-chain transfer of assets, and allows one to use d’apps seen on other chains.

What are the problems Solana is facing?

Well, remember that this is a very small community, including not too many exchanges and hedge funds.   So many firms have gone down, that the remaining firms are doubtlessly affected.

The Solana system has suffered more than their fair share of hacking exploits.(Hackers destroyed nearly $200 Billion in value.)  This makes people leery of trading on their platform, and causes other problems like outages.   These outages encourage other investors to consider using a different cryptocurrency.  Both blockchain bridges and hot wallets are targets for a constant line of hopeful hackers.  This is why most experts recommend that if you have a hot wallet, keep it in the custody of a reputable firm.

In the recent past, Solana has been a very popular option when buying or selling NFTs.   But as of late, the bottom has fallen out of that portion of the industry, and the usage of Solana coin has also decreased markedly.

Is this really a big deal?

Just recently, one day’s value of trading in Solana coin was over $3 Billion (USD).

Is there any relationship to other cryptocurrency firms?

In a word, yes.   Many cryptocurrency exchange firms sit on their Board of Directors, including Alameda Research and Genesis Trading, among others.  They are especially tied to FTX and their founder SBF.  SBF helped create Serum for Solana.   Serum is a centralized order book that serves to increase transactional speed and increase liquidity.    Serum is central to Solana.  By any measure, Serum is a very effective piece of software, executing more than $32 Billion of transactions in 2022.

Are there services helping these cryptocurrency firms?

Yes.   There are all manner of government agencies  offering advice in addition  to issuing new regulations.   Besides the government agencies, there are for-profit  services too that seem to serve as consultancies for these companies.   The largest of these that I have come across are TRM and Elliptic.  (Elliptic is really interesting as they are based in London, and the U.K. has been quite busy  in its work to attract cryptocurrency firms to the U.K. and especially London.)  In fact, the chief scientist of this company, a Mr. Tom Robinson, was quoted in the Washington Post.  “To date, approximately $1.8 billion has been stolen from these services and it’s worrying that their security standards don’t seem to match the huge amounts of capital being entrusted to them.”

The Verdict

Solana faces difficulty in many areas that include hot wallets and blockchain bridges  Solana might serve as a very useful reminder to do your own research thoroughly when making any investment in cryptocurrency.

REFERENCES

https://cointelegraph.com/news/solana-defi-project-friktion-shuts-down-its-user-platform

https://www.fool.com/investing/2023/01/29/better-buy-cardano-vs-solana/

https://www.washingtonpost.com/technology/2022/08/03/solana-nomad-hacks-security-questions/

https://www.thestreet.com/investing/cryptocurrency/cryptocurrency-solana-collapses-in-ftx-scandal

https://www.coindesk.com/learn/what-are-blockchain-bridges-and-how-do-they-work/

https://ethereum.org/en/bridges/

https://www.investopedia.com/terms/h/hot-wallet.asp

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.

 

At the water’s Hedge.

Uncategorized,

Headline:  Can cryptocurrency be used as an inflation hedge?

Body:  OK, this one seems pretty relevant, but it also seems pretty complicated.   We might think we know what this means (gut feeling) but, your gut might be incorrect.  Maybe.

So, what causes inflation?

In the broadest sense, inflation is an oversized number of dollars chasing an undersized flow of goods and services.    Between September and November 20089 the number of U.S. dollar bills increased sharply, but the inflation rate went down.   (The over-printing of currency makes inflation worse, but is not the proximate cause.)    It seems much more important that there is distrust in the central monetary system.   Throw in some supply chain disruptions, the war in Ukraine and some profiteering in the corporate world, and inflation was almost a fait’ acompli. 

What is an inflation hedge?

A hedge is a smaller investment made in a different item than our main ones, on the theory that if we are wrong on the primary investment, the error will be partially made up on this other investment.   For instance, in a period of rapidly rising prices (like we will ever see this?) a person might feel that the inflation rate is so high that the return earned on most investments will not keep up with the inflation.    So, they buy something like gold which will likely rise in price faster then the rest of the market.  Then, they can sell this investment when the price is significantly higher than their purchase price.  This is the idea of an inflation hedge.

Why do many believe that Bitcoin (primarily) and other cryptocurrencies are great inflation hedges.

According to its proponents, Bitcoin was designed from the start with inflation in mind.  There will always be a maximum of 21 million Bitcoin.   In a process  known as “halving” miners used to be paid 50 BTC to substantiate one  block of transactions.   As time went on, they were instead paid 25 BTC for the same type of substantiation.  Because of this planned halving, it was anticipated that inflation would be worked against by the rules of mathematics.  Furthermore, as there is no central authority, monetary maneuvers like quantitative easing, wouldn’t even be an option for cryptocurrency, and thus they would be protected from the consequent inflation.   It’s easy to access 24/7 and there is no central authority to manipulate it. All in all, it makes for a good surface story.

But, as the Fed begins to remove liquidity from the market, this narrative is changing.  (By raising key interest rates, the Fed can effectively remove liquidity by requiring a much higher interest rate to make a project go.  So few projects qualify for this high standard that fewer projects are undertaken, and the economy re-stabilizes at a lower level.  Or, so goes the textbook theory.)  In both economic conditions, “risk-on” (high liquidity  and “risk-off” (low liquidity), many different investments offer a more lucrative  rate of return.  Still, there were enough advocates of cryptocurrency as an effective inflation hedge, that it kind of became one.  But, contrarians claim that given its price volatility, it cannot be seen  as  a “store” of value, and thus cannot be considered an inflation hedge.  Add to this  the insecurity of this cryptocurrency ‘ ($1.2 billion hacked just last year) and the whopping amount of electrical power needed to mine cryptocurrency, the hedge hypothesis develops some holes.

Might this be something else entirely?

I don’t know if anybody else has REALLY bad sinus problems.   If you do, I’m sorry, but you’re in excellent company.  Problem is, in the drugstore, decongestants and specialty sinus medications are  in the exact same space, on the theory that they are related.  It’s true: they are related, in symptoms addressed.   But decongestants will not help your sinuses and your misery will continue.   In a similar vein, we have inflation hedges and then hedges for a drop in the value of the dollar.  They too are related, but it s quite possible that cryptocurrency could serve very well for one purpose and not so well for the other.

The Future’s so Bright… I gotta [be]-ware, shades!!

OK, the famous modern Western movie is called The Good, The Bad and The Ugly.  We’ve observed the Good, seen the Bad, what of the Ugly?   Or, in our case, crypto might be Ugly now, but it might ride glorious into the future.  Well, maybe.  The authors seem to argue here that cryptocurrency will become a more potent hedge  against inflation as more and more people begin to treat it that way.  Well, yeah, not really an earth-shaking prediction here.  What is interesting here is the idea of blockchains “maturing.”   What does that look like?  I think this mainly revolves around sensible regulation and the large institutional investors seeing cryptocurrency as a valid investment.  (I admit, these are NOT independent events.)  But the major point being made remains the same: When enough people feel secure enough, enough people will buy enough to make people truly secure.  As to timeline for this to happen, and how to kick-start this virtuous cycle, I have no idea

The Verdict

The more responsible and diligent the crypto community becomes, the more every sound protocol will benefit, and crypto will become a genuine hedge against inflation. Because cryptocurrencies currently follow growth stock patterns, they act as a good hedge against inflation during periods of stable growth but fail during times of financial crisis. As cryptocurrencies evolve, they’ll become an effective bulwark during these downturns too. 

I ran into many sentiments like this one in my research.  But I feel that I must ask, when do you NEED a hedge against inflation?  Most likely it is during those times of fiscal and monetary stress.    Given this, it seems most prudent to not assume cryptocurrency to be a good inflation hedge.  This might force us to confront  the inconvenient truth that we need to keep searching.

REFERENCES

https://www.fool.com/investing/2022/10/17/is-bitcoin-a-hedge-against-inflation/#:~:text=One%20that%20might%20come%20to,of%20a%20hedge%20it%20seems.

https://www.coindesk.com/business/2022/11/10/what-bitcoins-inflation-hedge-narrative-needs-more-time/

https://cointelegraph.com/news/crypto-will-become-an-inflation-hedge-just-not-yet

https://www.yahoo.com/now/cryptocurrency-inflation-hedge-135115613.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.