Weekly Wisdom #5

The mightiest will fall.

The cosmos will shake. Ripples will collide, asteroids will fly, and wanderers will subside. This journey is far from easy. Exploration of this realm is turbulent. The pitfalls are abundant, and the dangers are wide. So, who can you trust? Where should you wander? To whom should you confide? Those are the questions you should ask; those are the questions of the wise.

So, where does our wise wandering take us this week?

• A baron and a swine

• The future of Tokenomics

• The slow death of the euro

A baron and a swine

Well…

What a week. The collapse of FTX has had a monumental effect on the industry. My heart goes out to any wanderer that has been lied to, swindled and cheated by the conniving actions of a select few swines. It is ever more apparent that there are pitfalls on this journey, and some are far bigger than others.

So, what really happened and what does this all mean? What are the second-order effects? The event is far from catastrophic but the ripples will be felt for the years to come. In my quest to understand the situation, I stumbled across many wise articles that break down the saga down far more factually and eloquently than I could: Speechlesss

FTX - Blockworks

Here is my personal understanding of the saga:

A few weeks back, Arthur Hayes put forward the question; “Who would be the Lehman Brothers of this crypto credit cycle?” The FTX responses were almost laughed off. Surely not? FTX are the giants! Well, my DeFi wanderer, if you weren’t already aware - even giants fall.

So, how did this all begin? Back in 2017, SBF noticed substantial discrepancies in the price of Bitcoin across different exchanges. At the time, arbitrage trading across these exchanges wasn’t such a simple venture, but SBF mastered the art. The road to riches began. Shortly after, SBF launched his crypto trading firm - Alameda Research.

Alameda’s success snowballed into the creation of FTX, a crypto exchange intertwined with Alameda. The investment firm would earn the trading fees and capital from FTX to fund its future investments. A force to be reckoned with, SBF’s wealth grew to over 16 billion dollars! A successful trading firm and one of the biggest crypto exchanges, where did it all go wrong?

It all started with CoinDesk publishing a report on Alameda’s balance sheet.

It turned out that “the majority of the net equity in the Alameda business was actually FTX’s own centrally controlled and printed-out-of-thin-air token”. Essentially, the majority of Alameda’s assets was FTX’s shitcoin - FTT.

Alameda had 12 billion in assets and 7 billion in liabilities, but over half of their assets were this FTT token. If this token were to fall dramatically in price, its assets would far outweigh its liabilities. The house of cards was propped, all it took was for the markets to blow them down.

Then the baron walked in…

CZ announced that recent revelations required a reshuffle in Binance’s holdings. This subsequently resulted in the liquidation of all FTT holdings. Clearly, CZ had noticed something was off. Wanderes far and wide began speculating on what could be going on. SBF assured all was fine. It was all just FUD, right?!!!

SBF then made the surprise announcement that Binance was acquiring FTX. Something far more serious was underfoot. The curtain was drawn. Only a few days later, CZ announced that after analysing FTXs books, Binance would not go ahead with the deal.

The revelations on Alameda’s balance sheet caused a bank run on the FTT token. Users began running for the door and FTT’s value fell catastrophically. With a majority of Alameda’s capital wound up in this token, their liabilities were now far outweighing their assets. The house of cards was crumbling. Fearing insolvency, users began dashing to remove their funds from FTX.

Then withdrawals were halted.

The house of cards fell. The allegations were far more sinister than first seemed. FTX was alleged to have been illegally using customer funds to conduct trades and prop up falling collateral. SBF created a “back door” to syphon users' funds from FTX to Alameda. On November 11th FTX declared bankruptcy.

It has been a whirlwind of a ride. FTX wasn’t just a crypto giant; they are interwoven within politics and regulation. In fact, SBF was one of the biggest political donors in the US; he had ongoing meetings with the SEC and has lied and humiliated incredibly powerful people. This collapse will have lasting effects and may set industry adoption back years.

But, is there a silver lining? In the chaos, we have seen a record number of digital assets leaving Centralised Exchanges. Users are realising that the echoing phrase “Not your keys not your coins” is an extremely valid statement. This event is no different from the conniving actions of the banks, with trust and greed still the prevalent problems in financial systems. We haven’t yet set out what we hope to do.

So, what is the solution? It’s staring us in the face. A trustless, welcoming and promising financial system is critical. DeFi is the future. No longer can we place our trust in these centralised entities. The collapse of FTX may set us back on our journey, but it does not corrupt it; in fact, it highlights its importance even more so.

Learn from it, grow from it, and use this time to position yourself deep within a future that is certain to come.

The future of Tokenomics

DeFi is the most programmable form of money known to man. You can spin up monetary value from your fingertips! A few lines of code, a marketing campaign and voila! You have created a currency that users believe in. When you think about it, it’s pretty damn bonkers!

These past few years have been the crypto wild west. Rugs, scams, and shitcoins are abundant throughout the DeFiverse. We are still in the stage of creative infancy. So, what does the future hold?

Mike Sall is the co-founder of GoldFinch. A borrowing and lending protocol where yields come from real-world lending, and investments are collateralized off-chain. Mike recently released a timely article breaking down how he sees the future of tokenomics in this industry. It was a refreshing read. Let’s get into it.

A new stage in Tokenomics

Mike believes we are now entering a new phase for tokenomics. Rather than a token purely offering speculation in future value accrual, Mike states that tokens must provide value-driving utility outside of the speculative means. The token must provide a user-centric benefit.

A prevalent example has been GMX. The token offers users access to a share of the fees and has been a catalyst in sparking the “Real Yield” narrative. As such, GMX and similar tokens have dramatically outperformed other assets in the recent market.

However, the distribution of protocol fees wades through some murky waters. Fee distributions to token holders can raise concerns under U.S. securities laws. Mike also states that the most important utility for tokens going forward is not fee distribution per se, but participant-centric utility. What does he mean by this?

Focus on the Participant, Not the Tokenholder

Mike states that protocols should empower users to become owners through participation. To create sustainable systems, protocols should design their tokenomics to be participant-centric rather than token-holder-centric.

A “participant-centric” system encourages all of its participants to be co-owners of the protocol. The more tokens the participant owns, the more they benefit from participating in the protocol.

He states that any time you come across a token, you should ask:

“How is every participant incentivized to own the token, and how does that amplify their experience?” 

Rather than

“What do the token holders get?”

What does a system like this nurture? It creates an environment in which token holders must actually participate in the protocol to get value from the token. It ensures that users most actively participating in the protocol are rewarded for doing so.

Simply distributing value to holders who aren’t actively participating, is a waste. This sustainable user-centric approach to tokenomics unlocks a virtuous and interwoven flywheel for protocols.

1. A user participates in the protocol to do some activity they find valuable.

2. That user can enhance the value they get from that activity by owning more of the token.

3. This increases demand for the token, which increases the network’s value.

4. The protocol uses the increased resources from the larger network value to either further incentivize the activity or invest in improving it, like adding features to enhance the experience for participants.

5. This makes the activity more compelling, which attracts new users and more participation.

Not only does participant-centric tokenomics hint at a more sustainable future for protocols, but it may also significantly reduce risks related to U.S. securities laws. This is because instead of the upside of a token being purely reliant on price appreciation it is now tied to active participation.

I believe that Mike raises a pertinent point. This tokenomic model is critical for the sustainability and longevity of protocols, and when looking at protocols tokenomics, you should keep this in mind. 

Start asking yourself: 

“How is every participant incentivized to own the token, and how does that amplify their experience?”

The Slow Death of the Euro

All realms are related. As we journey onwards in the realm of DeFi, it is always wise to understand how the tokenomics of this dimension relate to the tangible world of fiat.

Let us traverse across the realms and uncover a currency that may be falling: The Euro.

Russel Napier is a market strategist and historian. He has endless knowledge in the financial realm, and in 2020, was one of the first to raise the point that prolonged inflation was on the horizon. Russel believes that developed economies are currently undergoing a fundamental financial shift. In a recent talk, he raised a pertinent and poignant point; The Slow Death of the Euro.

Russel opens the talk by stating that the European union is a sinking ship. And when a ship is sinking, something must be thrown overboard to keep afloat. So, what will be thrown overboard? Russel believes this will be the euro.

There is a fundamental problem in the world today. The supply of money and credit has been in control of the Central Bank for years. They control this supply via utilising a plethora of tools but most notably, interest rates.

However, we have now reached a point where this power no longer falls within the central bank's jurisdiction, in the present day, this power is now falling to the government. This is an issue for all countries; the United States, United Kingdom, Japan… but the issue is exaggerated with it comes to the EU. Why?

The issue and supply of money in these other countries confides in one centralized government. For the Euro, where does this power reside? There are 19 different governments in the EU, and how can you have a single currency when the power is dissolving from the central banks to 19 different governments?

Governments are starting to issue huge loans to companies. The other week Germany guaranteed 63 billion worth of loans to German Energy companies. They have told German banks that they can issue loans and that they will not lose money.

Bank credit grew through covid and it is growing now. This is unusual. Bankers don’t usually lend this money. But, now the risk is underwritten by the government, and credit is soaring.

The central bank tries to control the supply and growth of money via interest rates and capital adequacy rules. But, now the government is stepping in and telling banks to loan this money. So, what happens when 19 countries can do this?

If separate countries can determine the quantity and yield curve of one financial currency, this currency comes under extreme strain, both politically and geographically. Russel breaks it down with an example:

If all but one European government starts offering credit guarantees, an influx of euros will be printed and these euros are fungible across the whole of Europe.

But, what if one country decides they want to limit the amount of credit? One country aims to control and limit the money supply. If this situation occurred, would they then permit these Euros to flow across the border? Russel believes they wouldn’t.

Every country in the EU has different GDP, inflation and debt levels. They will need to control the money supply separately. It will be very difficult to set a single policy that serves everyone. This will likely cause further divide, questions and conflict between euro nations.

Russel believes that this dynamic paves the way for the slow death of the Euro. I highly recommend you listen to the full video; it is enlightening!