Crypto Long & Short: Beneath the Surface
 November 29, 2020  Weekly insights, news and analysis for the professional investor Sponsored By:  By Noelle Acheson Director of Research If you were forwarded this newsletter and would like to receive it, sign up here. PRICES (11/29/20 @ 12 p.m. UTC): BTC - $18,062.11 | ETH - $552.32
Hi everyone!
What was supposed to be a nice quiet week, with the U.S. Thanksgiving holiday and all, has turned out to be anything but.
In the first half of the week, bitcoin soared up to $19,374, caressing its all-time highs and encouraging many analysts to predict that the bull run was just getting started. It then sharply turned heel on Wednesday night, falling over 12% in 16 hours.
This no doubt colored the tone of many family discussions around the Thanksgiving table, adding "do you still have a job now?" to the traditional "what is this bitcoin that you work for?" I hope whiplashed U.S. traders got an extra slice of pie.
While narrative and sentiment are important drivers of bitcoin's market value, they are not the only fundamentals that matter. In THE BRIEFING this week, I point out the solid and steady progress made in the underlying technology, and some of the misconceptions around its importance.
Even though I'm not a U.S. citizen, I would like to enter into the Thanksgiving spirit and express my gratitude to all of you, for being the reason we do what we do. All of us at CoinDesk care about the world that you and your loved ones will inhabit tomorrow, next year, 10 years from now. We know it is changing, and we want to help you understand how, why and where. Thank you for being our motivation, and for making this one of the most fulfilling industries to work in.
– Noelle
P.S. Don't miss the last in our series of webinars on Ethereum metrics. Hosted by my colleague Christine Kim and featuring IntoTheBlock CEO Jesus Rodriguez, this episode looks at transaction volumes, and how they are commonly misinterpreted. You can sign up for free here.
P.P.S. If you're interested in Ethereum's technological upgrade, we're launching a new newsletter that will document our experiences with staking on the Eth 2.0 network. Its fresh-from-the-oven data and expert insights will shed light on what is arguably the most significant technological experiment in the industry in recent years. Sign up here!
 Transaction volumes on Ethereum represent the movement of a diverse array of crypto assets. In the fourth and final episode of How to Value Ethereum, CoinDesk Research explores unique insights about decentralized applications and their tokens based on volume data.
Register to join the final episode of How to Value Ethereum on Dec. 1 @ 1:30 p.m. ET.
The Briefing Beneath the surface
Today I want to talk about code.
I know, this newsletter is for professional investors and not developers – why aren't we talking about price? Don't worry, we will further down. But things are evolving with Bitcoin technology that are worth keeping an eye on. While these changes have little to do with the short-term price movements, they are likely to play a significant role in bitcoin's long-term value proposition.
Two things happened this week to make this top-of-mind: a new development funding source was announced, and progress is being made on a particularly ambitious protocol upgrade.
Before we go into more detail about why these are significant, let's look at why Bitcoin development matters.
Constant evolution
The idea of changes to the Bitcoin protocol will be surprising to many. I mean, doesn't it just, you know, work? Isn't one of its strengths that you can't change the code? These highlight two misunderstandings about the technology and its potential.
Bitcoin's code has been chugging along for over 10 years now, but it has undergone a few changes. In the early days, there were frequent bugs that Bitcoin's pseudonymous creator Satoshi Nakamoto and collaborators would fix. And old-timers will remember the "civil war" of 2017 around various scaling options that went to the heart of what the community wanted Bitcoin to be. The result was a change to the Bitcoin code to amplify block capacity, while dissenting opinions branched off to form a "new" Bitcoin blockchain, Bitcoin Cash.
There's also steady work on functionality enhancements, such as enabling sidechains or smoothing information exchange. And compatibility issues and other minor bugs require constant attention. Like all technologies, if Bitcoin is not maintained and frequently updated, it will wither.
As for how changes happen, anyone can make changes to Bitcoin's code – it's open source. Getting the changes implemented, however, requires network consensus, and that is extremely difficult to achieve. Imagine trying to get 20 people with different philosophies, political convictions, economic incentives and life goals to agree on a simple change. Now, multiply that by hundreds if not thousands, make the changes complicated, and you get an inkling of how hard it would be to implement a meaningful alteration. This protects the network from any change other than those the majority believe are beneficial to the entire ecosystem.
Incentives matter
An important question is, who pays the developers that work on Bitcoin code?
In the early days of the Bitcoin network, almost all developer funding came from one source, the Bitcoin Foundation. Since then, other funders have entered the scene, including several companies dedicated to Bitcoin work, such as Blockstream, Chaincode Labs and Lightning Labs. Also involved are well-known crypto businesses such as Square Crypto, Coinbase, OKCoin, BitMEX and others, as well as not-for-profit organizations such as MIT's Digital Currency Initiative and the Human Rights Foundation. In addition, many developers work on Bitcoin for free, out of passion.
Diversity in the backers of Bitcoin development matters, as it ensures that the network cannot be influenced by one set of priorities. This is why the Brink initiative announced this week is significant: it pushes the diversity of Bitcoin development even further.
Brink introduces an intriguing funding model. It aims to channel donations to developers from a range of sources, including individuals, companies and not-for-profits. Its initial funding comes from donations from investor John Pfeffer and crypto custodian Xapo founder Wences Casares, as well as the Human Rights Foundation and crypto platforms Kraken, Gemini and Square Crypto.
This form of sponsorship could be appealing to individuals and companies that want to support Bitcoin development but don't want to have to choose specific individuals to fund. The organization has applied for the charitable 501(c)(3) designation in the U.S. so donations can be tax-exempt.
Another big step is Brink's focus on training new developers, to ensure a steady stream of qualified and diverse contributors well into the future. This bodes well for the network's long-term resilience and growth.
Next upgrade
The second significant news item of the week highlighting the importance of the underlying technology concerns the Taproot upgrade, which will enhance the network's smart contract functionality as well as introduce some privacy features. Bitcoin mining pools representing over 54% of the network's current hashrate have signaled support. This is a strong step towards implementation (although there is yet some way to go – no change to the network is without controversy, no matter how popular the actual change is.)
This is significant not just because of the specific changes Taproot will introduce. It also shows that Bitcoin's use cases are constantly evolving, and that itself is a value proposition. In other words, if you think Bitcoin is a powerful technology now, just wait.
As an example of how Taproot could influence bitcoin's value, let's look at what smart contract functionality means. Bitcoin's program is relatively simple. It can do few things, but it does them well. Ethereum, on the other hand, is complex, but it can support the execution of a wide range of "smart contracts," or decentralized applications.
While Bitcoin will never rival Ethereum in flexibility (nor does it want to – the more complex the program, the greater the potential attack surface), some modest improvements could improve its utility as a store of value. For instance, imagine that accountability of ownership could be programmed to enable bitcoin to be more effectively used as collateral.
They could also enhance its use as a medium of exchange. A proposed new type of verification signature could make layer 2 transactions easier and cheaper. Taproot also introduces some features that could encourage more use by masking the type of transaction (not its send/receive addresses), which would offer more privacy.
Looking ahead
While it is convenient to think of Bitcoin as a perpetual machine that just keeps running, we shouldn't lose sight of the work involved in making that so. The more developers working on keeping Bitcoin clean and efficient, the more resilient the protocol, and the more likely it is that key improvements can be implemented carefully.
And the more diverse those developers are in terms of backgrounds and incentives, the less likely it becomes that Bitcoin could fall into the same trap as many of today's technology networks: built by a few, for a few.
It's also moving to see such a wide range of contributors involved in maintaining a "common good," even though a direct path to profit is not clear. This is about more than open-source tinkering. It's about building a new system that all involved believe is an answer to fundamental questions the world is just now waking up to.
Note: we use Bitcoin (upper case) to denote the network, and bitcoin (lower case) or BTC to denote the coin.
Time to serve
This week U.S. president-elect Joe Biden announced his intention to nominate former Federal Reserve chairman Janet Yellen to head the U.S. Treasury, and may name former Commodity Futures Trading Commission Chair Gary Gensler to become deputy treasury secretary, according to reports.
Treasury appointments are significant for the crypto industry in that the department could shape how some of the main U.S. financial regulators approach crypto assets.
Yellen has said in the past that she is not a fan of bitcoin (my colleague Nik De has summarized her views here) but supports blockchain and cryptocurrency innovation.
Gensler has demonstrated deeper expertise and enthusiasm. He testified before Congress about cryptocurrency and blockchain on multiple occasions, pushing back against comparisons with Ponzi schemes and declaring that the still-unlaunched libra token met the requirements of being a security under U.S. law. Late last year, he even wrote an op-ed for CoinDesk.
Gensler is currently heading up Biden's financial oversight transition team, which also includes four other cryptocurrency and blockchain experts:
Chris Brummer is a law professor and the faculty director of Georgetown University's Institute of International Economic Law, author/editor on a seminal book on cryptoassets, and host of the excellent Fintech Beat podcast. He also testified before the U.S. Congress regarding the libra project, and was nominated to serve as a commissioner on the CFTC under President Obama, although the nomination was reversed after the 2016 election.
Simon Johnson is an economist and professor at the MIT Sloan School of Management, where he supervised blockchain research and taught a course on the topic. He was part of the Congressional Budget Office's Panel of Economic Advisers from April 2009 to April 2015. Johnson has also co-authored a paper about the extensive impact blockchain technology can have on the financial world, and served on CoinDesk's advisory board, penning this op-ed in 2018.
Mehrsa Baradaran, a University of California at Irvine School of Law professor, specializes in banking law and also testified as an expert witness at a Senate Banking Committee hearing on the impact of digital currencies on financial inclusion, and at a House Financial Services Committee hearing on regulatory frameworks.
Lev Menand, one of the original creators of the digital dollar concept, is an academic fellow and law professor at Columbia University. He served as a senior adviser to the deputy secretary of the treasury in 2015-16, has also worked as an economist at the Federal Reserve Bank of New York's bank supervision group, and helped with a provision detailing the digital dollar in crisis relief bills from the House of Representatives drafted back in March.
Having stewards of U.S. currency regulation that are well-informed about cryptocurrency and blockchain is encouraging, as it makes innovation-killing regulation less likely. Furthermore, official support for the exploration of new solutions to financial barriers, including blockchain-based assets, is likely to encourage both progress on regulatory clarity, and further investment in the crypto industry as a whole.
However, a statement from current U.S. Treasury Secretary Steve Mnuchin offset the resulting market optimism, triggering concern that onerous rules might be pushed through from his office before the end of the year. Former National Security Adviser John Bolton's recent book revealed that President Trump had instructed Mnuchin to "go after" bitcoin. And earlier this year, Mnuchin said that FinCEN, the nation's financial crimes watchdog, was preparing to roll out some "significant new requirements" around cryptocurrencies.
So, some innovation-killing regulation may get rushed through before the transition. Crypto exchange Coinbase's CEO Brian Armstrong tweeted this week that he'd heard rumors that the Treasury was planning to rush out regulation limiting the use of self-hosted cryptocurrency wallets.
This would be bad news for crypto asset use cases such as decentralized finance and merchant applications, and would put U.S. cryptocurrency users in a "walled garden," effectively negating its core value of resistance to censorship and seizure. It would also force many users to go "offshore" for such services, weaking both the protective oversight from U.S. regulators and the role of the U.S. as a financial innovation hub.
Anyone know what's going on yet?
The S&P 500, Nasdaq and even the FTSE 100 saw further gains this week, which I still find bewildering.
It looks like I'm not the only one: the ECB, IMF and Federal Reserve have all warned this month about shocks to the market should the coronavirus situation continue to worsen. And it looks like it is doing just that, given the latest confirmed case statistics. The latest news on vaccination progress is hopeful, yet expectations are likely to be disappointed by logistical complications and revised efficacy estimates, and the markets seem to be pricing in a strong economic recovery in the short term. A lot can happen to delay that recovery, and not just further surges as Thanksgiving and Christmas throw us together and winter temperatures push us indoors. There's also the looming possibility of a hard Brexit, which will hit both the U.K. and Europe.
That doesn't mean that markets won't keep at the laughing gas, though. If there's bad news, the belief seems to be that governments will support the markets. If there's good news, then obviously it's not discounted. Obviously.
Gold also defied expectations this week, dropping to its lowest point since July as (according to analysts) investors decided now was a good time to move into risk assets and double down on the economic recovery bet. Yes, you read that right.
Bitcoin, which at times trades with gold and at times trades as a risk asset, continued to soar, reaching an annual high of almost $19,375 and only just depriving an expectant crypto community from a new all-time-high (ATH) celebration. (According to CoinDesk's Bitcoin Price Index, the ATH is $19,783. Here is a good explanation of why there is confusion over what the ATH actually is.)  The bitcoin price started to correct early on Wednesday, and once the U.S. markets closed for the Thanksgiving holiday, the correction turned into a rout, unwinding its gains for the past 10 days (at time of writing – at this pace, things could have radically changed by the time you read this).  (Note: Nothing in this newsletter is investment advice. The author owns some bitcoin and ether.)
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Chain Links In searching for the reasons behind the recent bitcoin run-up (before this week's slump), many fingers pointed to the institutions. While we have been hearing for years now about the fabled institutional "wall of money" poised to rush in and push BTC prices to stratospheric levels, there are some signs that institutional interest is growing.
The demand growth is not just coming from institutions:
In an interview on CNBC, PayPal CEO Dan Schulman said he believes bitcoin's usefulness as a currency will ultimately prevail over the buy-and-hold ethos. TAKEAWAY: He has invested his company's money in these beliefs, promising PayPal users the ability to use cryptocurrencies in approximately 28 million businesses as of early next year. While many of us will splutter and say "but who would want to spend a store of value?!," we should remember that some regions don't have access to convenient payment rails. For many, cryptocurrencies may be a more convenient online payment method than fiat. And the applications that could be built on top of public blockchains to enhance this could end up supporting both innovation and cryptocurrencies' overall value.
U.S.-based crypto exchange Coinbase no longer allows margin trading, in response to recent regulations by the Commodity Futures Trading Commission. TAKEAWAY: This is a setback for institutional participation on Coinbase – institutions want leverage, and will move to where they can get it.
In this compelling article, my colleague Ian Allison looks at the emergence of a strong mining industry in North America, encouraged by the access to capital markets, regulatory stability and the relatively low energy and hosting costs. TAKEAWAY: This is significant for two main reasons: 1) the diversification of the mining base strengthens the protocol's resilience against political interference, and 2) the enhanced access to capital markets is likely to encourage even more investment in network maintenance. The greater the number of miners working on maintaining the network, the greater its security.
New York-based investment management firm VanEck has launched a bitcoin exchange-traded-note on the Deutsche Boerse Xetra. TAKEAWAY: This will be the third ETP to list on Xetra, one of the largest electronic trading platforms in Europe, with a broad international reach (around 50% of its trading participants are from outside Germany). Diversity of choice is good for both investors and market maturity.
Canada-based investment firm Cypherpunk Holdings (listed on the Canadian Securities Exchange with the very cypherpunk-ish symbol of "HODL") has sold its positions in monero and ether and increased its bitcoin holding by almost 280%. TAKEAWAY: I do not have insight into their reasoning; I share this news with you because the strong bitcoin conviction demonstrated by this change, combined with the hint in their ticker symbol, is interesting.
Podcast episodes worth listening to:
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CoinDesk is staking 32 ETH in Ethereum's historic upgrade, and research analyst Christine Kim and tech reporter Will Foxley are breaking down Ethereum 2.0 and its sweeping impacts on crypto markets, weekly. Using data direct from CoinDesk's own Eth 2 validator node, Valid Points features original insights about what the future of Ethereum looks like for industry stakeholders and investors.
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