#11 Crypto governance, more regulatory pressure and China

Decentralized governance is one hell of a shield against regulation. Maybe that's what's making the SEC nervous. Plus, China strikes again.

Welcome to issue #11 of Carbono Insights. We are Carbono, and advisory firm specialized in cryptocurrency, and managers of the fund Abacus Carbono. With Carbono Insights we wish to help people get acquainted and updated on crypto from it´s many angles. We would love to hear your comments. Write us at team@carbono.com or find us on Twitter: we are @carbono_com, @raulmarcosl and @miguelatcarbono.

Decentralization against regulation

Crypto protocols are meant to be governed by decentralized communities of stakeholders. Not because it’s more efficient or important for ideological reasons, but because it’s necessary to unlock their core value proposition: that the underlying protocols will continue to run as designed and will remain open to anyone who wants to use or build on them, without having the rules shift under their feet.

These are not our words; they are Andreessen Horowitz's Jeff Amico's.

As an early VC investor in crypto startups, A16Z is knee-deep in decentralized governance. They are constantly exposed to it as token holders in some of the leading decentralized protocols in the space. Their experience tells them that decentralization of governance is another key feature in crypto's identity. It is a matter of trust to them: decentralization guarantees that projects will be transparent and remain faithful to their foundations.

The ultimate goal is to replace intermediaries like global banks and tech platforms with software built on top of networks that direct the value they generate back to the users who own and run them.

Again, not our words: this comes from The Economist.

Today we will be talking about yet another acronym in the crypto space. One that is likely to become as important as DeFi and NFTs and join the club of the most important applications of blockchain to date. We're talking about DAOs.

DAOs

The acronym DAO stands for Decentralized Autonomous Organization, and the concept refers to organizations who cooperate digitally through online platforms that are transparent, somehow democratic, binding, and self-executing. Blockchain technology built a bridge between digital decision-making and the movement of funds that opened the door to a new remote, global, digital way of working together. Blockchains can host programs where the conditions for cooperating are written in stone and open for anyone to read. As a result, DAOs are a new way of cooperating.

Let’s imagine a homeowner's association deciding whether to fix a fence or not while behaving like a DAO. This very modern group of neighbors frequently communicate via an app where decisions are discussed and voted. And the fence around their building is broken.

Their app shows them three different proposals to fix the fence. They have been voluntarily submitted in detail by one of the neighbors.

a) Simple fix: solve the problem with the hole and get on with life. The fix would cost $500; Contractor X would repair it in a matter of three days. The contractor would charge 50% in advance and the other 50% once the community votes to agree the job is satisfactorily finished.

b) Full fix. For those who think the hole is just a symptom of general deterioration, spending $5000 on changing the whole fence is the second option. Contractor Y would do the job in two weeks once an initial 20% payment is made. The community would unlock the rest of the payment by voting 15 days after the job kicks off.

c) Just pass. Holes give fences their unique flavor.

A fully decentralized and autonomous organization would require all the details to be written in stone. Or, in better terms, written in code. For example, what are the payment details for the association, Contractor X and Contractor Y; when would payments be made, when would the final consultation about the results be launched, and how long would it be open for voting. What are the voting thresholds to consider a vote approved or rejected, how is communication managed with the chosen contractor, and what happens if the job is not appropriately finished... Every detail would need to be laid out because the app doesn’t take decisions or ask questions; it executes the tasks.

In a DAO, once the neighbors voted on their favorite opinion, the decision would be automatically executed, for example, sending the initial payment and starting a counter before the final consultation is launched in the community's app.

According to Linda Xie´s definition:

A decentralized autonomous organization (DAO) is a group organized around a mission that coordinates through a shared set of rules enforced on a blockchain.

Or in other, more informal, words from Cooper Turley, they are “internet communities with a shared cap table and a bank account.”

DAOs are a new way of making decisions that could disrupt organizations as we know them. They prioritize transparency, debate, and collaboration. They make execution a technical challenge, devoid of human intervention, where every detail is pre-defined and binding. It is not hard to scale the example of the homeowners to larger communities and imagine how this would work for some areas in corporate and political decision-making.

Decentralized Autonomous Organizations are the iteration of online communities spun from crypto. They share features with previous manifestations of digital associating, such as good old mailing lists, forums, or Facebook groups. They add the component of decision-making and financial allocation.

Financial incentives are not just another ingredient. They are the fairy dust that makes communities fly. Web 2.0 brought unparalleled borderless cooperation between peers thanks to digital platforms. Now the communities formed by those people have a budget. This makes motivation and drive different.

There are many use cases for DAOs. Turley mentions some possible categories, and one single DAO can belong to one or more of them. Some of them are:

  • Grant DAOs, where participants pick projects to fund among a list of requests. Grant DAOs are frequent in the DeFi space, where the community of token holders is constantly seeking to make the community grow.

  • Venture DAOs, similar to grant DAOs, but whose purpose is to become investors in promising crypto projects. Flamingo, The LAO, or Metacartel are examples of these.

  • Protocol DAOs, frequent in DeFi: users can decide how the protocol should work and vote for changes in the code. For example, when a liquidity pool wants to add a new liquidity pair. Uniswap, Aave, Compound,… all main blue-chip decentralized exchanges have protocols governed by the community.

  • Collector DAOs, where participants with a common interest meet, debate, and decide. They are frequent in the NFT space, where a DAO can be made of the owners of a certain collection and decide on measures beneficial for the project, like purchasing more items or even burning some to make the rest more valuable (#truestory). Cryptopunks and Squiggles are some famous NFTs with their own communities.

DAOs obviously have many downsides. They are still an immature way of decision-making, often prone to inequality and unfairness. Sometimes they are plain unnecessary and just a shallow mannerism in the hands of over-enthusiastic players. But governance is becoming increasingly important, especially since decentralization is becoming the shield that defends projects from regulators.

If the value is to be retained within the confines of crypto, instead of shared with big institutions and corporations, governance, in general, will have to play a critical role in coordinating a huge variety of wills.

⬡ Six Angles

We select six topics to illustrate the very different angles crypto can be approached from. We could choose dozens, but six is the atomic number of carbon… and otherwise we'd be writing for ages.

1. Regulation | The SEC rolls up its sleeves

Gary Gensler is openly at war with crypto. Hopes were up in the industry when he was initially appointed as chairman of the SEC, given his background. Gensler was an MIT blockchain professor. The community expected a more nuanced approach from someone with one foot inside, but his recent words and actions show a much more aggressive stance.

It's been some busy weeks for Gensler and the SEC. After probing Uniswap and going after Coinbase for its staking service Lend (and winning), the SEC chairman appeared in front of the Senate and the media -Washington Post- and sent some clear messages to the industry.

  • As a broad statement, Gensler thinks the current regulation is clear enough, and it's time for companies to comply.

  • He claims that "many" tokens have the attributes of investor contracts or securities and should therefore be registered as such. He suggests exchanges and lending platforms should voluntarily register soon

  • He considers stablecoins "poker chips" and expects them to be soon regulated. (How? Read here about the 5 possible approaches outlined in a New York Times article). In the meantime, the Treasury Department, headed by crypto foe Janet Yellen, is currently working on a report to the President’s Working Group on Financial Markets

Regulation is very likely to make a stellar appearance in the US any time soon. The lowest hanging fruit for regulators seems to be centralized exchanges and stablecoins. And a careless approach could deliver a blow to DeFi too. Nevertheless, we believe that the ecosystem is already too strong to fall and that the downside of regulating poorly is so big that not even US authorities are interested in it.

2. Macroeconomy | China’s impact on crypto

The empire strikes back. Last week China was again in the front and center of crypto with two macro news that had a powerful (though temporary) effect on crypto. Evergrande’s fall and a(nother) ban on anything that smells like crypto.

Evergrande is the Chinese real estate behemoth whose fall is sending shockwaves through the whole financial system. Its crisis could become a Chinese version of the 2008 Lehmann Brothers. The company reportedly owes immense amounts of money to around 171 domestic banks and 121 other financial firms. And it is probably never going to pay unless the Chinese government does some of its magic and avoids the credit crunch.

The event is being widely reported (read about it on the BBC news site or a wonderful Twitter thread from Mira Christanto, a researcher at Messari), but what's interesting to us is how this affects crypto.

One of the most appealing features of crypto was its low correlation with more traditional assets. Institutional investors pointed at this as one of the reasons to believe in crypto, according to Fidelity Digital Assets’ 2021 Institutional Investor Digital Assets Study. But what we have witnessed these days says otherwise.

Crypto is increasingly intertwined with traditional finance. More investors from TradFi are approaching crypto. And with tokens being a very liquid type of asset, it is reasonable to think that in times of crisis, fear hits fast. Investment funds might also have to balance their risk profiles after the real estate crisis in China, and crypto-assets are an easy target there.

When the effect from the Evergrande crisis started to cool down, the Chinese government made a stellar appearance and banned crypto…again.

This is not the first time, and funnily enough, it will probably not be the last. The Chinese powers are strongly prosecuting crypto. The hardest blow came halfway through 2021, when the Chinese administration chased most miners out, creating an exodus that took crypto to a bearish trend. This time the announcement was sent out by the People’s Bank of China and just added a few details to the well-known official position, like specific mentions to Tether. But apart from that, things remain fundamentally the same. The announcement seems to be tied to the progress of the official Central Bank Digital Currency. China has been fast implementing a government-issued, government-supervised, government-surveilled, digital currency, and they probably want nothing to stand in the way.

Bitcoin both times went on a dip: once for the Evergrande’s threat, again when news from China broke. But things seem to be getting back to normal already. Crypto has proved great resiliency in the past, and fundamentals and on-chain metrics remain strong, indicating that we are very likely to be back on our feet soon.

3. NFTs | Insider trading in OpenSea

Everything started with a tweet

An anonymous OpenSea user pointed out that Nate Chastain, an OpenSea product head, might have been involved in some insider trading with NFTs. Chastain would purchase pieces he knew would end up featured in the marketplace's home page to sell them for a profit once their value increased.

OpenSea took noticed and kicked off an investigation that ended up with Chastain becoming a former employer.

Chastain had done nothing illegal, but it was immoral beyond doubt. And it might even bring unintended regulatory heat in a sensitive moment in time. With the US regulators sniffing around crypto looking for ways to protect investors, the last thing the industry needed was proof of wrongdoing from insiders.

4. Analytics | Platform digest

Overwhelmingly transparent. That is an accurate way of describing crypto. Yes, information is open and available. But it is also complex and overabundant, and newcomers can easily drown in data.

Analytics is one of the most necessary side industries that is blossoming on the sidelines of crypto. Even governments are hiring data consultants to help them oversee the sector.

There are dozens of analytics tools helping insiders and outsiders navigate the flood of information in crypto. Here's our humble attempt at scratching the surface with a selection of a few names and URLs. It is by no means an extensive list, just a selection meant to represent the breadth of the space.

  • Block information directly from the blockchain. Etherescan (for Ethereum) or Blockchain Explorer (Bitcoin, Bitcoin Cash, Ethereum…) are windows into the raw data of the Ethereum and Bitcoin blockchains, respectively. A rabbit hole where you can follow the lead of every single transaction ever made. Every Layer 1 solution has its own Etherescan.

  • Cryptocurrencies and tokens. Coingecko or Coinmarketcap are two of the many tools used to follow the daily evolution of assets. They also offer deep resources for training and learning.

  • DeFi insights. DeFi pulse or DeFi Llama offer usable approaches to DeFi. They might differ in the scope of their analytics: DeFi pulse focuses on Ethereum while DeFi Llama also explores other Layer 1 solutions such as Solana or Polygon.

  • NFTs. Cryptoslam, Nonfungible are platforms that dive into NFTs: collections, stellar sales, floor prices, etc.

  • Media. Messari, The Block, Delphi...three of the most outstanding information and research companies also offer freemium dashboards of curated metrics.

  • For pros. Glassnode or Cryptocompare (the latter, with a freemium model) are tools used by professionals for in-depth analysis.

5. Tech | Solana and Arbitrum outage

Solana and Arbitrum were the flavors of the week recently. Solana rode the wave of Layer 1 solutions: brand new, independent blockchains with value propositions built on top of the flaws of their elders, in this case, Ethereum. Solana is faster and cheaper and bears the promise of seamless transactions.

Arbitrum, on the other hand, is a Layer 2 solution. Layer 2 solutions speed up existing blockchains. In this case, again, Ethereum. Arbitrum joined Optimism in the list of solutions expected to bring a breath of fresh air to users who were choking on ETH fees.

More on Layer 1 and Layer 2 solutions

Both Solana and Arbirtrum had been the center of attention thanks to their outstanding results and timely appearance. When NFTs were sending Ethereum transaction fees to the moon, both solutions, and a few others, made their stellar performances.

But in a surprising turn of events, the platforms went down for a few hours in the course of one same day. Technical issues related to high transaction volumes sent them to the ground. Crypto Twitter was breathless.

Well, not really. Crypto Twitter is the opposite of breathless. Instead, it burst into explanations, post mortems, memes, and some vitriol from those who believe a zero-sum game is going on.

Regardless of technical explanations and civil wars, the signs of instability of the technology that is meant to become the infrastructure of modern finance are just a friendly reminder of how early we are in crypto history.

6. Social Media | Decentralized Social

There are a few normalized aberrations in the world of social media. Users are the ones generating the content, but platforms are the ones extracting value. And users, again, are consuming the content, but they are effectively the product being sold to brands.

Crypto has a suggestion to change this.

The same way it has happened in banking (think of DeFi platforms such as Aave or Uniswap) or in gaming (think of Axie's play-to-earn model)., where the community that generates the value is redistributing the returns, the same shift could happen in social media.

We are one step closer this week, after BitClout creator (former Google engineer Nader Al-Naji, who used to move anonymously under the name Diamondhands) announced he is ready to take his vision one step further with a little help from his investor friends...and 200 of their million dollars.

BitClout is a new type of social network that mixes speculation and social media, and it’s built from the ground up as its own custom blockchain. Its architecture is similar to Bitcoin, only it can support complex social network data like posts, profiles, follows, speculation features, and much more at significantly higher throughput and scale. Like Bitcoin, BitClout is a fully open-source project and there is no company behind it-- it’s just coins and code.

Al-Naji claims BitClout was an initial experiment. What is yet to come is called DeSo (as in Decentralized Social), and it will be a leap forward in this revolution.

Al-Naji is not alone in his vision. DeFi platform Aave is reportedly working on decentralizing social media. And so is, amusingly enough, Twitter. One of Bitcoin's champions, Jack Dorsey, put his money where his mouth is once again with project Bluesky.

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