#22 Russia, Canada, interest rates, and crypto’s increasing connections with global affairs
Seems like crypto has graduated into the adult world. In recent times our newsletter has moved from technical explanations to contextualizing regulation, politics, macroeconomy and now war.
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It seems like crypto has graduated into the adult world. Our newsletter has moved from technical explanations to contextualizing regulation, politics, macroeconomy, and now war in recent issues. In every corner of this newsletter, you can now see how crypto connects more strongly to the rest of the world: from the macro perspective of how crypto is used in foreign or national matters to new products and services that might help crypto grow a suit and a tie and get more involved with big corporations.
Crypto’s role in the Ukraine war
These are humbling times for crypto. Protocol hacks, NFT mania, beef between chains, flippenings, and memes today sound frivolous and silly. In recent times, crypto’s evolution has been determined by regulation, the macroeconomy, and now war. Our joyous garden of lawless innovation has smashed its face against the adult world.
These are humbling times for crypto, but the lesson here has two sides: on the one hand, the current situation reminds crypto of its meager size; on the other, it proves that crypto is increasingly intertwined with the strongest forces in the world.
The talk was walked: “some Russian banks” have been cut off from SWIFT to retaliate against the invasion. The president of the European Commission, Ursula von der Leyen, announced one of the most discussed and meaningful financial sanctions available in the Western bloc’s arsenal. An announcement that the White House immediately replicated.
Broadly speaking SWIFT is the communications system between financial institutions that allows for international payments. But SWIFT also facilitates other operations, such as securities exchange, trade finance, and FX, which is where the damage would be felt more strongly. Banning Russia from SWIFT was considered the “nuclear option” of economic sanctions. It would close off payments to and from Russia, inflicting a wound the size of 5% of the Russian GDP but sending ripple waves across the whole global economy. The measure would block Russian financial institutions from receiving payments and making them. As a result, many industries will come to a halt.
What is SWIFT?
SWIFT stands for Society for World Interbank Financial Telecommunication. It is an international organization, born in 1973 and headquartered in Belgium, that connects 11.000 financial institutions in 204 countries. SWIFT’s purpose was to provide a standardized form of communication between international financial institutions. The term SWIFT is sometimes used to refer to a network, a syntax, or software. But, in each case, SWIFT communicates transactions between banks across borders. And that’s an important point: SWIFT does not itself settle transactions. Therefore, banning Russian banks from SWIFT does not prevent them from a payments network. It just makes it harder for them to do it. It’s like taking away the phone from them.
When blocking Russia from SWIFT entered the discussion, crypto did too.
Russia had been quite ambivalent about crypto in the past. Back in October, Vladimir Putin mentioned in a BBC interview that he was open to a future role for crypto as a unit of account in energy trading. He also noted that the time was certainly too early for crypto to do this, so he probably meant that anything that undermined the US Dollar’s prevalence as the central currency of international trade was fine by him. In the same interview, Putin also said that the US is "making a big mistake by using the dollar in the capacity of a sanctions instrument,” foreshadowing what has eventually happened. Sanctions are coming in increasing sizes, but at the same time, Russia seems to be more ready to survive them.
More recently, the Russian Central Bank has warned against crypto, even asking for an outright ban, while working on a CBDC, following the Chinese book. But even after these recommendations from their major banking institution, the Russian government showed an open predisposition to digital assets.
Some pointed out that Russia could be contemplating crypto as a way to circumvent sanctions. As Putin explained in his interview, sanctions have a double effect: on the one hand, they inflict damage. But on the other hand, they make nations develop defense mechanisms. Russia had suffered sanctions since 2014 when the country annexed the Crimean peninsula. And since then, the government created an alternative (and mostly failed) alternative to SWIF, strengthened ties with China in terms of financial payments, and experimented with digital assets and a digital ruble.
But crypto, as Putin also pointed out, is too small in size to become a viable escape vessel. The scale and liquidity of crypto markets don’t make up for the loss of getting cut out of the payments system. SWIFT handles an estimated $5T daily transactions through 35 million communications. According to a recent report by Chainalysis, “total transaction volume across cryptocurrencies grew to $15.8 trillion in 2021, up 567% from 2020”.
The role of crypto will probably be very secondary from a national and corporate point of view. It might be more relevant on Moscow’s main street. As the Ruble struggles, the Russian population might resort to crypto, similarly to what happens in other countries with weak currencies.
This secondary role in the conflics might be good news for crypto, as it is more likely to remain politically neutral in this time of conflict. As Tom Robinson, chief scientist and co-founder at the crypto analytics firm Elliptic, claimed in a Washington Post article, “because there is no central controller who can impose their morals on its user, crypto can be used to crowdfund for the Ukrainian army or help Russia evade sanctions.”
⬡ 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. Politics | Weaponizing finances in Canada
This newsletter was already heavy before the war broke out. Justin Trudeau’s government was providing crypto for the example it needed to prove that the world needs a decentralized financial system. Following the protests of the Freedom Convoy (a series of blockades against COVID-19 vaccine restrictions) led mainly by truckers, the Canadian government updated and used a 90-year-old law to block the protesters’ funding mechanisms. This included crypto transactions.
Crypto immediately jumped. The Canadian government was weaponizing finance without the intervention of a judge. This is what Satoshi was working against. Nobody in crypto really felt much about the cause of these anti-vax truckers: they don’t want governments to hold this type of uncontested power. Because, as we are witnessing, they will use it.
Trudeau later revoked the decision, but the message was out already.
Who remembers Google’s first motto? Larry Page and Sergei Brin established that the company’s mission could be expressed as “don’t be evil.” Well, crypto advocates for a time when “don’t be evil” turns into “can’t be evil.” A decentralized form of finance prevents governments and companies from even exerting the power to block finance. As punk6529 expresses, paying is a fundamental part of exercising basic rights.
2 Macroeconomy | Crypto’s relation to interest rates
How does crypto correlate to interest rates?
Interest rates are a central bank’s weapon against inflation. In recent times, the increasing inflation has been met with measures to increase interest rates by the FED. An announcement that many point to as the reason behind the latest bearish turn of crypto price evolution. The rationale is that a more profitable fiat currency will attract investments from other less profitable (or more profitable but too risky) investments such as crypto. Read Sygnum Bank’s newsletter.
But the narrative seems flawed. With the inflation numbers we are witnessing, the current rise in interest rates is not enough.
According to Pantera Capital, “Real rates – the interest rate one gets after inflation—are at negative 5.52%, a 50-year low.”
We are in a moment where the storytelling beats the numbers. Yet, Crypto’s storytelling is still finding its footing in very convulse times. Is crypto a form of payment or a store of value? Is it a risk asset or an inflation hedge?
3 History | The DAO hack
Long before a DAOs were created to buy a copy of the US Constitution (ConstitutionDAO), an NBA team (KrauseDAO), a single Wu-Tang clan CD (PleasrDAO), or a copy of Dune for over $2M (SpiceDAO), there was one DAO that was THE DAO. No prefix needed. And to this day, everybody in crypto understands what The DAO was because it is one of the most significant moments in crypto history.
The DAO was born in April 2016, in the early days of Ethereum. It was a decentralized venture capital fund, where users could pool money and decide where to invest it through decentralized governance mechanisms. The DAO’s creators expected to raise $5M for it, but it ended up attracting $150M in Ether instead. At that time, $150M in ETH was almost 15% of all the ETH in circulation.
In June, a hacker found a way to siphon funds from the DAO and took away 3,64M ether (5% of the whole ETH supply). The hack sent shockwaves across the ETH community, and after much deliberation, Ethereum took the controversial decision of forking the Ethereum blockchain to overrule the hack. It was understood this was the only way to save Ethereum, but it involved a unilateral decision that contradicts Ethereum’s most important goal: decentralization.
A fork is when a blockchain gets divided into two different branches, with a shared past but diverging futures. Like in those science fiction movies where time splits, and the same characters live two parallel realities, Ethereum had divided into two timelines: one where the hacker retained his loot, but in the form of an alternative currency, Ethereum Classic (ETC), and another one that would go on to become the Ethereum we know today.
The DAO was a critical point in Ethereum’s history. Forking might have been the only solution, but it betrayed the most fundamental principle of the project. “Code is law” is one of the mantras in crypto: it means that whatever the code allows to happen is licit. Hacks included. This time, the “code is law” rule did not apply.
Laura Shin, one of the first journalists to turn her eyes into crypto, and now a Forbes columnist and author, recently unveiled an article where she claims to have found a likely suspect of performing The DAO hack. Exclusive: Austrian Programmer And Ex Crypto CEO Likely Stole $11 Billion Of Ether. The story is another example of how tools for analyzing and surveilling transactions are maturing to make crypto safer for institutions and large corporations. But that’s a whole other angle (and it starts below).
4. Financial crime | Chainalysis report
Speaking of analytics and surveillance tools, Chainalysis is a leading company in these analytics services. In fact, they were tools developed by Chainlaysis that enabled Laura Shin’s report on The DAO hack.
Chainalysis recently published a report on the illicit use of crypto. The company can trace and analyze the destination and behavior of funds coming from criminal origins, such as scams, stolen funds, or ransomware.
According to the report, illicit transaction volume increased 79% over the year, up to $14B in 2021. But the 79% increase in criminal activity is a minimal change compared to the 567% general increase in transaction volume across all cryptocurrencies.
The story here is how companies like Chainalysis prove that crypto is potentially much better at fraud control than other forms of payments. Analytics can team up with regulators and law enforcers to create an even more secure form of digital payment.
5. Web 3 | Vampire Attacks
Vampire attacks are a pure Web 3 phenomenon: it is the act of sucking users from a competing platform by offering a better incentive structure through tokens and token rewards. Sushiswap performed the most famous vampire attack on Uniswap. Sushiswap took advantage of the open-source nature of Uniswap to create a copycat platform that distinguished itself from the original only in the way it involved the community. Sushiswap was born more open and decentralized than Uniswap and offered better rewards to its users through the Sushi tokens and governance mechanisms.
More recently, LooksRare attempted the same strategy against NFT leading marketplace Opensea. While Opensea is a centralized platform with a Web 2 philosophy, LooksRare attempted to overrun it by creating a token that rewarded Opensea users, sellers, and buyers, according to their activity.
Vampire attacks are a competitive strategy that is likely to happen more often, as Web 3 companies decentralize Web 2 services. Imagine a Web 3 version of Tik Tok where users are financially rewarded for creating content and obtaining likes. While this is probably a far-fetched and unlikely example, it explains what an incentive war looks like in a few words.
6 Regulation | DAO Inc
DAOs are not legal entities at the moment. They are a new modern way of coordinating people around a common goal in a digital, remote, and decentrally governed manner,...but they do not have a clear legal status that fits with regulation. Rings a bell? It is the same thing that happens to DeFi as a whole or crypto in general. Is it a currency, a security…?
The most likely outcome is that regulation and use will meet halfway, and DAOs will end up having a legal status with conditions of their own. Borderlessness, pseudonimity, fund management...these are things that will have to be settled.
In the meantime, the Marshall Islands have already taken steps to become a hub for DAOs, in the hopes of attracting this wave of innovation.
The new law essentially grants DAOs the same privileges as limited liability corporations (LLC), allowing them corporate personhood and the ability to hold real estate, done through a modification to the nation’s Non-Profit Entity Act. How the Marshall Islands Is Trying to Become a Global Hub for DAO Incorporation
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