It has been a while since I wrote one of these, so I plan to just let my raw thoughts guide my fingers. Before we start, go grab a cup of coffee and sit back. It might get rather pensive. ☕

After all, this is a piece that aims to explain why are we even in crypto.

…

Crypto is now a decade-old industry. To be precise, it has been around for 15 years, but while the Bitcoin whitepaper was released in 2008, there wasn’t much to do onchain until Ethereum pioneered smart contracts.

Some would even say the term “industry” is still too generous.

The entire crypto asset market cap is still smaller than NVIDIA’s. Next time you’re thinking about selling your crypto to BlackRock, read the last sentence again. Having said that, gone were the days when crypto was considered a career suicide; the days when developers and investors were considered foolish for taking a stab at crypto.

Your families might still ask if what you’re doing is real though.

So, other than improvements in public acceptance and no longer getting the weird stare when you say you work in crypto (who am I kidding… that still happens) — after more than a decade of development, iteration, and experimentation, what have we achieved?

Turns out, there's a lot!

• Stablecoin settlement volume hit $10 trillion, around Visa’s level

• More than $100B of crypto assets are staked

• Bitcoin ETFs hit $10B in AUM, fastest than any US ETF in history

Hold on a second… why is everything that we’ve achieved related to the movement of money or some sort of investment products? What about web3, decentralized identity, and the metaverse! Yes, the kids want the Metaverse!

You’ll own no land but you’ll own this private digital land next to Snoop Dogg’s pixelated mansion and you’ll be happy! Next!

https://www.coindesk.com/tech/2024/03/27/vitalik-buterin-takes-a-dig-at-the-metaverse-calls-it-a-branding-ploy/?utm_source=launchy.beehiiv.com&utm_medium=referral&utm_campaign=why-are-we-in-crypto

Sigh. Okay, to understand why the achievements above are amazing even though we still don’t have any mainstream consumer app, we need to realize what crypto is.

• Is it a new asset class?

• Is it a new form of pseudo-equity?

• Is it a new form of money or commodity?

• Is it a movement?

• Is it an ideology rooted in libertarianism?

After being in the space for 7+ years, my definition of crypto is simple:

❝Crypto is a tool that increases the velocity of capital; and capital, at the end of the day, is a means to coordinate energy.”

Velocity of Capital

I know what you’re thinking. Is this another VC think-piece bullshit that we have to endure because the prices are down? Well… trust your instinct ;)

Moving on…

In the next 50 years, there are only two things that will remain true.

1. The world becoming more digital

2. The world becoming more volatile

I don’t care if you’re a techno-optimist or a Luddite.

Our world is going in a direction no one has ever seen before. Historians, aka another word for macro fund managers, might try to draw comparisons with the past, looking for patterns that can be used to analyze the current state of the world.

While there might be some benefits in studying the past, the world and our society have never faced such a rapid pace of technological innovation. In the past 100 years, we’ve created innovations that resulted in exponential progress compared to the 1500-1900.

And we’re not slowing down.

Think about it. There used to be more time for our parents and grandparents to adjust to every technology cycle. Mobile phones had some differences but all of them more or less did the same thing until the advent of the internet.

Since then, everything has become much more exponential. In 2015, the term “influencers” was relatively new. In 2017, we had the first crypto ICO bubble. In 2020 we had COVID & mRNA vaccines. In late 2022 we had ChatGPT. A college kid who graduated in 2019 has never seen technological innovation as rapid as the past five years.

Fast forward to 2024, we are having thriving discussions around nuclear energy, biotechnology, and space/military technology. All this is not even considering AI girlfriends. Yes, we shall not underestimate what will be the most impactful innovation to human society (but that’s for another post).

On the volatility side, we have to give some credit to the macro fund managers. When 75% of the existing USD in circulation was only printed in the past four years, something something will eventually break.

We also have, for the first time ever, a generation that won’t be doing better than their parents.

Why are the two charts above crucial? Because they signify the exacerbating inequality in our world that will eventually lead to volatility.

Massive wealth inequality caused by bad policy decisions and the maintenance of social constructs that don’t provide hope to the younger generations will inevitably result in societal upheaval, causing our world to become much more volatile.

So why are we here?

Done right, crypto is a tool to decentralize systems.

Many facets of our world, including money, power dynamics, and other social constructs, operate as systems. Currently, these systems are increasingly digitized and volatile. To forestall chaos and maintain stability, there must be a method for society to effectively coordinate its energies, pulling the pendulum back from the brink of collapse.

Done right, I believe that crypto is the right tool to achieve this.

This is because crypto increases the velocity of capital. Crypto makes it easier for any entity in the world to transact value with one another, reducing friction via its permissionless nature. And at the end of the day, capital is just a means to coordinate how energy is being directed. From funding new initiatives to creating incentives, our whole world runs on how capital is allocated.

In essence, our whole world is just mechanism design.

This is why crypto is often seen as an incredibly intriguing and controversial industry. It has the potential to disrupt the existing systems because of its permissionless and decentralized nature. It is the best tool to coordinate capital (hence energy) in an increasingly digital and volatile world where power and wealth inequalities continue to exacerbate. A tool for every person to truly own one’s capital, digital footprint, and ultimately, one’s energy.

Stay pensive, act pragmatically,

Marco M.

Hi folks 🙋🏻‍♂️,

I’ve been in crypto for almost 7 years. Yesterday was the second craziest day in my crypto career. The first one was in 2020 when I saw BitMEX’s BTC order book hit zero before BitMEX suddenly went into “maintenance” — Arthur pulled the plug and saved all of us. I had planned to write about Elon’s Twitter fiasco and how it might catalyze the rise of decentralized social media — but there’s no way I can write about that after what just happened. I really hope you readers are not impacted by this FTX debacle; and if you’re, know that things will always get better and the space will eventually bounce back. Stay strong.

Meme credits: @yuno0Zy

FTX: The Fall of an Empire

Sam Bankman-Fried (SBF), the Co-Founder & CEO of FTX has been the poster child and media darling of the “western” cryptocurrencies landscape in the past few years. He’s seen as a brilliant, measured, and thoughtful individual. After all, how can you not see him as such? He’s a quantitative finance wizard who was working at Jane Street before starting his extremely profitable crypto trading firm, Alameda Research. Not long after winning big by arbitraging crypto price discrepancies between the Eastern and Western markets, SBF founded FTX, which then became a massively successful crypto exchange.

His brilliant understanding of the derivatives market propelled FTX into the limelight as the premiere platform for crypto traders around the world to speculate on crypto derivatives. Don’t get me wrong, derivatives in crypto already existed since the days of BitMEX, but FTX's product was really good and took the crypto derivatives market to the next level. After achieving mainstream success with FTX, SBF was able to raise a significant amount of capital from notable investors around the world, the likes of Sequoia, and continued to expand his crypto empire. Not long after, come the Super Bowl ads, the athletes and stadium naming sponsorship, and other extravagant marketing initiatives to show that FTX is here to stay. SBF also then began courting policymakers, engaging with government officials in DC to help shape the future of crypto regulation in the US.

SBF had it all. A profitable business, a deca-billionaire status, athletes and celebrities endorsement, mainstream public awareness, and a promising regulatory engagement. But suddenly, in the span of 48 hours, everything crumbled down — FTX is having a liquidity crisis, most probably (or definitely) insolvent, and is in process of getting acquired by its rival, Binance.

https://twitter.com/sbf_ftx/status/1590012124864348160?s=61&t=qOIgiEklqXlJVN7QqiEymw

https://twitter.com/cz_binance/status/1590013613586411520?s=61&t=qOIgiEklqXlJVN7QqiEymw

In this piece, we break down what happened in the past 48-72 hours, what happened with FTX, and how did things go so badly so quickly.

Here are the quick takeaways:

• Rehypothecation, excessive leverage, and opaque reporting — crypto might be a relatively new asset class, but these are the same old problems.

• FTX (International entity) was most likely commingling funds with Alameda Research and got dragged down as a result.

• Binance *might* acquire FTX, but that’s pending due diligence, with many speculating that the deal will fall off because the hole in the balance sheet is too large ($6 billion+).

• There will be massive negative second-order effects on lenders and miners, including those who are regulated in the US.

• “Trust, don’t verify” will continue to be repeated as a talking point. This will hopefully usher in more on-chain solutions, but it will undoubtedly draw massive regulatory scrutiny in the near future.

https://pensivepragmatism.substack.com/

New Asset Class, Same Old Problems

What happened: FTX is rumored to be insolvent. The exchange halted user withdrawals and went MIA for approximately 12 hours before news broke out that Binance is going to acquire FTX. All this happened within a day after customers’ confidence in FTX waned because of Alameda Research’s balance sheet leak and a minor Twitter drama with Binance.

The Timeline:

• November 2, 2022 — CoinDesk broke a story leaking Alameda Research’s balance sheet.

  • The number doesn’t look too good. Out of $14.6 billion reported, $5.8 billion were in FTT, FTX’s own exchange token. $2.1 billion of that $5.8 billion is reported as “FTT Collateral”.

    https://twitter.com/hodlkryptonite/status/1588106234968043522?s=61&t=gptvFeX1atIMxjtIsV9n8Q

• November 6, 2022 — Alameda’s CEO confirmed the balance sheet, stating that it has $10b+ of assets that aren’t reflected in the leak.

• November 6, 2022 — Binance’s CEO publicly stated that Binance will liquidate its massive FTT holdings as part of its exit from FTX equity. They’ll be doing this because of “recent revelations”.

• November 6, 2022 — Alameda’s CEO offered to minimize the open market impact by buying all of Binance’s FTT at $22.

• November 7, 2022 — Binance’s CEO declined the $22 OTC offer and will stay in the free market.

• November 8, 2022 — FTT went below $22 and FTX paused all user withdrawals.

• November 8, 2022 — Semafor reported that SBF was talking to billionaires to raise emergency capital, with not much luck.

• November 8 EOD — Binance to acquire FTX. Pending due diligence. Binance can back off at any moment.

You might be asking: “all this doesn’t make sense”. For all that I care, FTT can go to zero and FTX should still be solvent. You’re right. That should have been the case. That will be the case for most other exchanges.

Crypto market participants have always known about FTX and Alameda Research's relationship. After all, they’re owned by the same person. However, no one really had any idea about the extent of their dealings.

The answers: FTX and Alameda Research were commingling funds, which include users’ funds, via the FTT token. In short, Alameda utilizes FTT as collateral on FTX to borrow other assets such as USD-backed stablecoin from FTX’s customer deposits.

Once again, the crypto industry is suffering from the same old problems. An endogenous collateral system, opaque reporting, rehypothecation of assets, and excessive leverage.

https://twitter.com/lucaprosperi/status/1590294060623069184?s=61&t=-KlvQYSn_UgSQXxrzjQiqg

Speculation Corner

Let us wear our tin foil hats briefly. Everything under this section is rumor and speculation, as well as hypotheses that I’ve heard from industry participants regarding what happened.

SBF and FTX had been lobbying US policymakers for a new bill called DCCPA, I wrote about it last week. It was speculated that the bill will more or less kill decentralized DeFi applications, benefitting FTX and other US-based exchanges in the process. There was also a rumor that FTX had been talking smack about Binance in DC — whether this is true or not, I wouldn’t be surprised if FTX has been laddering against Binance in DC, a strategic move where one company highlights the weakness of others.

Binance, obviously, doesn’t like this. They’ve been the opposite poster child of FTX. They were the target of investigative pieces from journalists as well as regulators around the world. CZ and Binance had practically been on a world tour in the past few years to rally regulators and former policymakers to their side. It must’ve cost Binance a substantial amount of capital lobbying retired policymakers as their “advisors”.

Somehow, Binance might have caught wind of the situation at FTX and Alameda Research and decided to catalyze further panic by dumping FTT on the open market. Although Binance has denied this. And also, we shouldn’t blame Binance for what happened. If FTX had really been commingling users’ funds with Alameda Research in a savvy way via FTT collateralization, it might have been… criminal. If FTX is kosher, no matter what happens to FTT, it shouldn’t be enough to make the entire exchange insolvent.

For now, we have a new god-king in crypto: Changpeng Zhao.

https://twitter.com/hsakatrades/status/1590018360611581952?s=61&t=PGD5sDQgumtNZ4PIZzWF7w

Main Character

You don’t want to be the main character. Actually, let me be more specific. In crypto, we’ve seen times and times again those who acquire wealth and fame too quickly let it get the best of them. When everything seems to be working extremely well, ask yourself; do I have enough people around me that will say “no, dude, that’s stupid and dangerous, don’t do that”. If you don’t have these people around you, it won’t take long for you to walk into an extremely obvious land mine. In this case, SBF had an extremely profitable empire printing a stupid amount of money every year, but he was still able to mess it all up. And oh, if somebody claims to be an effective altruist, maybe try to dig deeper and see if there’s anything off — I’d rather trust a person that blatantly says they want to get rich.

Musing

Sometimes, I try to take stock of the fact that I’ve been in the space for almost 6 years; made a good income; build skillsets, and networked along the way, but haven’t really “made it”. If the last sentence sounds like copium, trust your instinct. I used to beat myself up knowing that there are people who got into NFT in 2021, hit the jackpot, and made mid-8 figures in 6 months. The truth is, I don’t know how I would become if that happened to me. Too many young people got destroyed by becoming too wealthy too quickly without experiencing setbacks and having the necessary experience to manage large-scale operations. By operations, I don’t only mean your organization or capital, but also your life.

Until next time,

Marco M.

https://twitter.com/mrjasonchoi/status/1590046353249689601?s=61&t=wGbMBYYE2fBYbreJ1SDFQg

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https://pensivepragmatism.substack.com/

Hi folks 🙋🏻‍♂️,

There are 66 days left in 2022. Yikes. Sorry, didn’t mean to scare you there but I can’t believe that it has almost been a year since BTC and ETH almost hit $70,000 and $5,000. You read that right — the crypto market cap hit its peak of $3 trillion in market capitalization in mid-November last year. Time flies. Billions were raised and billions are evaporating as investors and builders experiment and try to find product-market fit. Some ideas were genuinely exciting and others were incredibly stupid when we stop smoking the hopium. Liquidity dries up as the US Fed and Central Banks around the world raised interest rates, putting the entire global economy in a state that we’ve not been in since 2008. Yet, amongst all this mess, there is one crypto sector that’s thriving more than ever: stablecoin.

Binance’s Quest for Stablecoin Dominance

The top three largest stablecoins, USDT USDC BUSD, collectively amass $135 billion in market capitalization. At the current interest rates of approximately 4%, these stablecoin providers are generating $5.4 billion per year. The entities related to these stablecoins are also related to the world’s biggest crypto exchanges: Bitfinex-USDT, Coinbase-USDC, and Binance-BUSD. To grasp the growth of these stablecoins, USDT, the oldest of them all, had a market cap (hence supply) of ~$10 million in January 2017. Within the span of five years, USDT grew 6,800 times, enabling crypto market participants around the world to have quick and easy access to USD, further strengthening the US Dollar’s position as the world’s reserve currency.

USDC found its product-market fit thanks to DeFi. It brilliantly capitalized on the DeFi summer of 2020, becoming the de-facto USD stablecoin for all major DeFi markets. USDC also differentiates itself by using a brand strategy technique called laddering: which is an attempt to deposition competitors by highlighting their weaknesses. To be precise, USDC did this by building a moat around compliance. USDC advertises on the fact that it’s US-based, has brand name partners (BNY Mellon, BlackRock, and is more transparent about its reserves compared to its competitors.

BUSD found success by piggybacking Binance’s established dominance when the stablecoin was launched in 2019. The world’s largest exchange had a lot of ways to promote the usage of BUSD on its own platform, as well as on its own blockchain, the BNB Chain. Fast forward to 2022, BUSD is the third largest stablecoin and Binance is more eager than ever to grow its stablecoin dominance.

When we talk about crypto use cases, the promise of decentralization, web 3.0 potentials, and a more equitable internet is often what comes out of VCs’ talking points. Although all the above are exciting, they’re all currently in a development phase, and it would take years before any tangible crypto products that don’t have anything to do with facilitating speculation or trading, will achieve mainstream success. That said, there is one very obvious use case of crypto that has been widely adopted in the past couple of years. A graphic designer in Brazil can now easily accept payment in USDC from her client in Finland without having to rely on centralized systems, pay an exorbitant amount of fees, and worry whether she’ll be able to access her money. Simply put, the growth of USD stablecoins propelled the global flow of capital, enabling a thriving digital-first economy.

In this piece, we discuss Binance’s recent strategic move regarding BUSD conversion and elaborate on why despite all of the recent regulatory issues, innovating on stablecoin designs will continue to be an important area for DeFi in the next few years.

Here are the quick takeaways:

• Stablecoin has the best PMF compared to any other crypto product.

• The three largest stablecoins, USDC USDT BUSD, collectively amount to $135 billion in market capitalization, generating $5B+ in annual interest.

• Even though Binance is the largest crypto company, being the dominant stablecoin player is a strategic win that it needs.

• Having control over a stablecoin can unlock enormous value for one’s protocol.

• Stablecoin providers’ affinity toward decentralization will be tested in a high-interest rates environment.

https://pensivepragmatism.substack.com/

Magnum Opus

Binance is the Magnum Opus of crypto. It is the largest exchange in the world. The company that was started in 2017 recently celebrated its 5-year anniversary back in July. I don’t think anybody who has been in crypto can deny that Binance is one of the greatest companies built in the past five years. While tech bros in Silicon Valley were chasing Uber, BNPL, and the next 15-minute quick commerce to bolster their returns, the most profitable companies built in the past few years were instead building under their noses the whole time. Perhaps, it was too successful to accept any substantial outside capital, was geographically too risky for institutional US investors, and deemed.

To truly comprehend how large Binance is, let’s do some back-of-the-napkin math. CZ, the CEO of Binance, reported that the exchange did $34 trillion in crypto trading volume in 2021. Actually, I’m not going to reinvent the wheel and let Zaheer, a Portfolio Manager at Ledgerprime, do the rest.

At a conservative estimate of $300 billion valuation, Binance will become the #21 largest company in the world. All this is happening while crypto hasn’t unlocked its full potential. The total crypto asset market cap is stagnating at around $1 trillion. It would be prudent to think that this value won’t go back up to $3 trillion, or even reach $5 trillion in the future. Binance is also aggressively growing its product suites across different emerging markets, as well as being more active with its on-chain initiatives.

The bottom line: Binance as a $1 trillion company is extremely probable.

Despite all of the success and amazing accomplishments stated above, Binance is in a tricky position.

Take a look at the list above. Only three out of the 21 largest companies in the world with $300B+ market capitalization are not US-based. Saudi Aramco is government-backed, LVMH is Arnault’s brainchild that only targets the top 1%, and TSMC is one of the most important companies in the world.

What’s in common: all three companies are US-friendly adjacent

• Saudi Arabia/Aramco is an important ally

• LVMH/France is not controversial and is an ally

• TSMC is an ally(?) — anyway, it listens to the US

  • We can clearly see how much attention the world is putting on TSMC right now as it’s the most important company that might fall under the crossfire between the US and China.

Not only crypto as an industry is still under a lot of scrutiny from governments around the world, but Binance itself also is not a “western” company. Mainstream financial publications around the world had published investigative pieces on Binance, some justifiable, others looked like hit pieces. Although CZ himself is a naturalized Canadian citizen (he was born in China), Binance had been marked as a Chinese company by uninformed journalists due to his ethnic background. This, combined with the fact that crypto is a nascent space that touches finance (the most regulated industry in the world), puts Binance in a tough spot with unique risks to consider.

Enter BUSD

Not only does it makes perfect business sense for Binance to continue expanding its stablecoin initiatives, but I would argue that it’s also a necessary strategic tool that can help them mitigate potential risks. The USD is the world’s reserve currency. Many stablecoin providers around the world have tried to create their own form of non-USD stablecoins, to limited success. The number one talking point that stablecoin lobbyists use when explaining the benefits of stablecoin to US lawmakers is that USD-denominated stablecoin will help the USD’s role as the world’s reserve currency. That argument is extremely valid and we’re already seeing its impact in the past few years.

As a global company that’s been constantly under scrutiny from governments around the world, Binance has been making strategic moves by placing headquarters and partnerships with developing nations around the world.

Where am I going with this: having control over your own USD stablecoin will provide Binance with more power in its regulatory discussion with governments around the world.

• OFAC risks: I don’t think Binance will completely ban BUSD like how USDC banned addresses associated with Tornado Cash. Sure Paxos (BUSD partner) is US-based, but Binance isn’t.

• Eurodollar → cryptodollar: this theory isn’t new — eurodollar refers to USD-denominated deposits held outside of the US, they’re not subject to regulation by the Federal Reserve Board. Cryptodollar is an extension of the eurodollar, fulfilling the insatiable demands for USD outside of the US.

TL;DR: Binance is a global company that has been under a lot of scrutiny by governments around the world, primarily western adjacent governments. In its regulatory play by establishing partnerships around the world with developing nations — combined with the uncertainties on whether or not some aggressive move will be made by US regulators against it, Binance will benefit significantly by being the numero uno provider of cryptodollar.

Binance started converting users’ USDC USDP and TUSD balances to BUSD automatically on September 29 and the strategy has worked quite well so far.

USDT isn’t included. There might be some strategic benefit, but that’s for another post ;)

https://twitter.com/binance/status/1573734906424868865?s=61&t=lbxBBR4S8fiFyaA71o7_Pg

Silver Lining

Matt Levine wrote a banger crypto piece. It’s 40,000 words. It might have saved the crypto market (BTC rose after his post).

My favorite sentence: "If the world is increasingly software and advertising and online social networking and, good Lord, the metaverse, then the crypto financial system doesn’t have to build all the way back down to the real world to be valuable. The world can come to crypto."

For the world to come to crypto, we to focus on building great products. When your product is primarily driven by speculative incentives baked into token rewards and ponzinomics designs, users won’t stay. Ironically, even DeFi products whose main source of attraction is yield are currently facing competition from US T-Bill yield. Bottomline: crypto need to focus more on building great products.

Until next time,

Marco M.

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https://pensivepragmatism.substack.com/

Hi folks 🙋🏻‍♂️,

It has been another gloomy week in crypto. The negative news doesn’t seem to be stopping. The week started with the SEC charging Kim Kardashian for promoting EthereumMax without proper disclosures — and it somehow snowballed into Binance Chain getting hacked for 9 figures, four DeFi exploits in the past day alone with Mango Market’s $100M exploit being the highlight, and the SEC launches its investigation to Yuga Labs (Bored Ape). Blame it all on the Kardashians.

https://pensivepragmatism.substack.com/

Gensler’s Crypto Superpower

For many years, people in crypto have been operating under the assumption that those who “get” crypto will eventually become proponents of the industry. After all, how can one be against decentralization and transparency? The premise of giving power back to the people, creating a more equitable financial system, and transferring trusts from our eroding institutions to immutable codes sounds like brilliant ideas. However, crypto is an incredibly cultish industry. If one isn’t careful, it’s extremely easy to fall into echo chambers, and there are many to choose from — ranging from Cardano maximalists to Bitcoin libertarian right-wing hardliners. As ugly as the previous sentence sounds, what’s most ironic is perhaps the echo chambers of builders that regurgitate the wild wild west spirit of decentralization and privacy without fully understanding how our world operates.

The most dangerous enemy is sometimes the one that’s closest to you. Nouriel Roubini and Peter Schiff are outsiders of the crypto space. They have bombastic personalities and might disagree with the spirit or value of crypto, but they’re not real concerns. They also have their own “narratives”. Just like how Michael Saylor is with Bitcoin, Schiff with Gold, and Nouriel with doomerism.

Gary Gensler is different. He was a practitioner at Goldman and taught crypto at MIT. He’s dangerous because he “gets” crypto, but he might not be fully on board with its ideology. Although the SEC sometimes made crypto remarks that turned heads in confusion, the point is that Gensler understands crypto a lot more than your typical crypto critiques that just spew talking points. One can be bullish on crypto and blockchain in general but believes that some form of restrictions is necessary and good for the growth of the space.

This mentality is not that uncommon. I’ve seen it play out many times. Friends and former colleagues who are brilliant in their respective fields (finance, tech, business) have asked substantive questions that go against the “core ethos” of crypto. These people aren’t environmentalists that got caught by the “crypto is bad for the environment narrative” nor are they incumbents with personal interests to be against crypto. It’s quite simply that not everybody agrees the transfer of money or value should be fully governed by unchangeable sets of codes, with no possible intervention from the governments at all.

SudoSwap → AMM for NFTs, making the NFT somewhat fungible → royalty fee is a form of revenue share → NFT collections began reducing their royalty to zero → the SEC investigates Yuga Labs → coincidence? Trust your instincts.

Governments, hence our society, function because of taxes. There needs to be a way for governments to understand the flow of money and charge taxes accordingly. This is a fact. This premise alone creates an argument that no matter how decentralized a financial system is; the very tail end of the chain-of-activities will be centralized. You might have made $10M in crypto via liquidity mining as an anon, but when you want to purchase a new house, a new car, or even a cup of coffee; you will interact with a system that enables the governments to be aware of your activity. Even in the very unlikely scenario where there’s a Point-of-Sales system that’s fully decentralized and private, the government can simply just ban it. If a government completely lets go of its control over money, it will cease to exist.

So what’s the future of crypto? With the way that things are developing, is crypto going to be a boring industry that gets regulated out of oblivion? In this piece, we break down why that’s not the case and explain how crypto will still unlock enormous potential given where things are going.

Here are the quick takeaways:

• Somebody might “get” crypto, but not be fully on board with its ideology.

• “Privacy” in the freedom of speech context and in a financial transaction context are two different beasts.

• Absolute privacy is impossible to have a semblance of a normal life.

• Security regulations are the primary issues; non-US jurisdictions have enormous opportunities if they know what to do.

• Crypto’s superpower is liquidity reflexivity, which will experience exponential growth once the regulatory framework becomes clear.

A Hard Problem

Balancing freedom and privacy with order is hard. Social media giants with billions of dollars in resources are still struggling to solve this problem. It’s not a quantitative problem. Letting go of control over how a system operates and completely relying on the free market to regulate itself is as if letting every social media platforms become 4chan. It will either end up serving only niche users or get outcompeted by a more moderate platform such as Reddit.

In the crypto space, decentralization and privacy maximalists often say that the technology itself needs to get to the point where it’s completely immutable and uncensorable. We’ve touted this talking point when Tornado Cash was banned. Additionally, discussions surrounding Flashbots’ role and base layer censorship are developing as the space realizes that when governments get serious, it’s not easy to fight back. Let’s do a simple thought exercise and imagine a future where blockchain has scaled and on-chain privacy is the norm.

Hypothetically, a person can do the following:

• Build a credential as an anon person on a decentralized social media platform

• Get a job at a DAO full of anon

• Get paid for contributing to the DAO

• Allocate the salary to a mixer or a privacy-focused chain

• Use the money to do private on-chain trades and make millions in the process

Then what?

When you want to use that money to eat, you need a way to tie it back to the real economy, and at that point, you’ll be traced by the centralized Point-of-Sales system that needs to report back to the government. Governments can easily say that merchants that don’t comply with this requirement can’t operate legally.

My point is that there’s no such thing as absolute privacy if you want to live a semblance of a normal life.

Sure, the Celsius doxxing situation is extremely stupid. People have the right to not disclose the full scale of their wealth. However, there are solutions to these specific problems even without the help of crypto. The majority of people who works for Facebook won’t even know if their colleagues secretly made $30M by going all-in on DOGE in 2020. We don’t need a crypto-specific solution to this problem — there might be demands from people who want to completely control and take custody of their own capital in private, but I doubt the TAM will be big enough.

Don’t get me wrong. There is enormous value to anonymity, but it’s not without its downside. Being an anonymous reporter fighting against an oppressive regime is different than being an anonymous crypto Twitter personality that wants to promote private on-chain transactions to pay fewer taxes. “Privacy” in the freedom of speech context and in a financial transaction context are two different beasts.

The ideal solution: a decentralized identity solution that keeps some sort of anonymity but enables tracing when necessary. Perhaps as ZK-proof tech improves, we’ll see an implementation of this idea. That said, it won’t be without trade-offs.

Liquidity Reflexivity

Crypto’s superpower is liquidity reflexivity. Having an internet-native way to transfer value with one another has exponentially increased the speed of capital flow. Since 2014, the crypto market has facilitated hundreds of trillions in transaction volume. In recent years, the crypto space has also been one of the most well-funded industries.

Perhaps the most obvious thing that needs to happen is clarity surrounding securities regulations. Alex’s tweet below only got 82 likes, but this is the key to unlocking crypto’s potential. The US currently has a monopoly in terms of securities regulations due to its standing as the world’s largest superpower and largest financial market. Other jurisdictions would benefit greatly if they can construct a framework surrounding securities regulations that enable founders to explicitly say that what they’re raising for is tokenized securities. To start, they might be able to simply ban US persons, which will create a brain drain for crypto builders in the US, potentially forcing US lawmakers to “act right” and not tread the water regarding this issue.

Crypto Will Thrive

Crypto’s superpower won’t go away even if the current regulatory climate continues. Although it might not be the “perfect outcome” for crypto proponents, we have to adapt and understand that this technology will still contribute so much to the world. It will unlock enormous value creation even if there are trade-offs that need to be made with the governments. Just like how the internet is neutral on some aspects and regulated on others, the same thing will need to happen to crypto before it will unleash all of its potentials.

Moving Forward

This past week, I sunsetted a daily newsletter that I was doing as a side project for 8 months. We published 246 issues and collected thousands of insightful data points, providing useful daily updates on all-things crypto for our readers. While consistency is key, understanding the market’s feedback: cutting your losses, and doubling down on what’s working is even more important. Three months ago, I started this publication. Instead of daily curated updates, it focuses on longer-form issues (7-12 minutes of reading time). I garnered 3x the number of subscribers and 10x the number of readers in under 3 months. It seems that, after being in the crypto space for close to six years, people do want to hear what I have to say instead of just curating the news.

Thus, I’m doubling down :)

Until next time,

Marco M.

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https://pensivepragmatism.substack.com/

Hi folks 🙋🏻‍♂️,

The origin of this publication is to serve as a place to document my thoughts while hopefully providing value for others. This week’s issue can’t be further from the previous sentence. On September 28, @codygarrison_ from Clearblock released a web3 VC ranking database for founders to better understand the crypto VC landscape. I’ve always loved the idea of reverse accountability. Auditing the auditors, regulating the regulators, and doing diligence on the VCs. Clearblock did a good job providing scores for these VCs, so I’m going to focus on the financials aspect instead.

https://pensivepragmatism.substack.com/

Diligence on Crypto VC

Investors often scrutinize founders about their burn. They scream “go fast and break things” when times are good and pontificate on how to manage burn when times are tough. Although it can be rather annoying and “obvious in retrospect”, the aforementioned attitude makes sense as VC firms’ ultimate responsibility is to generate returns for their LPs. As much as we like to meme about VCs “adding value” to their portfolio company, the reality is quite tricky. There’s no perfect formula for VCs to add value. It depends on a multitude of factors such as the stages of their portfolio companies and how experienced the founders are. Younger founders might need operational help while experienced founders might prefer if you just shut up.

In this piece, I try to make sense of crypto VC funds economics. For founders or professionals that aim to work in the crypto investing landscape, it’s paramount to understand the math behind these funds to prepare for any sort of circumstances.

Sometimes, it’s a simple question: can the fund still eat if there’s no performance fee?

This is especially important if we’re about to enter a multi-year bear market. I was working for a crypto fund in 2019 and got caught off guard by how severe a crypto market downturn could be. Granted, we might not see anything as severe ever again. The crypto ecosystem has matured significantly since then and there’s a ton of capital waiting on the sideline — but; this doesn’t mean that we shouldn’t scrutinize funds just like how we scrutinize startups.

Private markets are also often opaque. Due to lesser regulations, it’s harder to find information on best practices and the standards around VC firms’ accounting. This problem is even more apparent in crypto because of two things: (1) tokens and (2) global nature. Tokens create liquidity reflexivity, enabling private market investors to be savvier with their exit strategies and the global nature of crypto means that funds can adhere to different standards around the world depending on their jurisdictions.

P.S. before you comment, I’m not advocating for more regulations, in fact, I think the accredited investor rules are extremely outdated.

Additionally, job titles on venture funds can also be quite vague. What’s a research partner? Do you get part of the carry, or are you basically a senior investment associate? @Darrenlautf did a great job cleaning up web 3 analyst compensation survey results, which are accessible here. Anyway, let’s get into it.

Here are the quick takeaways:

• Private markets are often opaque, which makes it difficult to get a clear understanding of a fund’s compensation structure and financial health.

• Investment DAO can lead the way in improving a fund’s transparency by storing everything on-chain.

• As founders or young investment professionals, scrutinizing the VC firms themselves as a business is crucial.

• The bull market gave rise to many new VC firms, which deserve more diligence as they themselves can be considered “startups” also.

• VC is a “top-heavy” business — the majority of the value capture goes towards the founders and General Partners. Understanding this dynamic when one is raising capital is critical to find the best fit for your startup.

Context

I’m using Clearblock’s web3 VC database. The folks at Clearblock have aggregated a lot of good data but I’ll only be focusing on the top 50 firms whose amounts of capital raised are easily identifiable, excluding company spin-out venture arms (Coinbase Ventures, Binance Labs) and older funds as they generally haven’t raised much in the past few years and it’s much harder to distinguish between their returns from holding spot ETH since 2016 vs the returns from their more recent investments. So, I’ll be focusing my assessments on the following 9 VC firms.

Notes & assumptions:

• The management fee is 2%

  • In reality, this will vary. It depends on the fund's NAV in the following years after launch (based on portfolio company future raises). It also depends on the specific agreements with different types of LPs. In some jurisdictions, typically EMs, the fees also tend to be slightly lower (in the 1% range) as the dynamic of the industry differs from the maturity of US financial markets.

• The fund investing lifecycle is 3 years

  • In reality, most of these firms will most likely raise another fund before they fully distribute the returns from the current fund. It generally takes 3 years to deploy the capital and another 2 years to recoup and distribute the returns. Most reputable funds would be able to raise new funds before the 5-year lifecycle ends, bringing in more management fees to continue the operations.

• Employee: information is taken from the funds’ websites.

  • GP, MP, Founder, President column keeps track of the fund’s top leadership.

  • The most right column keeps track of the # of employees who hold top managerial positions, either “Partners” outside of GP/MP such as Research Partner, as well as Principal, Director, and any C-level executives.

• I’m sure some of these numbers can be improved, but the point here is to have a starting point on how to assess these VCs. The accuracy is bound to vary as each fund has different compensation structures.

• These are top-tier crypto funds and have funded Unicorn thanks to the bull market in the past two years, so I’m sure none of them will actually struggle. What I hope to showcase is how VC funds fare during market downturns.

Findings

1. Electric Capital has the highest management fee per employee

A VC firm can also be seen as a “start-up”, which was reflected in these numbers. For example, a16z might have the highest management fee per employee, but we haven’t considered how much of this fee goes towards the broader firm executives and founders who might not be directly involved in the a16z crypto fund operations (Marc, Ben, Margit, others). These details are not known to the public and can skew how we perceive these numbers.

Excluding a16z, the other funds here are crypto-native, making it easier to digest the numbers in an accurate manner. Electric Capital leads by having the highest management fee per employee, while Fabric Ventures has the lowest.

2. Pantera Capital has the highest leadership-to-employee % ratio

This number simply shows which firms have more people in leadership positions compared to the total number of employees. It can be treated as a positive or a negative depending on how you see it. For instance, Pantera Capital leads the way at 58%. On one side this can be seen as hiring enough personnel to do the work and actually support your portfolio companies. On the other side, this can also mean those leadership roles receive a smaller cut of the fees (management or carry). There was an executive exodus from Pantera a few months back. Take that with a grain of salt.

On another note, I’m positive that a16z being a non-crypto native firm has a lot more employees who are handling the operational side of the funds, that might not be listed under the a16z crypto team. This is why their number is the lowest at 10%.

3. a16z and Paradigm have the highest management fee per core leadership

Once again, the same context applies to a16z for being a non-crypto-native fund.

Putting that aside, based on publicly available information and subjective judgments on the leadership individuals’ titles, Paradigm leads the management fee per core leadership positions. We won’t know the exact agreement details that these firms have with their top executives who weren’t necessarily founders of the firms (hence outside of the “core leadership” classification), but it’s a start.

On-Chain Transparency

In an ideal world, we’ll have much more detailed reporting from VC funds about their compensation structure in order for founders to also do diligence on the health of the VCs that are investing in them. While the top VC firms assessed above might never have any liquidity issues, smaller firms that can go out of business because of the market downturn will be detrimental to founders. Founders will lose access to future support, and networks; and might even need to waste time dealing with secondary sales of a liquidated fund.

Alas, with the rise of many smaller crypto VC firms — if you’re a founder who needs to raise capital from these new entities, or if you’re young professional thinking of working for these funds; make sure to implement the basic models above and scrutinize the financial health of the firm. Perhaps investment DAOs can pave the way by putting all of their economics on-chain, making it verifiable for any parties who want to conduct business with the DAO, enabling others to do diligence on the entity that typically does diligence.

Being Young in Crypto

Yesterday, @knowerofmarkets, a great writer and a fun personality on crypto Twitter posted the following tweets. I’ve truly enjoyed knower’s work. In fact, his work helped reinvigorate my drive to write. So when I saw these tweets, I felt compelled to respond (or at least think internally) about what he said. Knower is young — I know this as he often talks about how he’s still in college. Being in crypto at a young age exposed one to a lot of interesting knowledge, both good and bad, and your growth depends on how you consume it. Some become “too online” and adopt an edgy libertarian incel personality while others become more thoughtful about the complexities of the world.

Crypto sits at the intersection of tech, finance, game theory, government regulations, privacy, individual liberty, and others. Getting bombarded by all of these thoughts when you’re young can be difficult. Most people aren’t able to become masters in one of those fields, let alone the intersection of all of them. Crypto also often glorified young entrepreneurs; the 18 y.o. that made $8 figures by capturing MEVs and has an anime pfp. While it’s amazing what some of these people have accomplished, we need to normalize talking about the mental toll of being in crypto. After all, an industry will only be as great as its next generation of builders.

Translation: I was drinking three nights a week in my early 20s and got rug pulled by Wanchain ICO.

Until next time,

Marco M.

If you enjoy this piece, please consider sharing :)

https://pensivepragmatism.substack.com/p/diligence-on-crypto-vcs

Hi folks 🙋🏻‍♂️,

Token2049 conference is happening in Singapore, so it has been a busy week. Apologies for the late issue. I’m not attending due to some personal matters, but the number of activities and energy is through the roof. Certainly one of the busiest times for crypto in Southeast Asia. From crazy crypto Twitter personalities walking around to the over-the-top Marina Bay Sands afterparties, it seems like the industry is very well capitalized. If the last sentence sounds like I’m FOMO-ing, trust your instinct.

https://pensivepragmatism.substack.com/?utm_source=substack&utm_medium=email&utm_content=share&action=share

It’s All About the Benjamins

Swiftly moving on, let’s talk stablecoins. As of September 2022, stablecoins account for ~15% of the entire crypto market cap, or roughly $150 billion. It’s heavily utilized by crypto market participants and has shown to have a brilliant product-market fit. In the bull cycle of 2017, stablecoins were barely there. They weren’t at the top of everybody’s mind as use cases were generally exchange-specific. Everything changed in early-mid 2020 when DeFi summer happened. Previously, there wasn’t any significant reason to utilize stablecoins if you were trading in a centralized exchange. Trades were settled off-chain and you could’ve easily cashed out to USD if you want to stay on the sidelines. Even in the derivatives market, traders would’ve done a 1x short BTC on BitMEX while holding spot BTC to stay neutral.

With the emergence of DeFi in 2020, on-chain markets infrastructure exponentially grew. Protocols such as Uniswap and Compound provided the necessary environment for stablecoins to find their product-market fit — starting the boom of their supplies.

Not long after, industry participants realized the significance of having their own stablecoins and started a series of experiments to innovate on stablecoin models. The most notable one is Terra’s UST stablecoin, which had the brilliant idea to create an algorithmic stablecoin without any real collateral. The stablecoin is tied to the protocol’s native token, LUNA, and utilized a mint-and-burn mechanism to maintain the 1:1 peg with the USD. For a second, this seemed like a genius idea, combining the native token of the blockchain with smart contracts capability with a native stablecoin.

Surprise surprise.

UST imploded and lost ~$18 billion of its value overnight. To make things simple, this de-pegging event was caused by UST’s endogenous design. Endogenous basically means that the stablecoin is backed or partially backed by any tokens from the same issuer. Luca Prosperi, a researcher who’s active in the MakerDAO community, has previously written about this concept. In fact, the term endogenous is a critical language in the US House draft stablecoin bill, which we’ll unpack in this write-up. The future of this trillions dollar industry might have been changed forever.

Here are the quick takeaways:

• The US stablecoin bill, if passed, will create a much more strict regulatory requirement, involving registration and banning endogenous collateralized stablecoins.

• The important part is the registration aspect, which can create second-order effects for protocol-owned stablecoins.

• A strong stablecoin industry will exacerbate the “dollar milkshake theory”.

• It’s unrealistic to not expect any form of regulation, or expect lenient regulations, against stablecoins.

• There will be a rise of non-USD peg stablecoins, that aim to stabilize value without pegging it to any FIAT currencies.

The Bill

The goal of the bill is to introduce a framework around stablecoin issuance. It covers the how and the who.

The “how” part dictates what type of stablecoins can be issued. Blame it on all Do Kwon. Under the new bill, there will be a 2-year ban on stablecoins that aren’t collateralized by cash or highly liquid assets, and issuing “endogenously collateralized” stablecoins will be punishable by crime. For existing stablecoins with the aforementioned model, there will be a 2-year grace period for the issuers to change their collateralization model.

There’s more detail to be covered here as the bill moves forward in the process. A conversation on Twitter pointed out an interesting language difference. “Relies solely” means that Terra’s UST might not have been impacted by this bill, because it was partially backed by BTC at the very end of its life.

The “who” part dictates the necessary requirements for stablecoin issuers to comply with, and who will be regulating these issuers.

Nonbank issuers of stablecoins backed by fiat currency would also be overseen by state banking regulators and the Federal Reserve.

Banks or credit unions could issue their own stablecoins, which would be overseen by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.

Issuing a stablecoin without approval from those regulators could be punishable by up to five years in prison and a $1 million fine.

— The Block

If passed, the requirement to receive approval can potentially create a lot more problems. It might directly disrupt DeFi’s composability. For instance:

• if USDC has received approval from the appropriate regulators, does Compound need to receive the same approval for the protocol to issue cUSDC, a yield-bearing asset for its lending platform?

• if I run a bridging protocol, do I need to receive approval for a bridged version of USDC?

• if a wrapped version of stablecoin is necessary to connect with real-world assets, how would that play out?

You get the point. This bill can potentially create more uncertainties instead of providing a clear framework for industry participants.

Existing Stablecoins

How would this impact the top non-centralized stablecoins?

• DAI

  • DAI is not backed by MKR, but MKR can be used as a last resort tool to cover the protocol’s deficit in the scenario that the Maker protocol is losing money.

  • This rarely happens, but it has happened before.

  • The bill shouldn’t impact MKR.

• FRAX

  • FRAX is partially backed by FXS, which is FRAX’s governance token.

  • The collateral ratio of FXS will update depending on the utilization rate of FRAX.

  • The bill will put FRAX under scrutiny as it is partially endogenously collateralized by a token from the same issuer.

• LUSD

  • LUSD is not backed by LQTY, which is LUSD’s governance token.

  • LUSD is primarily backed by ETH.

  • The bill shouldn’t impact LUSD.

• USDD

  • USDD is partially backed by TRX, which is endogenous to the USDD ecosystem.

  • USDD is ~30%+ backed by TRX.

  • The bill will put USDD under scrutiny as it is partially endogenously collateralized by a token from the same issuer.

• USDN

  • USDN is backed by WAVES, which is endogenous to the USDN ecosystem.

  • The bill will put USDN under scrutiny as it is partially endogenously collateralized by a token from the same issuer.

• MIM

  • MIM is not backed by SPELL, which is MIM’s governance token.

  • MIM is backed by other assets, primarily FTT.

  • The bill shouldn’t impact MIM.

I believe that we’ll see a rise of non-USD peg stablecoins, that aim to stabilize value without pegging it to any FIAT currencies. However, it’s very unlikely for these types of stablecoins to reach mainstream adoption. Don’t get me wrong, I haven’t given up on these concepts (e.g. RAI), but there’s a lot of work to be done to scale it and make it user-friendly for non-crypto native consumers. I have a few ideas, but that’s for another post.

Pragmatism

Aligning with the spirit of this publication, I think it’s unrealistic to expect no regulation or lenient regulation towards stablecoins. Despite the rise of libertarian tech bro public figures, we still live in a society where governments govern. Stablecoins are directly tied to FIAT currencies, which are a tool of governance and stability for governments around the world. That’s why even countries with amazing economic growth over the past few decades such as South Korea still implement some form of capital control.

Even in the scenario that the US let the stablecoin industry flourishes and exacerbate the dollar milkshake theory, non-US jurisdiction won’t stay put and let their currencies weaken. I’m a believer of the dollar milkshake theory, but it’s naive to expect that other FIAT currencies will go down without a fight.

Alas, we’ll see increasing regulations in the stablecoin landscape. Industry participants need to draw from both spectrums. Be pragmatic and adapt to the situation, while actively championing friendlier regulations through various measures. No matter what happens, the stablecoin industry will still be worth in the trillions, it’s not a matter of when, but a matter of how.

Life and Work

Being in your mid-20s is the best and weirdest feeling at the same time. In your early 20s, pretty much all of your peers are working towards their professional goals. People talk about work and how to make more money. But in your mid to late 20s, people start to diverge. You see those who are more ambitious than ever to have a FatFire lifestyle, those who become digital nomads in Bali doing e-Commerce dropshipping, and those that have settled down with children. I still don’t know where exactly I fall; but a few days ago, a friend of mine wrote a brilliant piece about the contemporary state of work. In his piece, he hypothesized that there are two types of people. For type 1, work brings joy to their lives and it’s their Ikigai. For type 2, work is an evil necessity to ensure livelihood. All that I know is that I’m grateful to have found the crypto space — this crazy whacky world is indeed my Ikigai.

Until next time,

Marco M.

If you enjoy this piece, please consider sharing :)

https://pensivepragmatism.substack.com/p/its-all-about-the-benjamins?utm_source=substack&utm_medium=email&utm_content=share&action=share

Hi folks,

The crypto market in the past week has been somewhat crabby although ETH created massive FOMO by going up ~50% in one week. They say the merge narrative aligns with the price movement but who knows what our macro gods will decide. On a completely unrelated note, we’re planning to launch a separate weekly quick bite issue in the next few weeks to provide more value for our readers—thank you once again for being my early supporters. The details are yet to be finalized, but we’ll be covering important charts of the week and presenting strategic ideas for protocols & DAOs.

My goal stays the same: to make this publication the most unique, informational, yet measured information source in crypto while serving as a platform for my brain dump. If you would like to converse in real-time or bounce ideas, feel free to connect with me on Twitter.

Unsustainable Crypto Business Models

In an UpOnly market, market participants tend to not care as much about the sustainability and defensibility of a company’s business model. New methods to assess a company’s valuation and moonshot narratives were brilliantly concocted to justify the price growth. No one wants to be the party pooper.

When the price continues to go up and to the right, browser-based virtual world online games with shitty graphics are dubbed as the next generation of gaming that enables users to own a part of the game, with virtual real estate plots selling for millions. Play-to-Earn often flawed mechanism design is deemed as the future of gaming and work, with radical proponents of the concept arguing that gamers will eventually prioritize the earn component, instead of focusing on building an awesome gameplay experience first.

New DeFi primitives that improve market efficiency by reducing end-users fees and protecting them from MEV arbitrageurs are seen as innovative ideas that deserve 9 figures valuation. Don’t get me wrong, these are cool features that certainly came out of months (or even years) of research work, but perhaps it does not justify the valuation given the underlying business models.

When the price goes down, even the most avid supporters and community members would start questioning how these protocols actually make money, and whether their business models actually make sense. In this write-up, we present some thinking on how crypto protocols can explore ways to sustainably make money. Remember, is it a good product, or is it just a public good?

Here are the quick takeaways:

• Founders need to expand their business acumen and learn about non-crypto businesses.

• Understand which business model is a race to the bottom and which is sustainable in the long term.

• There are hard-to-solve important problems that require deep research work, which might never become good businesses.

• The open-sourced, fork-able, and decentralized nature of crypto makes it challenging to predicate your business model on a mechanism that’s copiable.

• Selling tokens for revenue might be controversial, but it is one of the current working models.

https://pensivepragmatism.substack.com/

Is a Protocol a Business?

First of all, is a protocol a business? — No matter what you think about this (I wrote an entire piece about it), the reality is that these crypto projects have founders and team members that need to pay rent. While VC money might be able to subsidize the lifestyle of a 21-year-old crypto founder that rented out a yacht party as a means of “networking” for a few years, these projects need to eventually make money themselves in order to survive (not even thrive), especially as the macroeconomy enters a period of contraction. And oh, the yacht thing is a true story.

https://twitter.com/KyleSamani/status/1549611730195529728

I have long touted that the notion of decentralization and the need to generate revenue are somewhat on the opposite spectrum of each other. It is not easy to maintain a good level of decentralization while also operating in an effective manner to maximize profit. The argument usually falls back to the decentralization ethos and doesn’t actually make a lot of business sense, especially if you decentralize way too early in the process. A much more mature protocol/network can certainly do so once it achieves a certain level of adoption — hitting the right balance between knowing when to pivot to a more decentralized structure and when to maximize for growth is critical.

https://twitter.com/ManoppoMarco/status/1551862056194015233

Growing Your Business Acumen

People on Twitter like to mock management consultants such as McKinsey because they charge an exorbitant amount of money to write reports and recommend strategies without taking any real accountabilities. While it might be true that consultants are not the best operators, these folks generally have good business acumen by learning about multiple different industries during their tenure.

The number one piece of advice (if I even deserve to give one in the first place), that I would give to aspiring crypto founders is to learn how non-crypto businesses work.

Highly educated individuals in developed countries often focus on service-first businesses, whether that be financial markets, consultancy, or software. In emerging markets, your misinformed old-school Asian parents would say that these are not “real” businesses because you can’t directly touch the goods you’re selling.

Snarkiness aside, the point is: crypto founders need to think more about how what they’re building will make money — unless you’re aware that you’re working for the betterment of the technology, or you’re savvy enough to convince VC to pay your rent while you satisfy your intellectual cravings.

There are, of course, hard-to-solve important problems in crypto that require deep research work. However, when you’re raising capital to solve these problems, there better be a path to profitability. This is admittedly more difficult in web 3.0 because the majority of protocols are open-sourced and forkable, removing the IP defensibility moat that most web 2.0 startups have. Founders are also at risk of experienced operators coming into the space with large fundings, and vertically integrating into the business that you’re building; remember Apple entering BNPL? — to make matter worse, there’s no anti-monopoly law in the blockchain realm.

Alas, all of the above resulted in a natural progression whereby we need to continuously experiment with new business models that will work for crypto. As a result, the majority of successful crypto firms that we’ve seen out there are marketplaces. These firms are selling shovels during a gold rush.

Rent-Seeking Business Model

Oh, the irony. Crypto is supposed to be the new innovative technology that removes centralization, gives power back to the people, and creates a more equitable playing field for all parties involved. But at the same time, the largest and most successful companies are exchanges/marketplaces which are successful because they implement rent-seeking business models. CEXs, DEXs, and NFT marketplaces are the juggernauts of the space, which rightfully prompted critiques to argue that crypto’s entire use case is predicated on speculation.

One quick note. We’re not discussing Bitcoin and Layer 1 assets in this context because those are either digital currencies or blockchain networks, which require an entirely different framework of thinking — which also does not necessarily constitute a business model. Bitcoin’s “business model” is its narrative as a replacement for gold. L1 assets “business model” is gas fees and adoption.

• Out of the 20 protocols listed above, 9 are considered marketplaces, and 7 are considered partially.

• Excluding Ethereum, the majority of protocols revenue generated in the past year is coming from protocols with rent-seeking business models.

We get your point, so what are other ways we can start exploring new crypto business models?

Recurring Revenues

A recurring revenue model is one of the greatest business valuation multipliers for publicly traded equities in the past five years. Companies whose source of cash flow is primarily based on subscriptions not only create a more sustainable consumer cohort but also have a much more predictable future cash flow. This instills confidence in the investor class and builds long-term relationships with end consumers.

Let’s take a look at a few examples:

1. Amazon Prime

   82% of US households have an Amazon Prime membership. As a result, Amazon can vertically integrate and be the dominant entity within these households. This ranges from Alexa smart speakers to Ring smart home tech, and now even One Medical. The firm has practically become the go-to marketplace for everything that you might need in your daily life.

   Imagine you’re having a mild stroke (morbid, I know), you call for help via Alexa smart speakers, your Ring smart locks automatically unlock your front door, and a One Medical dispatch person quickly bolted into your house (this service doesn’t exist now, but let’s be creative shall we).

2. Apple One

   825 million subscribers as of Q2 2022. That is $100B+. The world’s most affluent economic class is willing to pay a hundred billion dollars for a phone with a margin premium that’s equivalent to luxury brands.

However, the recurring revenue model has largely not been implemented in the crypto space due to technical limitations and the lack of product variety since the majority of profitable crypto companies are making money via marketplace-related fees, which is not necessarily fitting for a subscription model. Robinhood has tried with Robinhood Gold and Coinbase is currently trying with Coinbase One beta, but both are seeing lackluster responses from consumers.

That said, the building blocks are starting to emerge, and we are seeing more projects tackling different problems that will eventually enable a more seamless programmable cash flow, including subscriptions. Combined together, we can see how the following stacks will eventually give birth to killer decentralized applications that can integrate a subscription-based business model.

• Sablier and Superfluid enable crypto payment streams.

• Aave introduces Lens protocol, a decentralized social media stack.

• Ethereum Naming Service provides clarity on web 3.0 identity.

• Mirror introduces a web 3.0 subscriptions and notification system.

• Web 3.0 messaging is being built.

Selling Tokens for Revenue

Just typing that headline title alone feels like a cardinal sin in the crypto space. The industry is extremely sensitive toward terms that might accidentally classify tokens as equities. That said, selling tokens and booking them as revenue for operational expenses is not that uncommon in the space. In fact, what used to be one of the top 3 largest crypto assets by market cap, XRP, has done this multiple times.

Fast forward to 2022, the model has shifted. A “sponsor” company built the protocol and owns a percentage of the token supply. With a proper design, the tokenomics of said protocol actually accrues value back to the token holders (usually some sort of fee-sharing mechanism), generating revenue for the protocol and the company in the process. The company then sells those tokens as revenues to continue its operation. With time and proper adoption, you can then sprinkle in spices of complexities by implementing a governance process or even a full-fledged DAO to manage the treasuries (and revenue) of said protocol, which is usually predominantly controlled by the original team members.

I don’t think this model is wrong per se, but it requires a lot of trust from the original team members before the protocol can reach a mature state and have a properly functioning DAO (is there even such a thing? ha. that’s for another post)

What’s the Big Idea?

During a bull market, it’s easy to sell big ideas wrapped in compelling narratives without meticulously considering the sustainability and defensibility of the business model. This happens with web 2.0 tech startups (Uber, anybody?) as well as crypto. In crypto, this can be further obfuscated because of the existence of tokens, which might create a false understanding of the projects’ actual health and money-making capabilities.

This is … a brave take by Tascha, although please give it more thoughts next time.

https://twitter.com/TaschaLabs/status/1551281069202083840

While builders and founders might be working on cool and innovative new technologies, it is important to be aware that crypto is open-sourced and you don’t have any real defensibility in terms of intellectual property. Understanding that first-hand will allow founders to carefully plan their strategy and be more thoughtful of the business that they plan to build. Don’t fall into the trap of building a public good if your goal is to make money.

As an industry, we need to do better and continuously brainstorm new concepts for projects to make money without resorting to predatory pseudo-ponzinomics machinations that depend on attracting new users and dumping them to generate revenue. I don’t claim to have all the answers, but the first step in solving a problem is to admit that there is one.

Shooting Yourself in the Foot

The firm I work for, Digital Asset Research, has entered into a strategic partnership with Cloudwall, the expert at digital asset risk, to offer portfolio risk management resources for institutional clients.

Promotional material aside, my first ever full-time job was at a crypto hedge fund during the last bear market in 2019. Long story short, the fund lost a significant amount of AUM and I knew that I needed to find another job. Ever since then, whenever I got a recruiter’s message about working at a fund, I always ask detailed questions about its AUM and risk management strategy. Experiencing that first-hand as a fresh graduate opened my eye to the importance of risk management and best practices when running a fund. Fast forward to 2022, no one would’ve predicted that 3AC will shoot themselves in the foot. “The essence of investment management is the management of risks, not the management of returns.” - Benjamin Graham

P.S. A few months ago, @thedefiedge reached out to me on Twitter and I’m now a contributor to his newsletter. We’re covering the latest trends, learnings, and frameworks in crypto in under 5 minutes every week.

Until next time,

Marco M.

https://pensivepragmatism.substack.com/p/unsustainable-crypto-business-models

Hi folks,

Welcome to the inaugural issue of Pensive Pragmatism, my blog about crypto, business, markets, and life musings in general. As the name suggests, I aim to provide measured and informational takes on relevant crypto topics, focusing on substance over hype. I’ll also be covering non-crypto topics (occasionally) as I have other interests too, but we’ll save that for later.

For the foreseeable future, the content of this publication will be 90% crypto.

I’ve been wanting to get back into writing long-form rather than a daily issue, especially because crypto topics are becoming too nuanced for a 3-min daily recap.

However, if that’s your cup of tea, kindly head over to my other newsletter, The Wagmi Journal.

The Token Endgame

In the past decade, we’ve witnessed the renaissance of a new asset class: tokens.

Now, whether or not you think there should be a differentiation between tokens, coins, digital assets, cryptocurrencies, etc — frankly, I don’t really care. The work of defining jargon and terminologies belongs to academics, lawyers, and regulators. I will gladly stay in my lane and pontificate on how this new asset class will create value. Alas, let’s get started.

For the rest of this write-up, I’ll refer to tokens as any crypto asset that is secured by a blockchain.

Here are the quick takeaways:

• The endgame for tokens is to become “equity-like”, but with more use-cases.

• Tokens will become the digital-native asset, more seamless and interoperable than all existing asset classes.

• The regulatory environment will catch up to this new reality, but it will take time.

• Values can’t accrue to both tokens & equities effectively.

• The next crypto bull cycle requires tokens to integrate with real economic activities.

What is a token?

The emergence and popularity of digital tokens started approximately a decade ago when Bitcoin showed the world the possibility of having an entirely digital, cryptographically secured, immutable form of money that can be utilized by any party and is free from centralized powers.

Thanks to blockchain technology, for the first time in history, we have a truly digital-native asset that can capitalize on the growth of the internet and transcend geographical borders. From a glance, we can simply see how this will unlock enormous value and enhance the rate of globalization, especially as the global economy became much more intertwined in the past decade.

Fast forward to 2014, Ethereum came to the scene and pioneered the idea of a smart contract. This unlocked the possibility of creating decentralized applications and businesses on the blockchain. Eventually, the discovery of smart contracts becomes the bedrock of what we’re now calling Web 3.0. Additionally, in the past 5 years, particularly since 2017 when crypto penetrated mainstream awareness for the first time, innovations surrounding the use-cases of tokens have been evolving at a rapid pace.

However, these innovations still fail to address the #1 question that has been haunting the crypto market:

What does my token represent and how does it accrue value?

In this write-up, we present mental models and ideas to help existing projects, builders, and other industry participants think about the future of tokens and create the appropriate framework suited for their business model.

To properly follow along with this write-up, we first need to understand the various types of tokens that have emerged in the past decade, and how they are shaping the current crypto space.

Digital Currency

As the name suggests, a digital currency aims to become a form of money on the internet that people can use to transact with one another. It does not have any other features such as smart contracts functionality, nor does it represent any use-cases tied to a particular project.

While Bitcoin started as a “peer-to-peer electronic cash system”, its current form and narrative are nowhere near what the original whitepaper described. Don’t worry, I’m not in the cult of Roger Ver.

There are initiatives to make Bitcoin more useful via projects such as Lightning Network and Stacks, which will make it so much more than just a digital currency. At the same time, the primary investment narrative being conveyed is to treat BTC like digital gold, with proponents saying that it should go up in value over time thanks to its embedded scarcity.

Network/L1 Tokens

Ethereum pioneered the idea of using blockchain technology to write smart contracts, enabling the creation of decentralized applications. This unlocks an entirely new type of token that is used to power blockchain “networks”, often dubbed as “Layer 1 (L1) token”. L1 tokens are used to secure the underlying blockchain network it lives on, as well as being the de-facto currency that users and developers need to pay with when utilizing the blockchain and decentralized applications built on top of it.

For example, ETH is required as payment when one transfers tokens via the Ethereum blockchain. Likewise, ETH is also needed when developers or users interact with decentralized applications and execute smart contracts on the Ethereum blockchain.

Utility Tokens

As L1 tokens mature and multiple blockchain networks with smart contract capability emerge, the number of developers who are interested in building applications on top of these networks also increases. In 2017, we saw many projects raising funds via Initial Coin Offerings (ICOs) to build their own blockchain suited for specific use-cases. These ideas were often big and broad but without any detailed explanation of what sort of problems they are actually trying to solve. Sales pitches such as “the Ethereum of China”, and “blockchain for global supply chains” were being thrown around as people realized that it was extremely easy to raise capital via ICO. Alas, crypto projects circa the 2017 ICO boom era were often criticized for trying to find problems for an existing solution.

What came after was, unsurprisingly, a spectacular crash with ICO tokens falling 99% and hard-swept regulatory enforcement from agencies around the world, causing founders to be wary of raising capital via ICO. The outcome of this then contributed to the rise of crypto VCs, but that’s a post for another time.

However, during this era, we also witnessed the rise of utility tokens. Projects that brilliantly imbue utility to their tokens without building their own chains such as Basic Attention Token (BAT) and Binance Coin (BNB) saw some form of success and started the era of utility tokens — what is also often called as “application layer” projects.

Governance Tokens

Fast forward to 2020, application layer projects found product-market fit and massive success via Decentralized Finance. The DeFi 1.0 generation projects such as MKR, UNI, AAVE, COMP, and SNX were not building their own blockchain, but instead, were building decentralized financial services on top of the Ethereum blockchain and issuing their own tokens for multiple reasons and with multiple use-cases.

While these use-cases vary, the common thread that emerges post the DeFi summer of 2020 is the notion of governance token. Owners of these tokens can submit and vote on proposals that can dictate the future of the projects, such as changing the fees charged by the services, or using the projects’ revenue to buy back tokens from the open market. Granted, the degree of governance power imbued to token holders also varies amongst projects — but for the first time in crypto history, token holders have rights that are quite similar to equity shareholders.

However, the concept of governance token doesn’t seem to be enough.

“but much governance token”

Perhaps you’re familiar with the saying above that mocks governance token value, which was arguably made famous by DegenSpartan. In retrospect, the hentai enjoyer had more insights than most crypto fund managers and tweeted actionable insights for market participants.

https://twitter.com/DegenSpartan/status/1512975937218150401

The chart below shows that despite Uniswap’s increasing revenue and user base, the price of UNI tokens does not reflect the growth at all. The Uniswap team had long touted that the fee switch, which will distribute part of the trading fee revenue to UNI token holders, will eventually be turned on. Expect to keep on waiting for any value to be accrued back to the UNI token as most of the Uniswap team resides in the US and the SEC is undergoing an investigation of Uniswap Labs.

https://twitter.com/degenspartan/status/1457744523249946624?s=21&t=8GTZ0xBSI_anMH4hfkB6ww

But wait, these governance tokens’ price action is even worse when they are not Uniswap, the de-facto largest decentralized exchange in the crypto market with defendable moats such as first-mover advantage and proper security track records. Application layer projects who raised money without properly thinking about the defensibility of the use-cases of their tokens and simply relying on “governance power” suffered the most, especially altcoins raised on alternative L1 chains.

https://twitter.com/hsakatrades/status/1479128272348717057?s=21&t=8GTZ0xBSI_anMH4hfkB6ww

A few weeks ago, a Blockworks podcast episode piqued my interest as Richard Craib, the founder of the crypto project and quantitative hedge fund Numerai, explicitly stated (23:00 - 25:30) that what if we live in a world where the regulators allow us to raise capital via ICO and simply state that “yes, we’re raising this $ for a business”. Unfortunately, that would mean that it is a security, and the government would much rather let us raise capital for an art project or a weird governance token. To me, this candid take was incredibly refreshing, especially coming from someone who has been in the crypto space for quite some time and has a good understanding of both the tech and finance side of things.

okay, so we have established that having governance power is not enough, then how about all the x-to-earn models?

Ride-to-Earn (R2E)

Uber and other ride-hailing firms subsidized ride costs in their early days by providing cheap rides at the expense of venture capital dollars to acquire users. This growth hacking strategy worked and has since been copied by many tech firms, hoping that the products combined with cheap costs will create a network effect and retain users when they eventually discover ways to be profitable.

Now imagine if instead of giving cheaper rides, Uber gave out tokens to its early adopters, enabling them to become part of the community and get rewards for being active consumers of said product. For every ride that you order and for every ride that you pick (as drivers), you will receive rewards in UBER tokens.

It is safe to say that the majority of end-users, including the earliest adopters, will dump UBER tokens for cash unless there is a reason to hold them. In crypto, this usually means that the price of a token will be sacrificed, at least in the short term, to help bootstrap the project’s user base and achieve growth (DEX liquidity mining pool2).

It is also safe to assume that opportunistic actors will try to game the reward system and suck out as much short-term profit as possible. Granted, if the product is actually good, users will still stay (e.g. STEPN has more stickiness vs Axie Infinity), but this means that projects need to be able to balance their growth hacking strategies with good products and sustainable token distribution.

Oftentimes, projects try to achieve this balance by obfuscating the true use-cases of their tokens or creating a use-case to artificially delay the selling pressure instead of improving on their products or simply turning on value accrual mechanisms.

https://twitter.com/jonwu_/status/1539259240958906369

Even then, this doesn’t address the question: who will be eligible for the cash flow?

Can I submit a proposal to the Uber governance forum and turn on the fee switch so that UBER token holders get a part of the revenue?

Maybe — but if that’s the case, then what is the Uber equity used for?

If UBER token holders receive cash flows and have the power to govern the future of the business, then it should just be a tokenized Uber equity with more utilities, or else one of the assets is going to be rendered worthless.

Also, focusing too much on growth hacking instead of the product tends to produce unsustainable gamification mechanics or worse, ponzinomics — but that’s for a different post.

The Token Endgame is: Tokenized Equity

Surprise surprise.

Like it or not, for application player projects, even if one is chain-agnostic, the endgame is to make your token as equity-like as possible. I don’t believe that value can accrue to both equity and tokens if both exist. This might be temporarily possible in an UpOnly environment, but when shits hit the fan, the tokens will be discarded first.

Some might argue that accruing value to both is possible if the tokens have proper “value accrual mechanics” — fancy-schmancy words, but all of the mechanics that might make your token have values will make it “equity-like” or render the equity useless. At that point, for god sake just pick one and decide.

So the next time you look at a project, ask yourself: do I actually “own” the project and the cash flow/governance associated with it, or am I simply a side piece.

Fortunately, some protocols are leaning more and more towards this direction whereby all value accrual is going to the token holders. But of course, they have to be careful in describing said mechanics to make sure that their tokens are not deemed as securities. Not. A. Dividend.

https://twitter.com/unchained_pod/status/1536528461937799168?s=21&t=8GTZ0xBSI_anMH4hfkB6ww

This is primarily the regulators’ fault. For the first time, crypto opened up a way to organize capital and run organizations in a truly global and decentralized manner. Not adapting to new technologies or trying to implement archaic laws will impede the growth of the space and cause mispricing in the crypto market.

I am, however, still positive that the regulatory frameworks will eventually catch up and be on the side of innovators. It might not start with the developed countries due to their self-interests, but we’ll eventually get there.

So What’s The Conclusion?

I’m no securities or legal expert but web 3.0 founders need to balance:

1. how “equity-like” their token is while making sure it’s useful

2. where to market & sell their token

3. create a truly remarkable product that people love even without the token

The token is not the product, but it needs to enhance the product.

Unfortunately, achieving decentralization via token is one of the easiest ways to claim that you’ve enhanced the product, but properly doing so might make your token too “equity-like”. So your best bet is most likely to target Emerging Markets where the laws might be more friendly and raise the majority of your capital from accredited investors and HNWs.

https://twitter.com/spencernoon/status/1536792774921572361?s=21&t=8GTZ0xBSI_anMH4hfkB6ww

This also means that the true level of decentralization and incentives of a project will be tested. I’m a believer that it is not only about code, tech, or governance (such as who are multi-sig holders), but true decentralization also means who are the penultimate owners of the project and the recipient of the cash flow.

If I own 10% of Apple stock, even if the stock goes down by 50%, that still means that I own 10% of the company and everything that’s associated with that ownership. If I own 10% of UNI total supply, and the token goes down by 50%, what do I actually own…? (For now, it’s the promise of a future value).

Until owning a token becomes as simple as owning Apple, we have a long way to go.

Letting Go of Control

This past week, I caught Covid. I’ve been avoiding it like a ninja for the past two years but it eventually got a hold of me. I didn’t feel too much pain, but it still wasn’t enjoyable. As I was laying on my bed, I opened TikTok in an effort to stay relevant with the GenZ when I came across a beautiful post in which a guy responded to the question: “When have you felt your weakest?” with “when I started taking my current relationship seriously; if you’re trying to build something with another person, you need to drop the belief that you have full control over everything”. Crypto people are some of the most driven, hardworking, and ambitious cohorts that I’ve ever met. Oftentimes, these traits tie closely with having the belief that you have total control in life.

To foster my most meaningful relationships, I’m learning to let go of control.

Until next time,

Marco M.