Bitfinex is still being hesitant to hand over documents to the NYAG. They have struggled to get access to documents relating to the transfer from Tether to Bitfinex, and this suggests to me that either the documents don’t exist or there is a very good reason they are not being shared.
Shortly after this we learn very interesting things, Tether’s lawyer admits to Tether investing in Bitcoin:
Luckily we have a sharp judge here who quickly gets to the meet of the issue and correctly points out that this seems contrary to the nature of a “Stablecoin”.
The Tether lawyer responds by confirming what we all suspected since the ToS change is that other assets includes cryptocurrencies:
The Tether lawyer then continues basically saying they will not produce documents and will instead appeal and challenge every single step of the way:
The Tether lawyer then also says that they do not think there is any amount of dollars they need to keep in reserve:
The Tether lawyer then takes the classic Tether defender tactic of it’s okay because banks do it too:
The judge quickly ascertains the issue with this and points out that this effectively means there is no reserves:
The Tether lawyer responds by saying it’s okay, if they need to they’ll earn money some other way, pay it back, and just delay redemptions:
A little further down the NYAG reveals that Bitfinex/Tether executives get lump sum payouts from the unsegregated Tether accounts where no reserves have to be kept:
The NYAG also reveals the juicy tidbit that the largest redemption ever was less than $25 million:
Now relevant to this entire document is the issue of disclosure. Tether claims that they are not in the wrong because once they started using other assets they disclosed it. However, is that true? I will contend it is not. Let us consider Tether’s own website: https://web.archive.org/web/20150521003646/https://tether.to/faqs/
In 2015 Tether openly admits to exchanging Bitcoins for Tethers without KYC. Now it is possible, but in my opinion unlikely that they still had sufficient fiat reserves at that point, but I think it is plausible to doubt that and to believe that Bitcoins have often been a part of the backing.
In conclusion: Tether has paid executives dividends out of non-segregated accounts, does not feel a need to keep cash reserves, is buying bitcoins with reserves, and cannot handle a rush to redeem. Their largest claimed transaction is also smaller than multiple apparent redemptions on the blockchain.
There was a recent comment by Joseph Stiglitz in which he expressed his desire to “shut down the cryptocurrencies”. This prompted me to seriously consider how one would go about shutting down or seriously damaging Bitcoin. This is not an easy problem because Bitcoin is designed to be a remarkably resilient system, however, I do think with coordinated international action a significant amount of damage could be done. My proposed plan relies partially on how Bitcoin does difficulty adjustments.
Every 2016 blocks (~2 weeks) the difficulty of Bitcoin mining adjusts so that blocks continue to come approximately every 10 minutes. This is important because the hashrate dedicated to mining Bitcoins has varied significantly over time, and so this helps keep block time relatively stable. However, major swings in hashpower can significantly change the time between blocks.
Furthermore, it is important to remember that Bitcoin mining tends to run with a pretty narrow profit margin, and as such major swings in price can significantly affect the profitability of miners on the network.
So knowing these things, how do we attack Bitcoin? Step 1 is to start buying up old mining hardware. Because mining demands a high level of efficiency to be profitable old generations of miners are rapidly abandoned as miners with access to more efficient technology can reap larger rewards. However, if you do not care about profitability you can acquire these miners. Now make sure you keep them off the network, you do not want people to know that you are acquiring hashpower as it would cause suspicion. Right after a difficulty adjust bring all of your hash online and wait until the next difficulty adjustment.
The next step is to try to negatively affect the price as much as possible in as short of a time as possible. These steps need to occur right after the difficulty adjustment after you brought your hash online. You will accomplish this price with drop with two primary techniques. The first, as a major state level actor you have seized and safeguarded Bitcoin and other cryptocurrencies in the normal course of law enforcement actions. You will now sell it all, or as much of it as humanly possible. Instead of trying to maximize your potential monetary gains from these sales you will instead try to sell them on the lowest liquidity places you can access, with the goal of throwing off indices and inciting further selling from major holders. While you are doing this you will simultaneously try to pull a major source of liquidity from the market. If there exists for example a poorly regulated exchange and stablecoin who combine for a significant portion of the liquidity in the market you will seize them right as you begin to sell. Allow as many people as possible to stampede for the exits.
Now we must do everything we can to reduce hashpower on the network. Turn off all of the hashpower you brought onto the network, and simultaneously coordinate with China to convince them to cutoff as many of their miners as possible. Seize any mining hardware you reasonably can and keep it off the network for now. This drop in hashpower, combined with a major drop in price will cause many previous profitable miners to now be mining at a loss. Many will choose to turn off their machines rather than lose money continuing to mine. The lower the hashrate goes here the less usable the network is. Block times will lengthen and people will grow increasingly frustrated and apt to sell, perpetuating the cycle. Whenever anyone sells mining hardware buy it.
Now you wait for the next difficulty adjustment. This will take longer than it normally will because the time between bloks has vastly increased. However, Bitcoin is a stubborn beast and there are likely some people who have isolated themselves reasonably well from state intervention and will mine to keep it alive. Once the difficulty adjusts again, you will again deploy your hash which should now be even more. If you control the majority of hash you will mine empty blocks making the network entirely useful. The only transactions you will allow through are those meant to help you sell your block rewards. You will sell your entire block rewards with the goal of continuing to push the price even lower.
If you do not control the majority of hash, but do control >25% you will selfish mine and continue to try to identify other miners on the network and seize their hardware.
Regardless of whether or not you are controlling the majority of the hash the next difficulty adjustment should come quick, in less than two weeks. Again you will withdraw your hash and let block times lengthen, but now transactions will be going through, giving desperate people a chance to sell.
Lather, rinse, and repeat. Eventually you will control the majority of hashpower and once this happens you will force the community to make incredibly tough decisions. These could include changing the hashing algorithm or changing how difficulty adjustments work. These decisions are likely to be contentious and will therefore further fragment the community. If these contentious issues result in forks you will see people on each side of the fork trying to dump the other side of the fork, further depressing the price. Even if some vague semblance of a Bitcoin is left standing after this attack it will be a shell of its former self and you will have demonstrated to people that it is more vulnerable than they have ever believed. Enjoy your continued monopoly on money printing.
Many Bitcoin proponents, chief among them Nick Szabo, laud Bitcoin for its social scalability. In order to discuss this issue fairly we must first define social scalability. In the famous blogpost where it was first used, Szabo defines it as:
“Social scalability is the ability of an institution –- a relationship or shared endeavor, in which multiple people repeatedly participate, and featuring customs, rules, or other features which constrain or motivate participants’ behaviors — to overcome shortcomings in human minds and in the motivating or constraining aspects of said institution that limit who or how many can successfully participate. Social scalability is about the ways and extents to which participants can think about and respond to institutions and fellow participants as the variety and numbers of participants in those institutions or relationships grow. It’s about human limitations, not about technological limitations or physical resource constraints.” (http://unenumerated.blogspot.com/2017/02/money-blockchains-and-social-scalability.html)
First, I must acknowledge that there are significant benefits to Bitcoin’s design that enable social scalability. Among these are the expense required to censor a transaction, the prevention of double spend without a centralized entity, and the issuance of rewards without a central entity. Each of these has contributed significantly to the success of Bitcoin and are what make it such a compelling piece of technology to me. However, certain design decisions have created a significant and hard to rectify argument surface that may limit future growth. The most important of these, in my opinion, is the choice of a finite, hard cap.
Challenging this hard cap is challenging many of the fundamental ideas held by Bitcoiners and as such I’ll belabor certain points in order to ensure they’re addressed thoroughly. First of all there is a conception among Bitcoiner’s that inflation is inevitable in our modern fiat system, and that this inflation will be bad either for them individually, or for society as a whole. I am willing to concede among these points that inflation may sometimes be bad for the individual, however I contend it is often still a net-positive. Furthermore, I want to challenge the assumption that a finite supply is useful in reducing argument surface.
As Bitcoin’s are lost to theft, technical mistakes, and deaths the supply will continue to contract as Bitcoin becomes a deflationary currency.. For existing holders this seems to be a positive thing. The more the supply contracts the greater proportion of the total value their investment represents. However, it may still be a net negative if it places an upper bound on total value of Bitcoin. Furthermore, it is valuable to realize that, due to the emission schedule of Bitcoin, a large number of Bitcoins are held by a small number of people. I will not attempt to estimate exactly how many, because it is beyond the scope of this article, but I would estimate 0.01% of the world’s population possess at least half of the Bitcoins that will ever exist (it is likely much less, for statistics go here: https://bitinfocharts.com/top-100-richest-bitcoin-addresses.html). This is an intense concentration of wealth, and as the price of a Bitcoin measured in fiat goes up you will expect significant wealth to accrue to these holders.
This natural enrichment of early holders could be considered fair for them shouldering the lion’s share of the initial risk, and believing in a nascent technology before there was significant evidence it would survive. However, the truth of the matter is that having such disproportionately large early holders makes it harder to convince people to buy in, because the primary benefit to their investment is enrichment of the early investors. Now, the response here would be that these people are still incentivized to buy in, as they will end up capturing a larger share than the later holders, however, a structure depending on convincing people to enrich early holders at the expense of later investors is a structure that has made many people at the top quite wealthy. Even now while we are still relatively early in the long life of Bitcoin, it’s difficult for me to envision mass usage, as most are unwilling to enrich a few solely to gain censorship resistant transactions. However, they may purchase Bitcoin as a speculative asset, but my only response to that is I do not see it as a path to adoption.
Furthermore, with Bitcoin (or any other deflationary currency) widescale adoption would provide the largest holders with an entrenched power base. If it were to become globally accepted in the manner described by the proponents of hyperbitcoinization, then early adopters will obtain incredible wealth, and from that, shocking power. Since they are incentivized to hold that wealth and not to spend or deploy it, the wealth changes hands infrequently. This appears to predispose Bitcoin to create an entrenched oligarchic system.
Next, it’s pertinent to consider the value of inflation. Important to this conception is the idea of a risk curve. The risk curve, which can be gracelessly summed up as a comparison between two assets showing how the change in risk affects the expected return, is important to understanding the said value of inflation: For example, you may choose to switch your excess money from USD (low risk, negative expected return) to equities (high risk, high positive expected return). The value of maintaining the negative expected return for USD is that it incentivizes greater deployment of capital up the risk curve. Investors are willing to take on risks in order to protect their wealth and ensure returns. This capital allows for the expansion of the total economic pie as businesses grow and create new products, new efficiencies, and new markets. However, deflationary money can seriously mess with this contention. If you have a well-established deflationary money then your money will have (low risk, positive expected return), and as such you have little incentive to deploy it up the risk curve. This may seem to be a relatively small and technical matter but it is a significant matter. Hyperbitcoinization would be destructive for society and would result in a regression of economic games to zero-sum along with establishment of an entrenched oligarchy. This may not prevent adoption, but it may affect the argument surface.
My argument rests on, “a relationship or shared endeavor, in which multiple people repeatedly participate, and featuring customs, rules, or other features which constrain or motivate participants’ behaviors — to overcome shortcomings in human minds and in the motivating or constraining aspects of said institution that limit who or how many can successfully participate.” The hard cap on Bitcoin has created disincentives to cooperative behavior. The reduction to zero-sum or net-negative games makes it such that the nature of every interaction becomes competitive instead of cooperative.
There are a couple potential counter-arguments to my points here.
The first many Bitcoiners/Austrians (big overlap there) will turn to is an effect referred to as the Cantillon effect or the injection effect. I am not a true economist, but it can be summarized as the place where money enters a system, has a significant effect, and is likely to enrich those closest to the injection point. There is little, but not zero, empirical evidence for this in traditional central banking systems, but even if we accept that it is a real effect other features of Bitcoin help minimize it. Consider who is closest to the injection point in Bitcoin: the miners. The miners are required to either exchange it for fiat to pay power bills, or purchase power directly using Bitcoin. This cost to produce helps eliminate the disproportionate wealth effect (if it exists) from monetary injection.
Some, Hasu comes to mind, have advocated that instead of removing the hard cap there could be a requirement to move your coins regularly or they will be ‘reclaimed’. I have always considered this idea seriously problematic because of the implications it has for some of the fundamental tenets of Bitcoin. One of the primary tenets of Bitcoin is that your key gives you, and solely you, control of your Bitcoin, and this invalidates that assumption. For those who keep their coins in cold storage it also represents a (slight) security risk to have to access the coins and move them to a new wallet. Additionally, this could destroy the predictability of mining rewards which may change the incentive structure. It seems to me this would more fundamentally change the protocol and argument structure than simply continual issuance.
The argument that creating a hard cap and creating such a cult around the inflation schedule has reduced the argument surface surrounding Bitcoin and in so doing improved its social scalability. This would fit neatly with Szabo’s definition, as it basically limits the participant’s ability to influence the inflation rate. It also helps with the argument that a cap was necessary in order to achieve any social scaling of Bitcoin, because the early adopters would not have been motivated to use it without that cap. This theory does have significant merit, and is even somewhat compelling to me. However, the fact that we are already having regular conversations about the cap suggests to me that the argument surface has not been maximally minimized.
The final argument I’ll address is that modification of the inflation schedule begets greater modification of the inflation schedule. I may have to concede this argument. It is possible that by deviating from the cap we have created a scenario where people will continually advocate for changes to the inflation schedule, but Bitcoin governance is helpful here. Bitcoin relies on what can be termed fork-based governance in which people have the freedom to run exactly what node implementation they choose, miners choose which chain to mine, and exchanges choose which versions to trade. This means that the only way for this inflation schedule to change is with a very difficult consensus making process, which reduces the likelihood of more than one switch (and makes the one switch I want incredibly difficult).
Fundamentally, Bitcoin does solve several important scaling issues by creating irreversible, censorship resistant transactions without a central party. However, the economic model of Bitcoin limits social scalability and mass adoption. It may also be important for Bitcoiners to realize that they may be potentially limited their returns and adoption due to devotion to this hard cap.
Note: This is an old article being moved over from Medium
After taking a broad look at stablecoins as a whole and then Dai in specific, I decided to keep the momentum going and take a deep look at the Basis Protocol. Same rules as I did for Dai, you guys are coming with me as we go through the whitepaper (I may skip things that are super boring, or I think are meaningless marketing speak). Also, always remember I do not edit, I write in one straight run through, and it is often late at night when I’m writing so my thoughts tend to…meander.
First we’re skipping all the stuff about why they think stability is important, because that is not what we are discussing today. Plus, most of it sounds like marketing speak to my ear. I am pulling out this one phrase though, just because it made me incredibly nervous when I read it for some reason. Mainly because whenever I see algorithm here, I imagine the potential for nefarious actors to manipulate it by exploiting weaknesses in the algorithm, however, I need to judge them on their implementation and not my biases.
This phrase is going to piss off the libertarians and “sound money” fans who love that Bitcoin is fixed, but I have always been nervous that Bitcoin’s deflationary nature represented a potential risk for a small number of oligarchs to end up with a disproportionate amount of wealth. (Apparently I’m okay with pissing people off tonight, sweet this is going to get interesting)
For the record it took until page 8 for them to start discussing how this works, and that upsets me. Way too much marketing speak before this. The next section is all about the quantity theory of money which is basically the ability to inflate or deflate.
Biggest problem I see here is the potential for aggregate demand to be mismeasured by one of the Oracles, or however they determine this.
Okay so here I am going to copy and paste my own previous explanation of these different coins from my stablecoins article.
Base Shares
Base Coins
Base Bonds
The base shares are created in the genesis block and all new base coins go to them as “dividends” (holy shit I hope they spent some of that $100 million on Securities lawyers). The base coins are a separate coin from the shares that is issued to holders of the base shares when the price of the base coin exceeds peg, in theory diluting their value and bringing the value back to peg. Base bonds are issued when the value falls below peg. When this happens you can purchase a Base bond for the current value so say $.80 and then redeem it for $1.
Now where this gets even trickier is when it comes time to issue new coins is that it goes first in, first out. So it goes to the oldest bond holder first, and then continues down the line, and if there are in theory no bond holders then the coins are issued to the share holders.
Now what is the issue with this system? Economics mostly. Let’s start with what is the most obvious to me, my incentive if I am a whale and if this is liquidity is to become a large share holder, and then whenever I get a dividend to immediately sell it, purchase bonds, wait for them to redeem, and then dump again. If the market gets too big for me to do this alone, I do what all the whales are already doing in crypto and organize this process with a few other people.
Printing free money and giving it to crypto-investors who are inclined to hold it and thus restrict supply;
Providing financial incentives to subsequent investors to introduce money into the scheme and subsidize the price of the scheme if the price of a coin should fall below a certain level (say, $1);
Vulnerable to a not-at-all-decentralized reliance on price indicators provided by unsupervised, unregulated third-party trading venues already suspected of serious shenanigans;
Granting primary benefits of the scheme to early buyers in an unregulated ICO;
Where every participant is betting on the price of their assets rising;
Which cannot sustain itself without finding new buyers for $BASE.”
Despite those issues we are going to continue on this whitepaper and make sure there isn’t anything that Preston Byrne and I have missed. (Spoiler alert: I doubt there will be.)
I’m pretty sure the Treasury issues bonds not the Fed right? Am I mistaken?
Okay let’s discuss these mechanisms for a minute. First one is obviously worthless. One glitch in the feed and you could seriously hurt your monetary supply. Toss it. Second one is probably reasonable. However, both the second and the third one are going to run into the problems that the Ethereum DAO and the EOS launch have had. Mainly most people just do not vote. The incentive may help, but it makes this protocol naturally inflationary, which will require the issuing of more bonds, and I worry that the inflation could start to outrun the system.
This claim that it would require 50% of the voting coinbase is an interesting one. Namely because it is important to remember that likely much of the coinbase will not be voting (see Ethereum DAO and EOS). Thus comparing it to Bitcoin where you need objectively 51% of the hashpower to execute a double-spend attack (closer to 33% for a selfish mining attack) is very different than 50% of the voting coinbase which might be closer to 10% of the total supply. Therefore, it is much more vulnerable than they make it seem here. They think that their incentive system will help increase the percentage who are voting, but it is important to remember much of this coin is probably going to be like other stablecoins where it is held at an exchange and used primarily for short-term trading, so I do not buy that
We already discussed this above.
Already discussed this above too.
Well I kinda want that later discussion, this makes me very nervous. Also means there is always going to be a risk that bond holders are taking on, which is different than the risk-less way they pitch it.
Here we go, they are saying basically what I said. Now, there are other existential risks that occur when demand falls like they are worried about here, mainly centered around the “stability fund” they discuss alter in this paper.
I’m just imaging what would happen if the United States Government decided to start just defaulting on their debt. (The answer is the rate at which people would lend them money would skyrocket as their credit rating plummeted, and the USD would likely lose it’s place as global reserve currency, while it inflates in order to try to cover remaining debt) So basically not the analogy you want to evoke.
Intuitively to me it feels like at any point of serious expansion, arising after a long period of stability, it is going to be more beneficial to be a shareholder than a bondholder.
Okay, so contraction is interesting. We’re back to these bonds. My issue with these bonds again, is that you could potentially (though five years is a long time) be left holding a worthless bond. If I am understanding the clearing price part right, they are also basically trying to incentivize bond purchases near the peg, which is actually really clever. I quite like the thought that went into that, because it was initially counterintuitive to me. Basically, you are encouraged to put your order at a high price, because if they need more coins than that, it will actually fill at a lower price than your order, but you are guaranteed to be getting in first. Clever little bit of game theory and incentive setting. Props to the Basis team for that.
Quite frankly, I do not think I am qualified to analyze this part. My one fear is the fitting of GBM parameters to those assets, which generally trend up. I am still worried about potential Black Swan events, but I am not qualified to judge this model setup.
This seems true, if the price is expected to return to peg. Though I am not sure about people taking short positions, because of the cost. There is also the key point here that as long as there is sufficient liquidity, that will come in later when they discuss the “stability fund”.
I just realized they do not discuss their “stability fund” in their whitepaper. In some of their other documents, they say that they will use money raised to provide a stability fund that will provide off chain stability in price. So just like the other stablecoins, they are trading their own coin to maintain the peg. One of the biggest peg breaks for Dai was when their bot doing this trading failed. They also need this to provide the liquidity neccessary for price responsiveness, but in order to maintain the fund they will continually need money coming in. That is….dangerous.
Overall, I would not trust Basis, or any other stablecoin I have analyzed so far. Remember, I wrote this late at night, and in one straight shot without editing, so if you catch any errors please let me know.
Sometimes life has a weird way of working out for me, like I was bored on Twitter looking for something to write about and then suddenly a scam decided to start spamming my mentions. I love when the scammers come to me! Saves me a step in my research process. This is a pretty blatant and awful scam too. So what is the Billion Coins Scam? It is basically a multi-level marketing scam applied to cryptocurrencies. (Note: I will not be linking to their sites in this piece because I do not want to raise their search engine ranking, instead I will embed screenshots.)
So the very first red flag for me was that it required an upfront wallet setup fee. This is very unusual in the cryptocurrency space. Then saw their claims of free transaction fees and I got really suspicious. After you pay this fee you can then be gifted 25,000 Kringles. (Actually cookie rewards but redeemable for Kringles.) Then things get well let’s call it crazy, but honestly that is being too nice.
This is a claim they frequently make, however, their Twitter account decided to contradict them and said this:
This kind of fundamental disagreement always puts me on edge when I am looking for scams.
This is where I get that sinking feeling in my gut that tells me this is without a doubt a scam. This kind of thing has been tried before. Anything that can only go up is without a doubt a scam and you should avoid anyone selling it. Then I kept reading and started to feel very sick to my stomach.
This chart is complicated but let me explain how it works to the best of my ability. This chart is an attempt to incentivize people to evangelize for this project. It dictates the price at which coins can be bought and sold at on any single day. The idea is that increases every single day, and you need to continue to recruit people in order to maximize the growth rate. It also encourages original stakeholders to sell their original tokens in order to “cash in.” This is classic multi-level marketing structure and it tries to avoid any free market input.
Any attempt to sell your tokens for less than the agreed on price and you lose access to your wallet. Any disparaging remarks on social media mean that that you will no longer be able to use your wallet. So what happens when there are no people willing to take anymore tokens at whatever price they end up at? You are left with worthless, illiquid crap, that a centralized authority can freeze at any time. This isn’t just a scam it’s fundamentally antithetical to the point of cryptocurrencies. The fundamental issue with any pyramid scheme is eventually the world runs out of fools.
Even this part confuses me, if they are guaranteed to always increase in value then as a holder I want to be purchasing as many as possible! However, the truth is if you do that they are not pulling in enough of the wallet fees.
Yes you should definitely do this! Sign up babies! Spam your friends! Get everyone involved in your pyramid scheme. Make sure they keep collecting your wallet fees, you are not the one who will end up profiting from this.
Hard for me to imagine why these places would block your email? You are obviously on the up and up. Nothing to see here.
This is not decentralized. We have already established the admin team can censor. They are lying.
Tell me if you think they have made it over 1,000,000,000 users. (Protip: they haven’t and they won’t.)
This video is where they say that people flow is cash flow. This is classic multi level marketing. Stop watching after that it is revolting.
They also cannot even maintain consistency as to at what price this locks in at.
This story starts to go completely off the rails when you follow the connections of Dan Lutz who is closely affiliated with this scam.
So who is Dan Lutz? Well he is a frequent scammer, and in this video where he is interviewed by Tracy Davison and claims to have met M1.
Now who is Tracy Davison and who is M1? Tracy Davison is another known scammer who promoted a Ponzi scam the SEC brought down. And who is M1? Well strap in because things go absolutely insane here.
There is a cult that is led by “M1” called Swissindo who claim to be able to pay off debt thanks to a vast fortune of gold and platinum, and he claims to be the one true world leader, with the blood of every royal family running through him. (Yes it is that crazy.) It’s also a lie that is used to prey on the most societally vulnerable people.
Also piles of gold sound familiar to me, let’s check and see….
There we go, they did claim to me they had a bunch of gold. In my opinion this scam is closely connected to Swissindo and all of these scams are awful because they take advantage of desperate people who feel like they are out of options.
These scams are preying on people, and selling them a dream that they cannot deliver. It is evil to so wantonly attempt to profit off another’s hopes and desperation.
Just know if you are one of the creators or promoters of a scam like this, working to intentionally defraud people I hate you. And if you are a scammer do not be stupid enough to serve yourself up on a silver platter by saying dumb-ass shit to me on Twitter.
Gonna miss out on my abundance for this post guys
h/t to Kyle Gibson for helping with the research for this.
Note: Old article being moved over because I hate Medium
Today I want to take a look at a token project that I stumbled across today. It is called Slidebits. It is an ERC20 that is currently (in theory) accepting “donations” of Ether in exchange for tokens. That is not a joke, they are literally called donations. I’m sure the SEC will be okay with that… If you get exit scammed by a token project telling you your money was a donation you deserve it.
Second red flag? THERE IS NO WHITEPAPER! I never would consider investing a penny in any project without a whitepaper, and this project couldn’t even go the Tron route and hack together a plagiarized one. There is literally zero whitepaper. No way to analyze it, or judge it. Never give any money to a project that will not even describe how it works.
Next red flag? The token creator can freely mint more tokens at any point they want. Here is the code that allows it:
it(‘should have a mint function’, async function() { const txResult = await token.mintToken(tokenBuyer, 100, { from: tokenCreator });
This is also admitted on the website:
Gotta love when people are upfront about their ability to print more at a moment’s notice.
Also there is evidence of sloppy OPSEC. For example it appears the crowdsale wallet was funded by the creators personal wallet because when we click to the funding address through Etherscan we find that they are a big fan of Cryptokitties.
You also need to worry about projects that have been going for several months and seem to have raised no funds. Now the amount a project raises is not a perfect symbol of the quality of a project, but if they have failed to raise even a fraction of an Ether so far it is quite likely that there is something amiss.
Finally, well there is an obvious appeal to crypto tokens that work with an app on something like Apple’s App Store please remember that this is a centralized point of failure. It lacks the essential censorship resistance that crypto was supposed to have been built on.
Oh and look at that, that is exactly what happened, and look at the reasons for that rejection, there is no reason they won’t pull it tomorrow. (In case it gets taken down: http://archive.li/qvdZZ)
I could continue, but I think it is clear to see some of the signs that should ensure you immediately avoid giving up your money. Oh and if you cannot answer in one second the advantage of it being a crypto-token instead of fiat, it’s probably a scam.
Note: This post is out of date but is part of my transition away from Medium.
So today we are going to take a look at some of the Tether drama that has occurred over the last week or so, and it gets interesting fast.
Background: There has been a theory for a while now that Tether has been used to fuel the massive price increase in Bitcoin during 2017.
This was exacerbated by the fact that they did, and still do promise regular audits but have never delivered it. After firing the last auditor they claimed, “Given the excruciatingly detailed procedures Friedman was undertaking for the relatively simple balance sheet of Tether, it became clear that an audit would be unattainable in a reasonable time frame.” I do not know about you, but that sounds to me like the auditors were you know trying to do an audit.
Now as for the price pumping.I was introduced to this theory by Bitfinex’ed and was recently supported by a paper published by a couple of professors that suggested again that Tether’s printing was used to increase demand, and was not created “naturally.” Now there have been some criticisms of this paper, including the fact that their method can only show correlation and not causation, and that it was not peer-reviewed, but it did increase public pressure on Bitfinex and Tether to start clearing the air.
Transparency report: So the law firm of Freeh, Sporkin and Sullivan, LLP has released a report meant to show that Tether actually does have the funds to back the Tether’s currently in circulation. Now this report is interesting for several reasons and I am going to try to highlight them for you, and then I’m going to take you down the rabbit hole. So the report can be read here. It basically attests that on June 1st that the accounts (yes there’s two banks now) had enough to cover the number of Tethers in circulation. However, there are several interesting phrases in here, and one that sends us down the rabbit hole.
Well obviously not great news, but probably not unexpected.
It is obviously not an audit, this one should surprise exactly zero of us.
Here is where they admit that this in no way proves that the Tether was always backed.
Good to know that Tether might still be used for money laundering.
WAIT WHAT?! That’s right, a partner for this law firm is an advisor to this bank. Time to go figure out which bank this is now right? I am not a lawyer, but that feels bad, like it could be a conflict of interest (especially if Tether is one of the only clients for this bank….), and casts doubts over this entire report.
Banking: The question we now had to try to figure out was what bank was Eugene Sullivan advising. Several of us set out to Google and dig and try to find something. I even spent several hours digging through the Panama/Paradise Papers in the hopes that I would find a connection and this continued until @eastmother tweeted at me and said this.
When you check the cached version of this page you can see that Eugene Sullivan was an advisor to Noble Bank in Puerto Rico!
This is valuable for a couple of reasons, first and foremost they deleted this and tried to hide it. Which seems odd. Secondly, it helps confirm the research from BitMex that suggested that Noble Bank in Puerto Rico was the most likely steward of Tether’s funds. BitMex also seems to suggest that Tether may be a significant percentage of the total deposits at this bank, suggesting to me excessive scrutiny into Tether likely does not work well for Noble.
Now, Noble Bank is an interesting entity because it is a full reserve bank. This means that they do not fractional reserve like the majority of banks, and they actually keep the cash on hand that they claim. So if your account says $1,000,000 then they have that $1,000,000 in their vault. These kinds of banks often do not offer interest rates, because they cannot afford to. They are not lending the money out and so cannot earn the money from loan interest. Several people have tried to contact Noble and have not been able to get an answer as to what interest rates may be offered. This leads us directly into the next part of the problem.
Business Model/Profit Model: So now we need to try and figure out how Tether could be making money. In their whitepaper they say that the way that they make money is by interest on their bank accounts and by charging a ten basis points fee on transfers to customers (of whom Bitfinex is their sole customer). So if we assume that a significant portion of their assets are being held at Noble Bank, which being a full reserve is likely unable to offer interest, then the only interest they could possibly be getting is from their second bank and from the ten basis points fee. This leads us to two issues. One the ten basis point fee by itself is almost definitely not enough for them to be profitable. So the question then becomes who is their second bank and could they be offering enough interest for Tether to be profitable. If we assume that the larger amount from the two accounts is held at Noble, then the only part earning interest is about $600 million.
Even at about 2% per year that works out to about $1 million dollars a month. It feels as though that would likely be insufficient for Tether considering the size of the operation, but I could be mistaken. However, it is important to remember that Tether is still a business that needs a way to be bringing in money, and so paying attention to this mechanism could be important.
The Brock Pierce Connection:
Now we start to flirt with where this all gets really crazy. Brock Pierce is one of those characters who tends to pop up in weird places and doing weird things in Crypto. He was one of the founder of Tether, though has since (according to him) sold his position in it. He is also the cofounder of Noble Markets which controls Noble International the bank. So one of the founders of Tether, is also a founder of the bank they use, which has an advisor who is also one of the lawyers who issued this memorandum. What we are seeing here is in my opinion serious conflicts of interest that force us to seriously question the nature of all of the relationships in play here. Also in general Brock Pierce has a history of being evasive about his relationship with various entities.
Plus, the more you look into Brock Pierce, the more you recognize how he represents much of the worst of the cryptocurrency space. In March he was interviewed and had this great little nugget to share with the world, ““I don’t care about money, if I need money, I just make a token.” Remember, this is the founder of Tether, and the man currently making sure they have banking. Let’s hope he didn’t need money when he made Tether huh?
The MTGOX Connection: This web of connections gets even weirder when we start looking even further into a very weird part of this story. Namely, these same players are connected to MTGOX. So after the whole MTGOX debacle there were several different players who were looking to be the ones who determined the best way to rehabilitate those were injured in the hack. It turns out that there was a group called Sunlot Holdings who proposed a rehabilitation plan. Both Brock Pierce and John Betts were partners at Sunlot Holdings, and John Betts is now a Founder and CEO of Noble Markets who controls the bank Noble International. Furthermore, Sunlot Holdings was advised by Louis Freeh, one of the cofounders of Freeh, Sporkin and Sullivan LLP the law firm that did the report. None of this is criminal, but it suggests that these players have an entangled and complicated relationship stretching back at least until 2014. The more entangled the relationships the more we have to worry that there is a shared incentive to ensure that Tether survives.
The Whole Web of Connections:
This whole web of connections was recently summarized in this image here. As you can see by how entangled all of these people are it becomes very dangerous to trust the word of FSS as to whether or not Tether is in any form usable.
The Imperial Pacific Connection: While researching Freeh, Sporkin, and Sullivan; specifically the fact that Sullivan was claimed in the report to be an advisor, I, along with others, found that he was connected to a casino called Imperial Pacific. He was part of their advisory board until recently. The reason this is interesting? Imperial Pacific has been dinged for money laundering and human trafficking along with general corruption. Freeh also used to be associated with this very same casino. This starts to paint a disturbing image of who these men are willing to be associated with.
Other FFS Shadiness: This law firm actually has quite a few unsavory connections like this. Eugene Sullivan has previously been dinged for trying to use his former position as a judge to profit. They have also defended Ukranian Oligarchs. There have also been criticisms of Freeh’s tenure as FBI director, including how he had handled the critically important Penn State case.
Phil Potter Leaves: Now as the waters start to get really murky and the pressure on everyone seems to be reaching a fever point, Phil Potter the Chief Strategy Officer of Bitfinex departs. The timing of this is very poor for Bitfinex and Tether as public pressure increases on them. He also claims that he is doing this because Tether is focusing less and less on the US, but to my eye, there banking and the majority of their volume is still in the United States, and so that excuse does not pass muster. Furthermore, we do know that the Fed’s were looking into Bitfinex and Tether and it is possible that he may have flipped to protect himself. Finally the most recent dump started shortly before the news of his departure became public, and as such we do need to wonder whether or not there were people trading on this insider information. Just to be clear I have no strong evidence for either of these claims, but the timing is quite odd.
Weird Connections from Noble: Now we are going to temporarily back to Noble, because there are some weird connections that I cannot fully explain.
I got another tip on Twitter:
that there have been some….interesting websites associated with the same Google Analytics ID as Noble. Including….Blockchain Capital! The venture capital fund that Brock Pierce used to be a part of! Isn’t it fun when little things like that work out? Also a bunch of other “blockchain” focused websites including: Blockchain Alliance, bloq, Chicago Blockchain Center, the Chamber of Digital Commerce, Dunvegan Space Systems (blockchain in space), Silk Road Equity. Now just to note, I do not neccesarily think all of these are connected, because there were also a couple of design sites for something called Neu Entity and so it is possible that is why these are shared. However, it is funny to see Blockchain Capital which is another of Brock’s babies coming up in here.
Other Recent Weird Happenings: So one of the last really weird things that has happened, was a weird transaction of Tethers. Namely there have been some “send-all” transactions which are quite uncommon, and sent primarily to wallets that are “back and forth” meaning they receive it from Bitfinex and then send it back and that’s it. These have happened before, but no one knows why.
Claim that Audit is Impossible: This is my favorite claim that Bitfinex makes. They try to claim that it is impossible for them to get an audit. First and foremost it is important to remember that back in 2017 they had someone who agreed to audit them, and they fired them because, “Given the excruciatingly detailed procedures Friedman was undertaking for the relatively simple balance sheet of Tether, it became clear that an audit would be unattainable in a reasonable time frame.” They fired their auditor being thorough….
Best part of this claim is that True USD, which is an incredibly similar stablecoin (with fewer, but not zero problems), gets regular attestations by an actual accounting firm. So apparently their claim that it is impossible, not just for them, but for anyone is false. (Important note, these attestations are only done once a month, and it would technically be possible to game them, but it is still better having an actual accounting firm do it, and having them do it every month.)
Conclusion: In conclusion, Tether and Bitfinex cannot be trusted. Their transparency report has actually helped expose how deep some of their entangled relationships go, and I am now more scared than ever for the cryptocurrency market. Brock Pierce is likely still materially involved in Tether, and is working with them to help maintain banking through his own bank, and even the lawyers have worked extensively with him before. Phil Potter was the first executive to leave, but he will not be the last. I would expect Giancarlo to be next, and when he does leave, I would recommend (not financial advice) to stand clear of the house of cards that is the cryptocurrency market.
So I recently did a pretty broad breakdown of stablecoins. When I was going back over it, I realized that I wanted to dive really deep into some of these and so I am going to start with Dai, and I am going to do it by going step by step through their whitepaper and giving my thoughts and potential problems with it.
First of all what is MakerDAO: it is the “Decentralized Autonomous Organization” that governs DAI.
What is DAI?: It is a soft pegged stablecoin.
What is a soft-pegged stable coin?: It is supposed to be near a certain value, but is allowed a degree of flexibility.
What is MKR?: MKR is a separate token used in the DAO to govern Dai and also to pay the “stability fee” which is the annual fee you pay to get your Dai.
Okay so that’s a lot of moving pieces, and as I have already discussed in my previous article there are issues in general with the concept of stablecoins. But without further ado let’s take a look at this whitepaper and see if there are any issues.
Okay, I can buy this so far, that’s a very fair opening argument.
Okay now we are starting to get into problems. It is going to be really hard for any collateral-backed cryptocurrency to keep a stable value relative to the US Dollar, unless the collateral backing it is the US Dollar. Otherwise we are going to be vulnerable to changes in the value of our collateral that are not reflected in changes in the value of the dollar. Also they never explain why it is necessary to realize the full potential of blockchain, but ignoring the grandiose marketing speak masquerading as technical language, we soldier on.
The issue here is appropriately incentivizing external actors. Namely it’s a really hard thing to do without accidentally introducing perverse incentives, but maybe they were able to do it.
First question, why would any in their right mind hold it for savings? Either directly hold your collateral or hold fiat. That is not a use case for a stablecoin. Also here we are bumping against an issue both I and the developers have acknowledged, we are not collateralizing with USD, but instead with Ethereum, and as the developers explained Ethereum is too volatile to be used as a currency, which means for this to work we are going to need to over-collateralize. Meaning if you want say $100 worth of Dai you will need to put up significantly more than $100 worth of Ether. Which makes it hard for me to figure out why someone is going to choose to do this.
So here we see where they say you need to have more collateral than Dai. They also say that you need to pay back an equivalent amount of Dai, and that is true, but what they have not explained yet is that you also need to pay a stability fee in MKR, their other token. Also they cannot always be collateralized in excess, because if there is a black swan event that destroys the value of Ethereum that is no longer true.
Here we finally get the mention of the “Stability Fee” which has to be paid in their MKR token.
It’s been six months and they still have not launched Multi-Collateral Dai, but they do still have time so that is not a true criticism.
This is my favorite part of the entire whitepaper. So I have mentioned how even with the overcollateralization this is still very vulnerable to a black swan event that destroys the value of Ethereum. This part is where they say they in the event of this crash they will dilute the “Pooled Ether” which means that when you go to reclaim your Ether you will not even be receiving the full Ether you put in (if I’m understanding this right). Why someone would trust this, I do not know. The developers are obviously aware of this risk, but it seems to be ignored.
This is where we start to look at their incentives to determine whether they designed intelligently. These are just definitions so do not help us a ton. Just a warning this next part they try to obscure what they are doing with really technical language, but I am going to do my best to break it down.
So best as I can understand this section, when Dai falls below $1 what happens is that generation of new Dais becomes more expensive, meaning require greater collateral. They hope this restriction on new supply and the knowledge that presumably this should be worth about $1 means that there will also be increased demand below this point. Then when it breaks above $1 it now requires less collateral to generate Dais and presumably people are less likely to want them. My biggest fear here is in the case of a serious, say 40% 1 hour movement in the value of Ethereum. You are going to have people selling their Ether, possibly into Dai if it is trading in a pair, creating a strong demand driving the price of us, at this same time it is now easier to collateralize and create more Dais, but the value of the collateral is rapidly depreciating, thus leading to a greater likelihood of Dai becoming under-collateralized. If I am misunderstanding this mechanism however please reach out and help me.
Intuitively, I feel like this is a value that is going to need to be set very careful, because otherwise I worry about appropriately capturing signal and noise.
Now this is again where things get really interesting. Basically shuts down the whole system and gives them their share of the “pooled ether”. Problem with it? If it is being used there is a very good chance that Ether is now worth much less than your Dai was supposed to be. The term “long term market irrationality” to me feels like their hedge against the chance that crypto prices fall and they have no recourse.
Basically saying what I said. This is the ripcord they pull when they are giving up because they are no longer collateralized.
So now we are starting to get into the MKR token and what powers it gives in the DAO. We have already discussed some of these, but you can see how these are very important decisions.
The important thing here is the liquidation ratio. This will help us figure out how likely it is that the whole house of cards falls down.
So the stability fee like I have mentioned is the annual fee you pay for the privilege of having your collateral tied up by them. The penalty ratio is a little bit more confusing to me. As I understand it, if the value of your collateral gets to close to the value of your DAI it is automatically liquidated and then it used to buy up MKR when we have the multi-collateral system, but for now it looks like it burns the “Pooled Ether” which helps if it had to be diluted previously. This is honestly clever. I need to give props to this. If I am understanding it right it can help Dai survive pretty significant corrections, but I am dubious about a black swan event.
This part is endlessly fascinating to me. Apparently the plan with multiple assets is to sell off MKR whenever they become under-collateralized. The issue here is the legal issues with basically continuing ICO sales. Plus, I feel like this gums up the works economically, but I cannot put my finger on why yet. Best I can come up with is this: MKR is likely to be highly correlated to other crypto assets, the need for this dilution would arise in a situation wherein the value of MKR is already depressed due to a crypto crash, this market condition will require huge amounts of dilution to raise the funds necessary to recapitalize. It also makes it interesting, because it’s a constant downward pressure on the governance token, potentially making it easier for people to start influencing the DAO, but that of course depends on how the holding of MKR shakes out.
So first question how is every Ether backed CDP not a risky CDP? But basically as I understand it sometimes they will force liquidation of the underlying asset to preserve the value of the Dai. The issue here could be if enough sales are triggered simultaneously, and they are selling into thin liquidity.
Again look at the last paragraph here. Our biggest issue is going to be events where the market moves fast and suddenly. They’re going to get caught in some ugly dilution issues if I am reading it right. I’m gonna skip the section of the whitepaper on multi-debt auctions because it does not exist yet.
The keepers here are interesting. Many of them are bots that are meant to trade Dai to help it maintain it’s peg and sometimes they fail… as they did here https://twitter.com/prestonjbyrne/status/953769228238286848 so not exactly a foolproof tool.
Pretty typical oracles. Some claim they represent an attack surface and they are right, but not an important one in my underinformed opinion. Some claim they aren’t truly decentralized, and that’s somewhat true, but sometimes you do not have a better option. I have no serious issue with them.
My biggest question here is about how many of these there will be, because this seems like a ton of power. The next section is examples of how to use it and we are gonna skip right over that. Section after that is called addressable market and is marketing bullshit so we are gonna skip that too. Then we get into the risks section and this is where I get excited.
All I have for this part is a reminder that a problem in a DAO smart-contract is the entire reason that Ethereum had to fork. $60 million stolen if I remember right. However, multiple security audits does seem reasonable.
Hey they are aware of my fears, do they have a solid solution though….
Nope….Next risk is competition which I do not care about so skipping.
Yes! We are finally to more of the problems and risks I have been pointing out. Namely they can only increase their liquidity so much to compensate, and they admit right here they need to maintain a large capital pool to feed the bots. You know what that sounds like to me? They’re gonna need more investment continually coming in to keep it working….
Better watch out for the SEC, and the CFTC, and the rest of the alphabet soup….
In conclusion, I still do not believe stablecoins are gonna be effectively created because unless they are backed by the asset they are pegged to and convertible there is always too much risk. This article was written in one night without editing, so please help me out in the comments if you find any errors.
Note: This is an old post with some minor flaws, I am posting it here in protest of Medium.
This post is prompted by something interesting I have noted in the cryptocurrency space, namely that there has been a significant proliferation of so called “stablecoins.” Besides the proliferation there has also been recent VC investment into some of them, making me wonder, “how does a stable coin make money for a VC?” Let’s look into this and make sure everything adds up.
Update: I published a deep look at the Basis protocol here.
Let’s start with Basecoin, oh wait I mean Basis Protocol. This “stablecoin” has raised well over $100 million dollars from VC investors. I’m worried about these investors, many coming from top firms after looking at the economics of this BitShares 2.0 (Worry anyone else that the founder of that project is the founder of the new $4,000,000,000 darling EOS?). The way it works as best as I understand is using a three-token system. The tokens are as follows:
Base Shares
Base Coins
Base Bonds
The base shares are created in the genesis block and all new base coins go to them as “dividends” (holy shit I hope they spent some of that $100 million on Securities lawyers). The base coins are a separate coin that is issued to holders of the base shares when the price of the base coin exceeds peg, in theory diluting their value and bringing the value back to peg. Base bonds are issued when the value falls below peg. When this happens you can purchase a Base bond for the current value so say $.80 and then redeem it for $1.
Now where this gets even trickier is when it comes time to issue new coins is that it goes first in, first out. So it goes to the oldest bond holder first, and then continues down the line, and if there are in theory no bond holders then the coins are issued to the share holders.
Now what is the issue with this system? Economics mostly. Let’s start with what is the most obvious to me, my incentive if I am a whale and if this is liquidity is to become a large share holder, and then whenever I get a dividend to immediately sell it, purchase bonds, wait for them to redeem, and then dump again. If the market gets too big for me to do this alone, I do what all the whales are already doing in crypto and organize this process with a few other people.
Printing free money and giving it to crypto-investors who are inclined to hold it and thus restrict supply;
Providing financial incentives to subsequent investors to introduce money into the scheme and subsidize the price of the scheme if the price of a coin should fall below a certain level (say, $1);
Vulnerable to a not-at-all-decentralized reliance on price indicators provided by unsupervised, unregulated third-party trading venues already suspected of serious shenanigans;
Granting primary benefits of the scheme to early buyers in an unregulated ICO;
Where every participant is betting on the price of their assets rising;
Which cannot sustain itself without finding new buyers for $BASE.”
Now the question that is blowing my mind is why the investment in this from VC firms? And then I figured it out. The reason this stablecoin has gotten so much investment is because of the structure of the shares. When they buy their shares they are trying to basically buy money printing machines they will continue to issue them dividends, as they accumulate the follies of every retail investor who purchases the coin to use to trade in the crypto world. They’re trying to profit of a couple really nice facts.
Many cryptocurrencies banks have no strong fiat on-ramp and thus depend on stablecoins like Basis protocol for people to trade, creating built in buy pressure.
The initial purchase of shares will allow for the stability fund to maintain the peg long enough for them to cash out their investment.
Plus, if the price of cryptocurrencies continue to rise and more people are purchasing then they can continue to print money for longer.
Not exactly a great product for all of us.
Update: I wrote an in depth look at MakerDAO, Dai, and MKR here.
So let’s look briefly at another stablecoin. This time MakerDAO.
MakerDAO which issues DAI confuses me because I cannot figure out the advantage to using it. Basically you put up about a whole bunch more money than you want in Ether. They then issue the Dai. So say you wanted $1,000 worth of Dai, you need to overcollaterize and put up let’s say $1,500. Now why would you do this instead of trading into the much more stable USD? Good question. I cannot for the life of me figure it out.
Best part is though how vulnerable this system is. Let’s say that tomorrow there is a another horrible event on Ethereum. Think like the DAO hack, but larger, and they are unable to achieve consensus to roll the chain back. The value of Ethereum plummets and then you are not overcollaterized, you are undercollaterized and the value plummets.
There is also a bunch of the same algorithmic BS that Basis Protocol and BitShares try to use to maintain their value thrown in for good measure.
Oh and the best part if they do end up undercollaterized? They dilute the pooled Ethereum so you can no longer claim back the same amount of Ethereum you put in. How’s that for a fun little twist?
So well I’m confused about this, at least it’s clear how they make money. To pay back their “Stability fee” you need to use their MKR token.
Worst of all? It hasn’t maintained it’s peg.
Finally, we need to discuss the elephant in the room. The one who’s imminent collapse will also be the black swan event that destroys MakerDao and wipes out a ton of value in the crypto ecosystem. Tether. I am not going to go back over ground that has been thoroughly covered, so just read everything Bitfinex’ed said. But more than that, it is supposedly backed, with no audits, and no convertibility yet trades with no counterparty or insolvency risk even when bank accounts get seized.
Plus, it’s linked to Bitfinex, which has also been linked to the delightful market makers over at Cumberland mining as Spoofy McSpoofface detailed already. Namely bad.
Though if you want me to answer how does Tether make money, again I’m not exactly sure, best guess I have is they don’t and it’s all used for money laundering. (Remember Kraken let’s you trade fiat into Tether with no fees, but won’t let you trade using Tether).
Update: I wrote a piece discussing recent developments in Tether here.
Update: Okay so Tether makes money in two ways, 1. a ten basis points charge on Tether purchases, and 2. Interest on the money held. However, it is still an open question as to whether or not they are actually earning interest due to the complexity of their current banking situation.
That’s the secret behind all of these stablecoins. They hide behind their algorithms and everything else, but they all rely on market-making bots in order to maintain their pegs. Some even outright admit it, like Basis with their “Stability Fund” or this one which is just beautiful: https://twitter.com/prestonjbyrne/status/953769228238286848
If you still are in doubt, ask George Soros about what happens when someone tries to peg something. In his case he got rich. For many people in this case they will get caught holding a bag. If you are going to trade crypto, then trade responsibly and do it with real fiat on ramps not magic pegged currencies. And as always nothing I say is legal or financial advice, I’m just an angry guy on the internet.
Update: Added clarifying comment about nature of Cumberland mining.
Myles Snider has already written an excellent introduction to Augur and Prediction markets and for the sake of brevity I will not rehash it here. I highly recommend reading his piece before considering my piece: here. In this I will present a different perspective on the coin, focusing on potential regulatory risk, but not on the normal worry of the SEC treating the coin as a security.
CFTC Risk
In the United States the Commodity Futures Trading Commission (CFTC) has previously cracked down on other prediction markets. Most visibly and noticeably on Ireland based Intrade. Despite its international basis it was still able to be shut down by the United States based CFTC. Even DARPA and the CIA experimented with a prediction market, that was shut down due to Congressional pressure. (Interesting read about it here) These and other examples of various prediction markets being shut down thanks to regulatory pressure, seem to suggest that the United States is not ready for a prediction market. The common argument given defending Augur is that because it is decentralized it is protected from this kind of intervention. However, several issues arise when you consider that argument. First and foremost there needs to be a way to get your fiat money (think USD) into and out of the currencies being used for Augur. I would not expect a significant crackdown on the Ethereum that is used to trade (though it is possible with the SEC comment about coins being security, and the fact that there was an initial sale). The greater issue here is that the market makers need to hold the REP coin associated with this platform. That means they must have a way to get into and out of this coin. In the Intrade shutdown it was possible because there was cooperation between the CFTC and the bank associated with Intrade. It is possible that any exchanges that offer trading from fiat to REP or vice versa will have difficulty finding banks that will accept their business, or if a bank is found it is also possible that individual holders of REP could become a target of investigations. We have already seen many cryptocurrencies including Binance and Bitfinex having trouble finding banking and I do not see that being an issue that will be easily solved soon. Carrying coins like this will make it that much more difficult for exchanges to find banking.
The second major CFTC risk I see associated with Augur is the ability for anyone to make a market on anything, and then collect trading fees on it. This potentially could mean that the real risk here is that these individuals market makers could end up sanctioned by the CFTC. Especially since they are receiving a portion of the fees associated with the market, meaning that they are receiving a direct and trackable benefit from this platform. This is especially worrisome in light of some of the specific complaints that were levied against Intrade that led to its closure. In 2005 Intrade was found to be in violation and they were then required to inform US customers with a pop-up on the exchange that told US customers they were not allowed to trade these options, and to try to ensure that US based customers could not trade these options. My fear with Augur here is two-fold, one the Augur trading platform will need to make sure that US customers are told that they cannot trade these options, and that individual market makers will become liable for US customers who do trade their options.
Insider Trading Risk
There is another risk that is neglected, but in my opinion represents a smaller overall risk to Augur as a whole, however, it does represent a risk to people using Augur. Every single market participant on the Augur platform needs to understand that they are liable for insider trading regulations in their countries. Many of these options, especially if they are tied to the price or performance of “real” securities, are ones where anyone trading in the market need to ensure that they are not in violation of insider trading laws. Failure to appropriately recognize this risk, by any market participant increases their legal liability.
Manipulating market to affect real world
Augur has described the potential for these prediction markets to serve as a more accurate way to predict various real life events. However, what I have not seen described yet is the fact that if these markets are being used to predict various real life events, they are open to manipulation. For example, consider a prediction market in Augur that is predicting the price of oil a month later. The market on Augur is likely going to be much smaller than the equivalent futures contract. This means that a sufficiently large enough whale could potentially make large enough bets to manipulate the Augur market, which could then potentially change either the futures market or the actual price of oil. This is in my opinion is one of the smallest risks to the price of REP and to Augur in general because it requires several things to happen:
Augur needs to become a large enough platform that its predictions are used in securities trading.
The market needs to be small enough that a single or a team of whales can manipulate the market.
The whales need to be able to make these manipulations, while hiding that these manipulations are occuring.
As such this seems to be the smallest risk in my opinion to Augur as a platform or REP’s price.
Conclusion:
In conclusion, while I feel that Augur is a fascinating platform, and the way REP is used to adjudicate disputes in the prediction market is innovative, I worry the regulatory risks are being underestimated. There is a history of these kind of markets coming under regulatory investigation and that is neglecting the fact that it is possible that the REP ICO may have also been an illegal security sale (based on the recent comments suggesting most ICO’s were illegal). This suggests to me that REP may initially gain value, it is likely to fall under regulatory scrutiny that will significantly depress its value, and may permanently prevent Augur from flourishing, which is disappointing because I find prediction markets fascinating.
However, I’m sure that there is no reason to think that Bitfinex is hiding something. No reason at all.
