$FEW Care About This

If there is one thing that crypto can regularly provide it is drama. Today, the controversy (or at least one of them) centers around a token called Few. The token seems to have started when Sam Ratnakar decided to invite a small number of influential people from cryptocurrency to work on an “Experiment”. Each would receive an equal proportion of the tokens and a small proportion would be reserved for liquidity.

Archive link just in case: https://web.archive.org/web/20200923022606/https://twitter.com/mrdotboson/status/1308538094463844352

Many members of the telegram who received the token seem to have an honest desire to build something. However, the Telegram was also quickly filled with ‘jokes’ about pumping and dumping the token.

Archive link: https://archive.li/x07W6
https://web.archive.org/web/20200923023443/https://twitter.com/bluekirbyfi/status/1308533204224110592

Now let’s give all of these people the benefit of the doubt and assume they were working honestly with the goal of building something important. Even still they are doing it in what seems to be an inexplicable manner.

Generally, tokens should be created in order to serve a purpose. You decide on a project, a protocol, something, that in order to function optimally requires a token. What happened instead here seems to be that the token was created, distributed to a list of people with influence in crypto, many of them started “jokingly” shilling it on Twitter, and there was still no reason for the token to exist.

My intuition, and I hope I am wrong, is that the earliest creators and shills of $FEW were not doing it entirely as a joke. I believe many of them were experiencing FOMO (Fear Of Missing Out) and in order to rectify that feeling settled on creating their own token, airdropping it to a small group of influencers, and then “influencing”, so that they too could share in the mania.

Even if it was all a “joke”, where’s the punchline? Is it a meta point that most tokens are worthless? Is it a commentary on the large amounts of wealth that generally accrue to the earliest and most connected in crypto? Is it supposed to be a mockery of the “great team” method of crypto investing? None of those feel convincing to me, and I am left with a sadness about the state of cryptocurrency.

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Learning about Kimchi

There is an obsession passing through crypto over ‘yield farming’. I have very little idea what yield farming is. In order to learn what it is I am going to look into a coin that recently launched that I saw people tweeting about called Kimchi. I chose this coin as it came out the same day that I made my first batch of kimchi. This post will be a log of my trying to understand this coin.

First, I need to figure out what is yield farming. As far as I can tell yield farming works by placing your token into a Uniswap (or similar auto market maker) contract that is against a dollar equivalent (often Tether or USDC). In order to understand the impact of this I have to zoom out again and refresh my memory of how Uniswap pools work.

[Aside I learned while researching this: Tether and Binance violate the ERC-20 standard by not returning an integer boolean when transfer() is called and both instead return nothing.]

Each pool consists of two ‘ERC-20’ tokens (as discussed above they do accommodate some non standard implementations) (this also means that the contract does not natively handle Eth and instead must use WEth which is ether wrapped in an ERC-20 compliant token). When you make a swap in this pool the token you transfer is exchanged for the proportional value of the other token in the pool. Say there is 1 Eth in the pool and 100 USDC and you swap 0.05 Eth then you will receive 4.747 USDC. This amount may seem odd at first glance, but Uniswap charges a 0.3% fee on the trade which is paid out to those who have contributed their assets to the pool. (Note: this examples ignore gas fees)

So now we need to zoom out slightly more and focus in on the liquidity providers. The way these pools work is that you deposit your tokens to the contract as a liquidity provider and then are paid a liquidity token which represents your proportional ownership of the fees for that contract. This token can be transferred, traded, and lent (this is where some of the more complex interactions come into play) and to receive your payout of the liquidity fee your liquidity token must be burned. On contracts with decent volume you can receive meaningful returns from contributing your tokens to the contract and thus people are incentivized to contribute to further liquidity.

Okay now I feel like I have a strong enough understanding of these systems to actually look at the token in question Kimchi. In the past when assessing new contracts my instinct has always been to read the whitepaper, however Kimchi and many other of the ‘new’ tokens do not have whitepapers. So that stymied somewhat, however Kimchi does tell us it was forked from Sushi and Yuno. I was optimistic that one of these would have a whitepaper. They do not. Sushi however does have a Medium post. Perhaps that will help us understand their system.

The first change is that the liquidity token provided in Uniswap is replaced with a Sushi token that gives an ONGOING right to fees deposited into the contract. I emphasized that in case any securities lawyers come across this article. The way this works is that the majority of the liquidity fee is distributed to active liquidity providers in the same way that it is with Uniswap, but a small portion of it (1/6) is converted to Sushi and issued proportionally to Sushi stakers. Every block Sushi are minted and 90% are distributed to Sushi stakers and the remainder go to the ‘Dev Fund’.

Now we can shift back to Kimchi and try to figure out how it differs from Sushi. First, they mint more tokens in each block. Second, they offer preferential rewards for some pairs. Looking around on Twitter it appears that YUNO the other token they forked from had a backdoor, and Kimchi preserved that backdoor but made it impossible to exploit by tying it to a non-functional contract. https://twitter.com/emilianobonassi/status/1300925536747876354

This also means that there is no real governance or changes that can happen with Kimchi, whereas Sushi claims to be working on governance.

Now we need to zoom out one more time and look at yield farming as a whole and why these tokens are popping up in the first place. Many different DeFi products like Compound issue governance tokens to users and this has incentivized a large amount of liquidity to flow into them. Furthermore, there are people who will contribute their token to liquidity on Compound, and then use the resulting token representing their lent token on Compound as liquidity on Uniswap (or Sushi or whatever). The ability for the same collateral to be used in multiple places, and producing yields in multiple places that can then also be used to generate yield seems to be the basis of yield farming.

My fundamental and deep seated issue with all of this is that this all seems to be happening with such speed that any kind of due diligence is skipped. There are no whitepapers. There are no security audits. There is no community due diligence before money starts pouring in. Many of these contracts have admin keys that allow for the creators to mint a large amount of tokens, to remove liquidity, to change the contract in other ways. This does not seem to be the future of money, but instead a mad cash grab built with the assumption that the black swan will never happen. That the stacked yields won’t eventually succumb to abnormally large withdrawals, or exploits, or extraordinary market conditions. Inevitably they will. I hope every single person with funds committed to them are fully aware of that risk.

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Sunday Reads – Links I Found Interesting 6/9

Mapping human microbiome drug metabolism by gut bacteria and their genes

A fascinating look at how the microbiome may affect drug metabolism. Important to remember that the game does not end at pharmacogenomics and we need to be paying attention to the complex interplay of numerous complex systems to understand drug action.

Deep learning can predict microsatellite instability directly from histology in gastrointestinal cancer

Thanks to the ‘magic’ of deep learning we may be able to better predict which patients are going to respond to immunotherapy in gastrointestinal cancer with cheaper tests. More people treating their cancer certainly sounds good to me.

CCR5-∆32 is deleterious in the homozygous state in humans

The gene that was CRISPR-ed in those Chinese babies makes it more likely you die. This isn’t even accounting for the potential off-target effects. Turns out the thing we all knew was unethical is in fact unethical. Who da thunk?

Principles of and strategies for germline gene therapy

Following in the same vein as the previous article we take a theoretical look at the potential for these germline therapies.

The Sweetgreenification of Society

Interesting Substack post about the increasing stratification of society through the lens of boutique businesses.

RNA sequence analysis reveals macroscopic somatic clonal expansion across normal tissues

From one, many. Our bodies are a huge mess of different mutations each of which could or could not be maybe contributing to diseases. Thinking of yourself as having one genetic identity is flawed.

A Jaunt Down Financial Fraud Lane

A fun article taking a look at some of the numerous scams in the cryptocurrency ecosystem. I am partial to the disaster that is EOS.

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Sunday Reads – Links I Found Interesting 6/2

EfficientNet: Improving Accuracy and Efficiency through AutoML and Model Scaling

Google did that thing they do again where they make vast steps in artificial intelligence and machine learning. Efficiency of these image recognition networks is up to 10* greater. Most of this gain is because they try to use “scaling coefficients” so that the network scales in a predictable way. I’m just mad because it’s a TensorFlow model and not PyTorch so I can’t drop it into any of my existing image recognition notebooks.

A promising step forward for predicting lung cancer

Another Google blog post about how they are doing incredible things. Man what I wouldn’t do to work for Google Brain. (This research is also being done at the same university I am doing my capstone with, so hey maybe they can sneak me in) Okay so in this article they describe a state of the art result for predicting lung cancer using improved volumetric predictions of CT scans. They instead of looking at individual slices in the image are instead reconstructing 3-d structures to improve the accuracy. This both is and is not a crazy step forward. Being able to use the 3-d structure seems to be truly revolutionary, but some of the radiologists performed equally as well as it. Seems that it will be a useful assistance tool for now.

Moving Camera, Moving People: A Deep Learning Approach to Depth Prediction

I promise this won’t be all Google, but again what they are doing right here is incredibly cool and a little bit scary. They have found a way to approximate the 3-d size, shape, and depth of moving people even when the camera is moving. This work has really cool implications for AR and VR and a little bit terrifying uses for a potential police state. There are many places where face recognition has been banned or people are considering banning it, however, combining a 3-d map of a person with existing effective identification techniques like gait tracking can serve as a proxy for facial recognition in those areas. Combined with facial recognition it could provide an even stronger match limiting false positives, and avoiding false negatives.

Speech2Face: Learning the Face Behind a Voice

Okay we are finally away from Google, but into something even more terrifying. This neural network when fed a small sample of speech is able to generate a qualitatively accurate facial guess. The model seems quite adept at identifying both race and gender. Scary stuff.

Defund Crypto

This fun parody site created by Joshua Davis, Kyle Gibson, and the pseudonymous Cas Piancey mercilessly lampoons the tomfoolery of Kik’s attempt to challenge the SEC. For the record, I do not think promising an Ethereum public DApp and delivering a one node Stellar fork is a good thing.

Exist 

This interesting service will likely not be appreciated by the privacy minded. While they do have a strong privacy policy its purpose is to bring a ton of your disparate personal data together and find interesting correlations. Whether it is useful or just noise remains to be seen.

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Billion Grains of Bullshit: Calling out an Exploitive Cryptocurrency Scam

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.

-Team Red

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How to Identify a Token Project that Deserves None of Your Ether: With Example

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.

Update 9/5/19: turns out I was right and it does not need a token. Whoops Archived whoops

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Untethered Tether: Old Developments

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.

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How Does a Stablecoin Make Money?

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:

  1. Base Shares
  2. Base Coins
  3. 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.

The second problem and the more troubling one, where this needs more investors always coming in (gotta maintain the stability fund they talk about) is better captured by Preston Byrne than I could: “It seems to me on this very cursory review that Basecoin depends on

  • 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.

  1. 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.
  2. The initial purchase of shares will allow for the stability fund to maintain the peg long enough for them to cash out their investment.
  3. 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.

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A Bear’s Perspective on REP

A Bear’s Perspective on Augur

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:

  1. Augur needs to become a large enough platform that its predictions are used in securities trading.
  2. The market needs to be small enough that a single or a team of whales can manipulate the market.
  3. 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.

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