Chicken Nuggets: Crypto Follow-ups

The difference between involvement and commitment is like ham and eggs. The chicken is involved; the pig is committed.” – Martina Navratilova

You know I’ve been sitting on that quote from the beginning, right?

Interesting things happen after you write a Substack article. You receive great feedback from readers, the world continues to evolve, events unfold, and predictions you’ve made either prove true or, as I prefer to describe the alternative, too early. As Michael Jordan famously said:

I’ve never lost a game. I’ve just run out of time.

Often, the things I want to say in follow-up to a particular piece don’t justify a full Doomberg article but they do deserve some abbreviated airtime nonetheless. My solution to this dilemma is the Chicken Nuggets series, in which I’ll occasionally group together several (hopefully) interesting follow-ups to previous Doomberg articles. In this inaugural edition, I revisit four articles I published about the crypto market.

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When I wrote Crypto Carnage Coming? in mid-May, bitcoin was trading digital hands for about $50,000 each. The motivation for the piece was twofold. First, every instinctive bone in my body was screaming that regulatory action in the crypto space was imminent, driven mainly by my observation of the behavior of Elon Musk, CEO of Tesla, and Jack Dorsey, CEO of both Square and Twitter, as well as comments by various US and European authorities. I have a firm belief that powerful people get tipped off just ahead of big events, either directly or indirectly, and you’d do well in life if you searched for (and listened to) these signals. Second, I was surprised to learn that Sam Bankman-Fried was an actual person. I freely admit this proves how new I am to the crypto world, but hey – I pride myself on being a fast-learning chicken! I’ve since discovered that good old SBF (as he is colloquially known by those in the know) was the second largest donor to Joe Biden’s presidential campaign. That’s certainly the egg of a future Doomberg piece – time will tell if it hatches.

While I got both the price action and the general cause correct, it was a crackdown by the Chinese government – as opposed to US or European authorities – that seems to have catalyzed this most recent crypto winter. In hindsight, I should have known it would be Chinese regulators that spooked Musk, in particular, as he certainly has no track record whatsoever of reacting to threats from US regulators, and for good reason. Alas, to err is chicken.

When I wrote Instability Coins a week later, in which I collaborated with the prolific and formidable @DesoGames to describe numerous red flags surrounding the “good” stablecoin, USDC, I assumed it was kinda sorta understood that the “bad” stablecoin, tether, was, in fact, bad. Real bad. Made-up-Ponzi-fraud bad. Judging by the explosion in new and negative articles on tether in the weeks following the publication of Instability Coins, the assumption that everybody already knew tether was a huge scandal was false (and for the record, lest you think I’m letting the modest initial success of Doomberg get to my head, I don’t for a second think Doomberg is impacting the news – I just hope to describe it, and occasionally predict it, while having fun doing so).

Since the initial publication of Instability Coins, Circle has published both their March and April attestations as to what they – and their auditor-who-isn’t-actually-doing-an-audit – claim is backing USDC. I described the peculiarities of the March attestation in A Test, Attest (Potato, Potahto), which, if nothing else, proves how a terrible title leads to poor engagement for a Substack piece. In a subsequent and truly remarkable interview by Coindesk TV with Circle’s co-founder, chairman, and CEO Jeremy Allaire, published on June 30, 2021, Mr. Allaire validates the old adage that one should never, ever talk to the police (or the press, in this case). I transcribed a lengthy but illuminating back-and-forth between Mr. Allaire and his dogged inquisitor, Lawrence Lewitinn, below:

Lewitinn: Hi Jeremy. You brought up central banks and general positive comments about stablecoins, but the Boston Fed President, Eric Rosengren, he cited tether specifically as a challenge to financial stability. And USDC positions itself as the antithesis of tether, but, you know, a lot of people on, particularly on social media, are concerned about what you list on your attestations as what you call ‘approved investments’, as one of the assets, as essentially the assets where the USDC assets go. And people are saying look, this is no different than what tether does with its ‘commercial paper’, where it’s kind of murky as to what commercial paper it owns. So, what exactly are ‘approved investments’? Who approves it? And, you know, what percentage of the assets are in that category?

Allaire: Yeah. So. There’s just dramatic differences between the way that USDC is governed and regulated, and the fiduciary responsibility that comes along with that, versus something like tether. So, just to start, and this is, I think that most people don’t really understand. USDC exists under a regulated regime in the United States. It exists under the rules of electronic stored value and money transmission. Circle is licensed and is supervised by banking supervisors throughout the United States. We are audited by top global accounting firms, and we are audited against our compliance with law. Those regulations, which, by the way, include regular government examiners coming in, and looking at the books and records of the company, and ensuring that we are, in fact, in compliance with all of those supervisory requirements, that’s like just a level of just, first of all, fiduciary accountability that is just completely lacking in a system like tether. The second is that if you actually look at it, and understand it, those laws are the same laws that govern the, you know, $35 billion dollars of balances that are held by PayPal, or all of the dollars that sit with Square, or Apple Pay, or Stripe, in all of their platforms. It is the exact same regulatory framework. So, we live underneath that. Within that universe, we are basically constrained, from a consumer protection perspective, to ensure full reserve, and effectively, you know, complete liquidity at all times. And so, there’s a very, very narrow set of permissible financial instruments that are able to be held, that is a fairly narrow and restrictive set of covenants that we have to follow or we are breaking the law. And then even within that, Circle operates in an even more narrow, more bounded, more conservative posture, and that’s something that actually we set as a set of standards with Centre Consortium. So that, we’re sort of saying, okay, here’s what the law allows for regulated financial institutions that are doing electronic money, in most of the world, including the United States. We’re going to do something that’s even more conservative because that’s really critical to really building that trust around a digital currency model like USDC.

Lewitinn: Yeah. You know, so, I mean, I guess some of the concerns is what exactly is in that list of approved investments? Would that include corporate debt, for instance? And if so, what grade? Who grades them? And also, just how much cash is actually there?

Allaire: Yeah. So, we have a mandate to, obviously, always ensure that 100% liquidity and shock test that, et cetera. I think anyone can go and look at the laws. And so, what I would encourage you guys to do, and others, is to actually to go see what is allowable and understand that we are very much more conservative than that. And what’s important is that this is a regulated financial infrastructure. And we are held to an accountability that, if you go on crypto Twitter, you have people, you know, who are speculating ‘oh this is fractional reserve’ or ‘these guys are doing this or that.’ I would be in jail if that were the case. I have got government examiners, public auditors, and all these folks that are holding us to account. And the other thing I always want to reserve people, to remind people, is that the dollar balances that you hold with your Chase account, or your Bank of America account, et cetera, those are fractional reserve dollars. You don’t actually have a dollar there. You have an IOU. And then they are taking that and they are rehypothecating it at a 10X leverage. That’s what banks do. They create money. We’re building a full reserve model that is built within the highest level of credential standards that exist in the world, in the US regulated banking system. And we’ve been doing that consistently in holding and publishing attestations from top accounting firms for three years straight. And no one else can claim that.

Lewitinn: So, to allay some of the concerns, I mean, can you at least give some examples of what would be counted as an approved investment?

Allaire: Yeah, absolutely. I mean, if you look at it, it’s obviously cash. It’s, you know, government treasuries, those types of short-term instruments, and, you know, those are, you know, a huge, huge component of this. So, we don’t break out the actual individual line items in USDC reserves, but what we do is actually publish exactly what we are required to do and we make it very clear that we are holding ourselves to an even higher standard.

Where I come from, it’s three strikes and you’re out. Mr. Allaire was given every opportunity to answer the single most important question facing Circle and USDC today. Each time, he deflected, demurred, and/or filibustered his way through what should otherwise have been a straightforward answer. This is all the more damning when you consider that the straightforward answer, if true, would make him the most money. If the CEO of Circle declared specifically and unequivocally that each USDC stablecoin was backed 1:1 by cash and cash equivalents, as defined and understood by the investing public, or even gave a detailed accounting of what “approved investments” are, USDC would immediately and permanently become the dominant stablecoin in the world. He didn’t, ergo it isn’t. He spoke like a politician advised by a lawyer worried about defending himself in court someday, which is a fine strategy if you’ve got something to hide. There’s something rotten with Circle and USDC, and this chicken intends to keep on the case.

Finally, I’ll close with a follow-up to A Drunken Saylor, the most recent Doomberg article on crypto. By the methodology defined in that article, MicroStrategy Incorporated’s stock and convertible debt are now trading for $76,915 per bitcoin owned, up nearly 8% from the $71,275 per bitcoin they were fetching on the day A Drunken Saylor was published, even though the price of bitcoin is essentially unchanged since then. I bring this up because, despite my clear warnings in the piece that this was not a tradeable situation, at least in my opinion, I’ve had several traders I respect reach out to discuss playing the obvious arbitrage of going long bitcoin in some fashion and shorting MicroStrategy’s stock. My answer to them is sure, it has to close eventually, but eventually can be a very long time and extremely expensive to see through. The closest analogy I can think of is the movie theater industry. A few months ago, another no-brainer trade appeared on offer: buying Cinemark and shorting AMC. There was no way to justify AMC’s enterprise value versus its better-financed competitor through reasonable fundamental analysis. AMC’s stock is up five-fold since I last took a serious look at that situation. You can’t view stocks as stocks anymore, they are stonks. Given Saylor’s maniacal cult following, MicroStrategy has serious stonk potential. Don’t stare at a laser unless you are prepared to go blind.

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