Crypto Long & Short: Does Decentralization Create Value or Destroy It?

To bitcoin (BTC) proponents, the world's need for a decentralized form of money is more apparent than ever as challenges mount to government monopolies on money-printing and military force, from the U.S. to Uganda.

It's possible this vision is attracting new investors into crypto, but this week's price surge (notwithstanding the sudden bitcoin price whiplash at midnight Eastern, today) may also be driven by circular enthusiasm among existing crypto traders. That seems to be what's happening with ether (ETH). The No. 2 crypto asset outperformed bitcoin on the week (23.7% to bitcoin's 18.7% Friday-to-Friday close provided by Coin Metrics). It wasn't likely due to excitement over a decentralized alternative to the tech giants who testified virtually in Washington. Ethereum's buzz is coming from decentralized finance (DeFi).

You’re reading Crypto Long & Short, a newsletter that looks closely at the forces driving cryptocurrency markets. Authored by CoinDesk’s head of research, Noelle Acheson (or in this case, Senior Research Analyst Galen Moore, who's filling in while Noelle is taking a well-deserved week off), it goes out every Sunday and offers a recap of the week – with insights and analysis – from a professional investor’s point of view. You can subscribe here.

This week, total value locked (TVL) in DeFi climbed toward $4 billion, driven upward as holders of ether and other crypto assets sought liquidity rewards, paid for by holders of native tokens issued by DeFi lending networks. YFI, a novel token issued by Yearn.Finance, an aggregator of DeFi deposits (as explained here), was a standout. It took DeFi’s blue-chip stablecoin, dai on a dizzying ride to new heights of issuance and back again.

This example of circular enthusiasm is not alone: Compound Labs' COMP token and the inflationary token AMPL both use similar mechanisms. The enthusiasm for these lending-related DeFi networks was not dampened by Tuesday's news that OnDeck (ONDK) would sell to another fintech lender for $90 million. OnDeck went public in 2014 at a valuation of $1.3 billion.

I still don’t know what the DeFi platforms could be doing right that so many lending fintechs have done wrong.

Ethereum's core value proposition, meanwhile, is taking on a shade of irony. DeFi is interesting, but Ethereum transactions and fees – metrics you might call ether's fundamentals – are pushed skyward right now by tether (USDT), a stablecoin with a centrally maintained dollar peg. It crossed $11 billion in issuance on Wednesday.

DeFi's recent performance is indeed impressive, but so far it's been outstripped by centralized projects.

Tether demand is also prodded upward by a circular trade. As derivatives data shop Skew pointed out, basis, or the difference between cash price and futures price, on one of the world's most liquid bitcoin futures markets hit 20% this week. With tether borrowing rates on Nexo somewhere between 6% and 10%, borrowing tether to fund a bitcoin cash-and-carry trade is a nice way to make a low-risk return.

One thing that centralized service providers like iFinex, the issuer of tether, are doing right, it seems, is fueling speculative markets. So far, the most valued applications in crypto are centralized offshore exchanges like Binance or BitMEX. Like iFinex, their operators have developed innovative market structures that have removed barriers of wealth and geography that limited access to high-volatility, high-risk investing, much like Robinhood has putatively done in the U.S.

In that way, the "Robinhood Effect" may represent a threat to crypto from stocks, which also seem to now trade unencumbered by fundamentals, via onramps that broaden access. (Jill Carlson with NLW on CoinDesk's Breakdown podcast earlier this month is a must-listen on this topic.) Kodak (KDK), which licensed its name to an ICO in 2018, is this week's poster child.

That may help explain why FTX, another innovative provider of access to sophisticated and volatile financial instruments, has announced Serum, a decentralized exchange (DEX) for crypto derivatives. On the surface, it doesn't make much sense. Binance's DEX is the most successful so far, but its flagship, centrally controlled exchange outstrips it in both scale and rate of growth.

Maybe FTX's DEX will outstrip its larger rival. Maybe it won't, and it's just good marketing to have a DEX. But if stock markets more and more resemble crypto markets in their memetic volatility, these DEXs may prove strategically important.

For now, crypto is the frontier. In the future, traders may look even further out. Bitcoin offers access to money, anywhere, unburdened by government interference or inflation. A DEX offers the same for trading and speculation.

Today, it's hard to find a decentralized product that doesn't have a more successful, centrally controlled cousin. In the future, under a different geopolitical reality, amid a widening universe of crypto assets and synthetic derivatives? Maybe DEX-building isn't a defensive move to protect existing crypto markets from regulators, but an offensive move to prepare for even wilder and less-regulated markets in the future.

Hat tips: Nick Gauthier at Nomics for data; Sarit Markovich at Kellogg School of Management for starting my wheels turning on decentralization's value impact; Emmanuel Goh at Skew and Michael Moro at Genesis Trading for helping me grok the cash-and-carry trade; Mengxi Lu for hearkening back to the heady fintech days of 2014.

Anyone know what's going on yet?

I don't know about you, but I am getting 2017 feels all over. Kodak is in the news and $TEND, a meme coin based on poultry and deflation, reached $8.8 million in volume in 24 hours, as I was drafting this column. Is this the future? Should I move funds to Uniswap, like this guy on Twitter says he's doing?

Or, should I listen to Goldman Sachs: buy gold and just decide to take off the rest of the summer. The U.S. Dollar Index (DXY) hit year-to-date lows last Saturday and kept falling all week, so I know I've got to do something to get rid of those.

At least I can count on the U.S. Federal Reserve not to even hint at raising interest rates, no matter what happens. Knowing that, I don't feel so bad that we're probably not going to get noted gold bug and digital currency fan Judy Shelton onto the Fed Board of Governors.

Here's this week's returns table:

Chain Links

What makes Ethereum tick? My colleague Leigh Cuen took a deep dive into ETH culture, including supporters' penchant for public dancing. (No, it's not like Steve Ballmer punching the air to "Start Me Up.") TAKEAWAY: If investing is memetic, maybe memes are fundamentals? Anthropologist Ann Brody likened investment in ether to a social movement: “I think the dancing in itself speaks so much about Ethereum’s cultural values related to freedom, creative expression, fun, unconventionality, and even the desire for collective unity to some extent."

Bitcoin forensics firm Chainalysis has a new suite of public-facing tools that it's publishing in a free-to-use dashboard at markets.chainalysis.com. TAKEAWAY: One of my favorites is this view of bitcoin liquidity: most of the bitcoin out there is held tightly, rarely moving.

BCB Group, a European Union payments services provider to crypto exchanges and investment funds, rolled out a clearing and settlement system, BCB Liquidity Interchange Network Consortium, in partnership with BitStamp, a crypto exchange. TAKEAWAY: Along with the increasing number of providers offering prime brokerage services, it's another notch on the door frame, marking crypto market infrastructure's growth to accommodate large institutional participation. Whether large investors will ever drive these new roads in large numbers, remains to be seen.

Bitcoin's Taproot improvement proposal, designed to improve privacy and scalability, and add richer programming capability to bitcoin, has moved from if to how and BitMEX's research arm has studied past changes to Bitcoin's code, to map out possibilities. TAKEAWAY: BitMEX Research asserts it was controversy over block size that caused a messy upgrade process for the SegWit scalability improvement of 2017. This underscores how important Bitcoin's social layer is to its security. It's also good to see firms like BitMEX devoting resources to these questions, which may fall below the attention level of most of their customers, but are critical to maintaining the system on which their business is built.

Fidelity Digital Assets published its "Bitcoin Investment Thesis" this week. TAKEAWAY: Fido has been invested in bitcoin for a long time and it isn't breaking new ground, but lays out the case for a handful of reasons to expect bitcoin to increase in value over the long term: 1) it's an "aspirational store of value," meaning it has store-of-value properties but hasn't been adopted as such; 2) its volatility will attract new attention and investment; 3) its properties of verifiable digital scarcity are unique and may gain value in a time of global economic change; 4) wealth transfer to a new generation that looks favorably on bitcoin.

Yum China Holdings, the operator of KFC in the People's Republic of China, has reportedly added whole fried chickens to its menu. This seems important.

Podcast episodes worth listening to:

• The Bond Market Is the Truth Teller No One Heeds, Feat. George Goncalves – The Breakdown, Nathaniel Whittemore
• Allison Lu: UMA – The Open Financial Platform for Building Synthetic Assets – Epicenter Podcast
• Coinbase CEO Brian Armstrong on Bitcoin – What Bitcoin Did

(Note: Nothing here is investment advice. The author owns bitcoin and ether.)