Discover more from Alex’s Substack

This is a journal about my journey through crypto-finance, with a special focus on Cosmos-based blockchains and other alt-L1 Ethereum competitors. == NOT FINANCIAL ADVICE ==

The Vampire Squid Strikes Back

The Biden Admin's seizure of SEN (Silvergate Exchange Network) and SigNet killed the startup I joined 18 months ago, and also crypto's future in the USA.

Alex

Mar 20, 2023

As I wrote almost a year and a half ago, I left TradFi after 13 years to join a promising DeFi startup. I felt that compliance-driven red tape had squeezed every ounce of innovation out of TradFi years ago. Crypto was exciting, and the long-term value-add of programmable money over the 75-year-old USD tech stack was obvious.

Furthermore, in an industry with way too much blockspace (web3 compute capacity) and way too few real products, the startup I joined was building an actual product with actual real-world utility. Our startup was basically trying to build a blockchain-based NASDAQ to originate, standardize, and put on-chain private credit transactions.

Even though 2022 was a year from hell for the industry, we had the raw materials to build a viable product. We also exited 2022 with over a year’s worth of runway ($4m cash) to continue product development into 2024.

But our startup couldn’t survive the nationalization of SEN and SigNet, the two unique 24/7, Federal Reserve-to-stablecoin API’s, under the guise of a bank bailout. The chilling effect of killing these networks, complete with throwing Signature’s crypto business under the bus, is a devastating policy signal.

Our final interactions with Circle and others were completely consistent with Barney Frank’s assessment that this is a direct attack on crypto: these two networks are essentially frozen in place for existing customers while the government attempts to sunset them. They are not taking on new business, and in the current legal environment in the United States, nobody in their right mind would want to anyway.

So, our startup is shutting down and returning its $4m of remaining cash to investors.

Unlike most of the crypto industry, we explicitly dealt only in securities. We spent hundreds of thousands of dollars with 3 (or was it 4?) different law firms figuring out what we could do, under US securities “law,” to issue tokenized debt that was SEC-compliant.

But we had the same experience as 99% of others who have used lawyers to comply with what we think the US government might want: Uncle Sam rugged us anyway.

IMO, the nationalization and apparent sunsetting of SEN & SigNet have destroyed the future of “the money layer of the internet” in the United States.

Crypto today is like the internet in 1993 or 1994, before HTTPS and TCP, before the 1975-95 Protocol Wars were won. Before Amazon, let alone AWS, existed. Before Akamai’s global Content Delivery Network (CDN), which routes bits from server in country X to user in country Y to deliver that YouTube video’s bits per second at the optimal speed and resolution for that user’s network infrastructure, existed. Before the 15-year “search engine wars” had even started, since search engines didn’t even exist.

Crypto today, like the internet 30 years ago, is characterized by bad UX, and products that are clearly inferior to the analog alternative for most people, in most of the important ways. Like the internet in the mid-90s, 95% of crypto projects are stupid, a scam, or both. The large majority of the non-scummy top-5% will fail because the industry’s tectonic plates underneath shift so far, so fast.

But that isn’t the whole story. And the great untold story here is the rate of evolution in crypto (very high) versus the rate of innovation in American tradfi (zero).

In this 1994-internet world, everything moves fast and breaks all the time. The causes of breakage are simple yet unforeseeable. The internet of today has abstracted away so many facets from the user (like CDNs) that most users use the product — and indeed, most builders of new internet products — live an entire lifetime without ever being aware of these layers’ existence.

But this level of abstraction, where a user can tell GPT4 to build a fully functioning end-to-end e-commerce website and have it built 30 seconds later, took 30 years of trial and error to build.

In blockchain development, very little has been abstracted away. Unlike with web2, you don’t have key features of your tech stack “figured out” by the likes of AWS, Akamai, As opposed to “reinventing the wheel,” everyone has to invent the wheel on their own for the first time, and brute-force the problems by trial and error. Which means a level of frustration and negative surprises unheard-of in web2 engineering, to say nothing of the weekly hacks, rugpulls, and high-profile failures of promising projects.

In this world, failure is very common and expected, as it was for the internet. Luckily for America, the US government of 1995 was neither able nor willing to kick internet development out of the United States, and the US was also a society that tolerated failure.

That America clearly no longer exists today.

The benefits of “blockchain technology” for USD payments aren’t merely speculative. It is a fact that blockchains today can settle USDC or USDT transactions more efficiently than TradFi banking networks can. But the US government essentially destroyed that capability 1.5 weeks ago. Why did the US government do it?

I think there was a confluence of 4 DC interest groups that made this possible:

progressives who’d been conned by FTX and deftly pivoted to smear the entire industry for SBF’s crimes, while saving their own skins
- It was an open secret in DC that if you wanted to influence Biden Administration crypto policy, you had to get SBF to sign off on whatever you wanted, because Ryne Miller (FTX’s chief of compliance starting in Aug. 2021) was literally the only person in crypto who could get Gary Gensler on the phone. Ryne Miller was Gensler’s loyal sidekick at at the CFTC in the Obama Administration, and Miller loved to gloat about how much more access he had to Gensler than anyone else (and he wasn’t exaggerating).
The IRS and Treasury, who are basically unable to deal with blockchains at scale in terms of proving whether or not people cheated on their taxes
The NATO / intelligence / “weaponization of the USD” lobby, for whom blockchains represent a similar problem of complexity outracing their ability to process it
The tradfi lobby in DC (banks, payments, etc), which normally fight Elizabeth Warren on everything, believe this benefits them by allowing them to finally tart taking share in a nascent industry (so they tell themselves)

Progressives caught with their pants down by FTX

The Covid policy response (massive asset price inflation + massive real wage declines) represented the intellectual bankruptcy of political progressivism in the United States. It also previewed an increasingly dark future for the younger generations who will have to be robbed in ever-increasing amounts to fund the excesses of America’s progressive/Dixiecrat gerontocracy. Crypto, the only natural way over this Berlin Wall of DC’s making, was a natural Public Enemy No. 1 for this clique.

Adding insult to injury, the relevant progressives of FinReg were caught red-handed in how totally they were conned by SBF/FTX.

It was also an open secret that SBF was the favored son of Gensler and Warren. His blatantly superior access to regulators was not an accident at all; it was a brazen inducement to the rest of the crypto industry to pony up a metric shit-ton of money to Democratic politicians and PACs if it wanted any pull within the (100% Democratic) regulatory mafia.

When SBF turned out to be the Bernie Madoff of crypto — as the SEC had been denying basic due process to every crypto company in the industry other than FTX, grossly abetting SBF’s fraud just as it had grossly abetted Madoff’s — DC’s FinReg progressives were terrified. Their fingerprints were all over the crime scene.

However, by pivoting the narrative to crypto delenda est, they Took Charge Of The Situation, and deflected their own failures onto an industry they always despised. As always, the Beltway media gave them all the cover they needed. Even the WSJ would rather protect its access to DC politicians than report the ugly truth of this issue.

The IRS/Treasury tax lobby

Taxes are going up, and tax compliance is going down.

The vast majority of crypto holders have no interest in breaking laws, or even evading taxes. It’s just too risky, at least in the US, to do that.

Or at least, at current levels of taxation, it’s too risky for the rich ones. But with effective tax rates at 45-50% for even middle-class people in blue states, and the government still drowning in deficits when unemployment among those looking for jobs is at historic lows, taxes, inflation, or both are going up a lot.

With crypto, the first time ever, a user can hold electronic assets which a) are a mouse-click away, b) are difficult for the government to seize, and c) can have its audit trail concealed or obfuscated at at an unacceptably high cost for the government to disprove.

Wealthy crypto specs aren’t interested in evading taxes in any risky way. But normies hiding millions of crumbs from the government are a different story. It’s too much work for an “overworked” IRS, and the payoffs of finding individual needles in the massive haystack are too small to justify focused government investigation. Crypto, in the long-term, represents such a revival of financial due process for individuals that it will cripple the government’s power to tax.

The Treasury / CIA / NATO sanctions lobby

For the same reasons that crypto undermines the government’s long-term taxing power at a time when its need to tax is rising, crypto has been a preferred method of Bad People, both foreign and domestic, avoiding the worst consequences of de-dollarization.

The weaponization of the US financial system has been a 20-year mega-trend. It began after the Patriot Act of 2001 and had become a very low-cost, high-impact foreign-policy tool under the Obama Administration. By the Covid era, finance was weaponized not just at universal Public Enemies like Putin, but also domestic political opposition (Jan 6th protesters, “Covid deniers,” Canadian truckers, and individual targets of federal prosecution).

This lobby includes not just American law enforcement, but also foreign intelligence agencies and governments. They are fully capable of destroying almost any individual who uses crypto, but the crypto “haystack” evolves too quickly for them to be able to find the needles at sufficiently low marginal cost to scale web3 metadata the way they have scaled web2 metadata.

In other words, the web3 haystack is too varied, evolving too quickly, and too unstandardized for them to track at scale. In the short term, it’s easier for them to just de-dollarize that entire haystack.
Team Regulatory Capture (banking / payments / credit card / TradFi DC lobby)

This group, which is usually Warren’s and Gensler’s nemesis in DC, was happy to go along with them in this case, because they aren’t crypto stakeholders.

This is a really dumb argument. The US financial sector has had negligible endogenous innovation for decades, and America’s extreme levels of compliance bureaucracy are lethal for innovation. When every incremental product feature is held hostage by lawyers who are paid to tell you everything you’re doing is criminal (without having a clue about what you’re actually doing or needing to educate themselves about it), product and engineering quickly get the memo: don’t weird the suits out, create Asana tickets to document how new features are shipping. (If those “new features” are actually kind of pathetic compared to what’s on offer in the marketplace, it’ll be years before the suits will ever figure that out. By then, the good prod/eng’s will have jumped ship to a better company.)

As a result, in money and payments, American companies haven’t innovated at all. (I’m not counting “chipping away at inefficiencies idiosyncratic to the US payments system” or “building a Chase banking app” as innovation here.) But in mobile payments and mobile free to play gaming (the precursor industry to web3 gaming), Chinese companies like Tencent and Alipay were and are years ahead of American companies.

In crypto, Binance v. Coinbase is perhaps the most telling example. Coinbase had an infinite head start in resources & vision, yet is a dwarf compared to Binance today. I would argue that the sole reason for that disparity was Coinbase’s trust in America’s long-term regulatory sanity.

The heads-we-win-tails-you-lose vampire squid of 2008 was Wall Street banking, personified by Goldman Sachs. But the vampire squid of 2023 is an unaccountable regulatory Raj of unfireable, politically ambitious civil servants who lean into progressive policy priorities during Democratic administrations to climb the greasy pole in Democratic administrations, and wage low-risk, low-visibility guerrilla warfare against Republican administrations, advancing progressive policy prerogatives regardless of electoral outcome, piling up skulls of failed startups that bet on the long arc of regulation bending towards sanity in this first-world-to-turd-world country.

It’s hard to see how “regulated crypto” or “real-world asset crypto” work makes any sense an American citizen, outside of a major bank. And if you have ever worked inside a major bank, you know that their internal politics, compliance, and red tape make it impossible to take any risk outside of that bank’s most familiar areas. So the idea that US banks or RegFi will now take big share in blockchain development is, IMO, delusional.

This has a lot of profound implications for the crypto industry. To name a few:

The industry basically can’t use a USD stablecoin anymore, because the US government will annihilate whatever access point you use to interchange w/ dollars. The crypto industry has lost a key potential tether (no pun intended) to real-world cashflow. I’m still trying to process them all.
A decentralized stablecoin — the original Do Kwon vision — seems more prophetic, and more needed, than ever. But it needs time to evolve and take root, and it’s not clear that it can do so under existential threat of gov’t annihilation. And without diversified sources of cashflow and supply/demand of leverage (from being integrated with the real-world economy), any decentralized stablecoin will just be a roller coaster of DeFi leverage.

And this all happened without a single relevant law on the books. It just happened because a critical mass of feds agreed that crypto was bad, and kissing Elizabeth Warren’s ring was more important than creating a more honest kind of money.

If you are a young, single crypto dev, and you are really passionate about this industry, GTFO of the United States. You are a massive liability to any crypto project you work for, and as far as Uncle Sam is concerned, the world is his plantation.