Blockchain Bites: FCA’s Crypto Crackdown, McAfee’s Charges, Ethereum’s Store of Value

CoinDesk is preparing for the invest: ethereum economy virtual event on. Oct. 14 with a special series of newsletters focused on Ethereum’s past, present and future. Every day until the event the team behind Blockchain Bites will dive into an aspect of Ethereum that excites or confuses us.

The Top Shelf news you subscribed to is down below. 

Now, a few words from CoinDesk tech reporter Will Foxley.

Making consensus

Scaling for censorship-resistance
The shakedown of bitcoin derivatives exchange BitMEX last week is a healthy reminder of what motivates many DeFi developers: building censorship-resistant financial markets.

The meaningful comparison between BitMEX and decentralized finance, of course, is the self-executing nature of decentralized exchanges (DEX) on the Ethereum blockchain. Through bits and bytes, developers are working toward a future where U.S. regulators cannot take down financial markets – let alone any application built on top of the Ethereum blockchain.

Still, while theoretically capable of supporting a new world of censorship-resistant finance, the Ethereum blockchain has hit the hard limits of its own infrastructure. 

Ethereum isn’t ready for prime time performance. Its mainchain and many decentralized applications (dapp) can barely handle the economic strain users have put it under this summer, which saw fees shoot to record highs twice.

One of the most urgent and interesting questions in crypto is how to create a censorship-resistant economy that actually works. While there are no easy solutions to rising gas fees, it’s a topic drawing some of the most creative minds, all with their own ideas.

On Oct. 14, MakerDAO’s Rune Christensen and Near Protocol’s Illia Polosukhin will discuss the issue of gas fees at invest: ethereum economy. Others will focus on the future of Ethereum, and the long road it has taken towards scalability with Ethereum 2.0. While under development for years, this updated chain remains a gamble.

For instance, Phase 1.5 and Phase 2 – the latter stages of Eth 2.0 that should theoretically push the blockchain to tens of thousands of transactions per second – have not been fully scoped out. Some aspects remain completely unknown. (Perhaps as it should be, given the fast pace of discovery in crypto land.)

But phase 0 is nearly upon us. Multiple testnets have led developers and stakers to the autumn’s main event: the release of a deposit contract for stakers expected this month. Once enough ether (ETH) is deposited in the contract, the new Proof-of-Stake (PoS) blockchain can begin to turn along.

Called the Beacon chain, the PoS blockchain will act as a spinal cord of sorts for Eth 2.0’s multi-blockchain settlement scheme. For now, the Beacon chain stands as a symbol of a censorship resistant future. A promise of technology, but one under development.

It’s a topic Vitalik Buterin will likely go into during his keynote speech at Invest. Others, like Alchemy’s Michael Garland and Anchorage’s Diogo Mónica, will go further into the weeds, discussing not only the mechanics behind this multi-year blockchain swap but also why it matters for people’s bottom line during “ETH Staking: The Service You’ll Want to Buy.”

Join us for a day-long exploration of the ins and outs of the go-to platform for decentralized applications, its current setup and future roadmap.

– Will Foxley

Featured panel

Stake it or farm it? 
Ethereum has introduced new ways for people to get their money to work for them. Whether it’s securing or participating in a network or creating other interest from your money, new rewards and incentives abound for those willing to engage. In a panel discussion, titled “Making Your Money Work for You,” Gauntlet’s Tarun Chitra, Stake’s Tim Ogilvie and Balancer Lab’s Fernando Martinelli will discuss how to manage risks, optimize rewards and build a portfolio using ether-based assets. 

Tune in from 10:30 a.m. – 11:00 a.m. ET, Oct. 14.

Ethereum 101

Ethereum 2.0 represents the first time the cryptocurrency industry will see a blockchain of its size and value attempt to transition all users, as well as assets, to an entirely new decentralized network while keeping all operations on the old network active and running. 

So what will happen to your ether and non-fungible tokens (NFT) once Ethereum 2.0 goes live? CoinDesk research analyst Christine Kim explains.

Ethereum 2.0 is coming 
The years-long upgrade – intended to radically transform the world’s largest smart-contract platform – is inching closer to deployment. 

As of July 10, some developers, including Ethereum founder Vitalik Buterin, estimate the oft-delayed Eth 2.0 will launch by the end of this year. 

When phase zero of Eth 2.0 does ship, little about Ethereum will change in the near term for users and dapp developers. This is because unlike all other system-wide upgrades in Ethereum history, the Eth 2.0 overhaul will primarily be happening on a different blockchain. 

The first phase of development for Eth 2.0 is centered around the creation of a separate proof-of-stake blockchain network called the beacon chain. On this new network, ETH holders with a minimum of 32 ETH can earn rewards in the form of annualized interest on their wealth. To earn these rewards, ETH holders must have the appropriate hardware and software connecting to the beacon chain and a strong understanding of how the technology works. 

Ethereum as we know it today will eventually be folded into the Eth 2.0 upgrade in its entirety. The report features commentary from Ethereum developers about what benefits – but also risks – this may bring. 

The culmination of over five years of research and development, Ethereum 2.0 is a highly ambitious upgrade.

For an even deeper dive, CoinDesk Research published a 22-page report on “Ethereum 2.0: How It Works and Why It Matters.”

– Christine Kim

At stake

Osho Jha is an investor, data scientist and tech company executive who enjoys finding and analyzing unique data sets for investing in both public and private markets. 

In this essay, published in early 2020, Jha details why the transition to a Proof-of-Stake chain will turn Ethereum into a functioning store of value.

Store of value
Before diving into the impact that staking could have on ether (ETH), it is important to understand how the ETH “money supply” currently works. As we know, bitcoin (BTC) has a fixed supply of 21 million coins and the rate at which these coins are released into the money supply decreases over time. ETH does not have a fixed supply but, like BTC, it has a declining inflation rate.

There is a fixed issuance of new ETH annually. As the money supply grows, that fixed issuance becomes a smaller portion of the total money supply. As with BTC halvings, ETH over time has reduced the block reward for miners. The transition to Ethereum 2.0’s staking mechanism is set to reduce the inflation rate of ETH to 0.5%-2.0%, putting it in the same company as BTC and gold in terms of supply inflation. 

I look at ETH as the fiat to BTC’s gold. Despite negative connotations in the crypto community, fiat currencies aren’t inherently bad and the main advantage of an unfixed total supply is flexibility to adjust supply during different economic climates. Central banks have taken this flexibility to an extreme in recent years, and, while ETH’s supply is not fixed, its projected long term inflation may be a happy middle ground between fixed supply and unbridled money printing.

Demand-side dynamics
In many ways, ETH trades like a venture investment. Investors believe Ethereum will be the underlying technology for the future of decentralized apps and they buy ETH in the same way they would shares [of stock]. I find this troubling because, by its very nature, ETH is not a stock and these investors are taking on a bigger risk than they might think.

Staking is the key to making ETH function as a value store. At its core, staking incentivizes holding ETH in a node that can then be used by the network to verify transactions. The greater the number of nodes, the faster the network can function and the more secure it becomes. Staking is not new. Projects ranging from Hedera Hashgraph to Facebook Libra have some sort of staking mechanism built in. But they don’t have the advantage of being the de facto network decentralized app developers lean on.

For investors, there are incentives to staking tokens in a node, including rewards similar to earning interest on a bank deposit. While the staking rewards vary based on network performance and utilization, target returns are close to 10% annually. Though actual returns will vary as the network gets up and running, the possibility of earning returns on coins that would otherwise be in a wallet should entice ETH holders to stake.

In a global low-rate environment, these returns are certainly attractive. And staking may be the killer app that allows ETH to become a “positive carry asset.” In other words, it generates a positive return for holding it as opposed to, say, gold, which is negative-carry, as it incurs storage costs. Long term, positive carry stimulates demand and creates an incentive to borrow cash to purchase and earn yield. Overall, positive-carry assets increase stability of price movements by creating long term holders and widening the investor base.

Investors are becoming aware of this dynamic. To stake a node, there is a minimum required 32 ETH (thought staking pools can allow staking to be done with as little as 1 ETH). 

ETH as a store of value
Current events have forced us to adapt to a more digital life and also shown us the limitation of legacy banking systems. Even the distribution of stimulus checks became a nontrivial problem. With the market focused on bitcoin and its role in unstable economic times, the advances being set forth by Ethereum 2.0 have been largely overlooked. However, Ethereum 2.0 lays out a platform which can help create better digital experiences and ease the friction as individuals and institutions transition to a digital-first world.

As we mentioned earlier, staking will turn ETH into a positive carry asset, which in turn brings price stability and broadens the investor base. By staking accumulated tokens, investors will both earn yield and help scale the network in a secure way. 

While ETH is being staked, there is demand for stablecoins and banking-esque services, which are being deployed and iterated on in the DeFi space as a whole. With this dynamic, transactions can be made using stablecoins while ETH itself is staked to generate interest income. This may sound foreign and futuristic but it’s not much different than when people keep savings in an interest-generating savings accounts, or investments, and keep day-to-day money in a checking account.

– Osho Jha

The ledger

Going back to Will Foxley’s introduction, Ethereum 2.0 promises to revolutionize finance and the crypto economy, but there are still a lot of open questions.  Last year, my former colleague Leigh Cuen wrote an article examining many of the most contentious issues surrounding the development and eventual deployment of Eth 2.0.  During the largest blockchain overhaul to date, many of the nuances being discussed are reduced to simple gut reactions: is what’s happening a “scam” or an iteration. 

Iterative processes
For Ethereum’s critics in the Bitcoin community, [September 2019] brought a “gotcha” moment.

Joseph Lubin, co-founder of the second-largest cryptocurrency by market cap, acknowledged onstage at Ethereal Tel Aviv that the network, in its original form, wasn’t built for mass adoption. “We knew it wasn’t going to be scalable for sure,” the ConsenSys CEO said.

Predictable cries of “scam” from ardent bitcoiners followed. But Lubin’s statement wasn’t scandalous in the least to the Ethereum fans at Devcon – the community’s largest and most influential annual gathering – where roughly 3,000 attendees gathered this week in Osaka, Japan.

Even those who knew the first version wasn’t scalable don’t see early marketing claims as misleading. They see iteration as an inherent process.

“Bitcoiners are kinda like hardcore fascist Catholics that just think everything else is wrong,” Dean Eigenmann, a researcher at the Ethereum startup Status, said [in 2019]. “I think [Ethereum] underdelivered on its promises, but it has delivered.”

The sanguine vibe at Devcon highlights the difference between Bitcoin and Ethereum, which has emerged as its own force to be reckoned with: Bitcoin is an individualistic monetary asset while Ethereum, convoluted as its path to mass adoption may be, is a communal promise to continue experimenting with smart contracts, together.

James Prestwich, one of the leaders of a project aiming to create cross-chain capital flows between Bitcoin and Ethereum, said at the time he believes all cryptocurrency narratives evolve. So even if a blockchain manifests something different than the original white paper, that doesn’t make it a scam.

So what have the Ethereum founders delivered since they sold more than 7 million tokens to retail investors to kickstart the network in 2014?

The original Ethereum platform inspired billions of dollars worth of economic activity, from token sales to DeFi loans, and influenced the way regulators view cryptocurrencies that “decentralize” after fundraising. 

But the jury is still out as to whether that accrued value will translate to the next version of the smart contract platform.

‘Lack of strategy’
Devcon attendees weren’t shy in discussing the road ahead, or who will fund this work.

According to Peter Mauric, Ethereum client Parity’s head of communications, the bulk of Ethereum-related funding programs will now prioritize creating a new blockchain, Eth 2. Sources with knowledge of such development plans estimated it would take at least two years to build this next version of Ethereum.

“No one really knows what Eth 1 will look like once Eth 2 exists,” Mauric said at the time. “There’s not a ton of new development going on in the current chain clients. Most of the ongoing work is maintenance.”

There’s no clear plan for how to migrate hundreds of Ethereum-based tokens and smart contracts, including DeFi projects, to the new chain in the foreseeable future, according to Buterin, Prestwich and Mike Porcaro, head of communications at the MakerDAO Foundation.

Developer Jamie Pitts, contracted by the Ethereum Foundation, kicked off the opening ceremony on Tuesday by sharing his concerns.

“I feel like there’s a lack of strategy,” Pitts said. “I think there’s a lot of teams working on their ideas, but there’s a lack of coordination.”

According to James Beck, communications lead at ConsenSys, the Brooklyn-based venture studio helmed by Lubin, there were in 2019 nine teams working on clients for the upcoming Eth 2 blockchain, including Prysmatic Labs, Chainsafe, Status and the ConsenSys-owned startup PegaSys.

However, according to several sources with knowledge of Ethereum infrastructure projects, the bulk of funds for Eth 1 and Eth 2 development still comes from either the Ethereum Foundation or ConsenSys, in addition to smaller funding mechanisms like the MolochDAO and the Meta Cartel, both of which also accept public donations. Pitts told CoinDesk this doesn’t concern him because these funders don’t control development choices.

While there are still many unanswered questions about how the project will diversify beyond reliance on funding from its founders, Josh Cincinnati, director of the Zcash Foundation, said Ethereum has achieved a significant level of decentralized participation from the bottom-up.

“Something Ethereum has proven to be really good at is making exotic financial contracts approachable for developers,” Cincinnati said.

Vitalik’s view
From Buterin’s perspective, Eth 1 was a successful experiment that paved the way for Eth 2, which will require a focus on incentives, through Proof-of-Stake, before live transactions.

“I’d argue it has done a lot of good. The ICO boom has pretty much single-handedly funded research into all of these general cryptography things,” Buterin told CoinDesk.

As for layer-two solutions, which allow a high number of transactions to take place off-chain and reserve the ethereum ledger for final settlement, Buterin said some are proceeding “slower than expected. Raiden hasn’t gotten too far too fast and Plasma hasn’t gotten too far too fast. But people are still iterating and working on that.”

Buterin also mentioned pressure from businesspeople who discouraged him from speaking openly about these scaling challenges, which, as noted, many felt were obvious.

“You’re not supposed to say your own platform has limitations,” Buterin said.

Top shelf

McAfee arrested
John McAfee, the 74-year-old software magnate turned crypto bull, was reportedly arrested in Spain on allegations of tax evasion, according to the U.S. Department of Justice. His extradition to the U.S. is pending. The announcement comes the same day the U.S. Securities and Exchange Commission (SEC) sued McAfee for allegedly pumping initial coin offerings (ICOs) without disclosing he was being paid to do so. McAfee is said to have received BTC and ETH worth more than $11.6 million for promoting seven ICOs in 2017 and 2018. He also allegedly received $11.5 million in the promoted tokens. The SEC does not name the projects in the suit.

Crypto crackdown
The Financial Conduct Authority (FCA) has published final rules banning the sale of derivatives and exchange-traded notes (ETNs) that reference certain types of crypto assets to retail consumers. The U.K. financial regulator said it considers these products to be ill-suited for retail consumers due to the harm they pose. Specifically, the ban will affect “the sale, marketing and distribution” to retail investors of any derivatives contract or ETNs that are linked to “unregulated transferable crypto assets” issued by entities in or outside the U.K. The U.K. ban will come into effect on Jan. 6, 2021. Some U.K.-based crypto firms plan to dispute the ruling.

Buck up
Bitcoin is unlikely to replace the greenback as a global reserve currency any time soon, according to one of the most highly regarded analysts in foreign exchange. “Backing the dollar is the world’s biggest, deepest and the most transparent government bond market,” Marc Chandler, chief market strategist at Bannockburn Global Forex and author of the book “Making Sense of the Dollar,” told CoinDesk in a recent video chat. “I just don’t know how bitcoin can replace the greenback from that viewpoint.” CoinDesk’s Omkar Godbole reports, before bitcoin can threaten the dollar’s hegemony, the crypto community’s focus needs to shift from playing for price rallies to building infrastructure that would accelerate adoption at the institutional level. 

Ripple suit
Ripple was only partially successful in its bid to have a class-action lawsuit over alleged securities fraud thrown out. In a court ruling filed last Friday, District Judge Phyllis J. Hamilton granted with prejudice two parts of Ripple’s motion to dismiss the 10 claims against it and its CEO, Brad Garlinghouse. The accusations come as a consolidated action from a group of disgruntled investors who claim Ripple and Garlinghouse failed to register XRP as a security and made misleading statements about the cryptocurrency. Judge Hamilton ruled that some of the plaintiff’s claims were unsupported, though the case was not dismissed. 

Going dark
Popular privacy-enhancing cryptocurrency wallets and other technologies were named as “top threats” in Europol’s 2020 Internet Organized Crime Threat Assessment published Monday. According to a report by the European Union’s law enforcement agency, “privacy-enhanced wallet services using coinjoin concepts (for example, Wasabi and Samurai [sic] wallets) have emerged as a top threat in addition to well established centralized mixers.” And, “Criminals have started to use other privacy-focused, decentralized marketplace platforms, such as OpenBazaar and Particl.io to sell their illegal goods,” the report says. According to the report, bitcoin remains the top currency on the darkweb, though privacy coins are seeing increased use.

Quick bites

• BitMEX Ether Futures Trading Contracts Fall by Half in Wake of US Charges (Omkar Godbole/CoinDesk)
• Downvoted: Security Researchers Slam Voatz Over Stance on White-Hat Hackers (Ben Powers/CoinDesk)
• CBDC Design Needs to Address Risk to Users, Says Bank of Canada (Daniel Palmer/CoinDesk)
• Guggenheim-Collected Artist to Release Digital Artwork on Blockchain Marketplace (Sebastian Sinclair/CoinDesk)
• Binance Alliance With Japanese Crypto Platform Abandoned (Sandali Handagama/CoinDesk)

Who won #CryptoTwitter?