Salute to the bulls, and wish you a Merry Crypto Christmas!

Cryptocurrency not only survived the collapse of FTX , but also became a hot investment this year. It turns out that decentralized finance does not require exchanges.

Happy Crypto Christmas! Bitcoin is up 167% this year and Ethereum is up 91%. If you had predicted these gains a year ago, my hat is off to you. Crypto's ROI has been outstanding compared to other asset classes. Remember, the Nasdaq is up 36%, the S&P 500 is up 19%, and gold is up 10.7%. If you were bullish on oil or commodities, you would have had a negative ROI of 10% to 12%.

A year ago, many of us (myself certainly included) thought the game was over for cryptocurrencies and that the crypto naysayers would be proven right.

It’s no shock that Sam Bankman-Fried has fallen. He’s now in prison on seven counts of financial fraud, and his exchange FTX is defunct. The fate of rival Binance hangs in the balance following an investigation by the U.S. Department of Justice. Binance ’s founder, Changpeng Zhao, admitted to money laundering violations, stepped down as CEO, and agreed to pay a $50 million fine, while Binance was fined $4.3 billion.

By this time last year, the storm of scandals surrounding cryptocurrency exchanges had convinced me that the blockchain-based financial system was extremely bad and that I should immediately sell most of the Bitcoin, Ethereum, and other tokens I had acquired since becoming a crypto believer in 2017.

What a fool I was. I forgot the first rule of crypto investing: Once you buy, you should always HODL. Hold on!

How wrong my decision to sell at the bottom (SATB) was can be seen in the transformation of Nouriel Roubini (Translator's Note: A well-known American economist who predicted the 2008 financial crisis. He is also a public critic of cryptocurrency and blockchain technology, and often questions the sustainability, security and value of Bitcoin and other cryptocurrencies.) - just a year ago, he was gloating over the demise of all the "shitcoins", but now he is launching his own blockchain-based "flatcoin".

The past 12 months have made it even clearer that cryptocurrency exchanges or other custodial intermediaries are not, and never will be, the core and key to the future development of blockchain fintech.

Don’t forget, the original intention of all this was to enable peer-to-peer transactions without the involvement of intermediaries such as banks and without involving state surveillance. In retrospect, the period when cryptocurrencies were dominated by exchanges should not have existed at all, as the centralized role of these platforms ran counter to the original concept of decentralized finance.

The only reason exchanges have sprung up is because it is technically difficult to exchange cryptocurrencies directly between parties without an intermediary platform. Early participants used a website called LocalBitcoins , which functions similarly to Craigslist. Users would post ads to buy and sell Bitcoin on the website and then choose the payment method they wanted to settle. Although cryptocurrency trading is still somewhat complex, and I encountered some problems when using Ledger and Metamask , the whole process is gradually becoming more convenient.

However, the key steps of cryptocurrency deposits and withdrawals are now almost entirely controlled by regulated exchanges. Among them, Coinbase looks like a survivor after a series of scandals, and therefore a winner. The cryptocurrency industry is still full of risks because the connection between traditional finance and decentralized finance is monopolized by a few leading platforms.

The year-long rally in BTC and ETH tells us three things:

First, as the world suffers the consequences of poor fiat currency management after two decades of historically low inflation, interest in cryptocurrencies is bound to continue to grow. According to the International Monetary Fund , of the 191 countries for which records are available, only 22 have seen consumer prices rise by less than 10% since 2019. Another 68 countries have four-year inflation rates between 10% and 19%; 42 countries have between 20% and 29%; 46 countries have between 30% and 99%; and, sadly, 13 countries have seen consumer prices rise by more than 100%. If we had reliable data for Lebanon and Syria this year, the number of countries with increases of more than 100% would be even higher.

In Argentina, consumer prices increased eightfold in four years, in Sudan they increased 103fold, in Zimbabwe they increased 159fold, and in Venezuela they increased more than 5,000fold.

The worse the inflation, the more attractive cryptocurrencies become. The current mood in Argentina is telling. Last Sunday, libertarian economist Javie Milei was sworn in as president. Unlike crypto investing, this is one thing I got right this year: I have been promising my Argentine friends all year that when inflation reaches 100%, voters will choose radical solutions over mainstream ones.

Milei is radical to the point of paranoia. He sports a haircut like a sixties rock star—almost like he stepped off the cover of an old Yardbirds album. His presidential scepter is inlaid with silver carvings of his five English mastiffs and their names: Conan (named after his previous dog, from whom all five were cloned), Milton after Chicago free-market economist Milton Friedman, Murray after Austrian-influenced libertarian Murray Rothbard, and Robert and Lucas after Robert Lucas, another Chicago School master.

Some English-language media have mistakenly lumped Milei in with right-wing populist figures like Brazil’s Jair Bolsonaro. Milei is a very different breed. He announced his intention to convert to Judaism at a time of surging anti-Semitism around the world and made his first overseas trip as president to the graveyard of an obscure Hasidic rabbi in Queens.

In his inaugural speech, Milei told the crowd: "We have no choice but a major fiscal adjustment," and warned them of the coming recession. The crowd responded with "Motosierra! Motosierra!" (Chainsaw! Chainsaw!) - a show of support for Milei's promise to cut public spending. Milei told the crowd: "There is no money." Hearing this answer, the crowd cheered. Milei's balanced budget plan was the most daring shock therapy the world has seen since Margaret Thatcher became British prime minister.

However, it was explained to Milei that his cherished wish - to exchange the Argentine currency for dollars - was not feasible. The Argentine central bank was short of dollars, and the very mention of dollarization would risk sending the already collapsing Argentine currency into hyperinflation. As a result, Argentines who were paid in pesos and saved in pesos were bound to see their currency depreciate further - a depreciation that had already begun last week.

At times like this, every Argentinian would like to own some Bitcoin, right?

The second lesson is that cryptocurrencies have evolved.

The first cryptocurrency bull run was driven almost entirely by a belief in Bitcoin’s technology as a potential censorship-resistant digital cash. That run was interrupted by the first major hack of the Mt. Gox exchange in 2011, which lost about 25,000 Bitcoins. Although Bitcoin quickly recovered, the era ended in 2013 and 2014 with the FBI’s shutdown of the darknet marketplace Silk Road and the collapse of Mt. Gox, which handled 70% of Bitcoin transactions at the time.

The second bull run of cryptocurrencies began around 2016, driven primarily by the initial coin offering (ICO) boom on the Ethereum network. ICOs are speculative activities where crypto teams sell tokens to retail investors. These teams promised to build smart contract blockchains that were better than Ethereum. However, when it was discovered that these blockchain projects had almost no "useful" activity, the industry fell into another cold winter.

The 2020 bull run seems to have answered questions about the usefulness of cryptocurrencies, starting with the “Summer of DeFi ”, followed by the craze for decentralized autonomous organizations (DAOs) and non-fungible tokens (NFTs). Crypto networks now appear to be embracing activity from real users, both retail and institutional, although much of it is highly speculative and high-risk, often involving huge amounts of leverage. It is this excessive risk level and poor financial engineering that has led to the failure of projects such as Terra and the bankruptcy of funds such as Three Arrows Capital.

Today, the total value of assets locked in DeFi smart contract protocols (TVL, Total Value Locked , refers to the total value of digital assets pledged by users in a crypto project) is basically the same as in 2022. However, according to the analysis of Manny Rincon-Cruz , a researcher at the Hoover Institution, this data actually reveals that cryptocurrencies are transforming from high-risk tools to safer bond-like assets.

During the bull run of 2020, the most used DeFi protocols were margin lending platforms and decentralized exchanges. In contrast, today’s DeFi is mainly about yield-bearing assets, which include not only interest-bearing lending positions, but also tokenized real-world assets such as treasury bills.

But the most important yield-earning assets today are liquid staking protocols, which are simply a way for users to delegate their tokens to validate and secure blockchain networks. For example, users can deposit their Ethereum into the Lido protocol, which delegates the work of building transaction blocks on the network to a network of Ethereum validators to earn Ethereum fees, which are then returned to the user. (Liquid staking is roughly similar to how Bitcoin users can use Bitcoin to participate in Bitcoin mining.) Today, the largest liquid staking protocols already account for 56% of DeFi TVL, up from just 0.1% at the beginning of 2021.

It’s unclear what the consequences of this focus on yield will be, but in 2024 and 2025, the cryptocurrency industry will likely continue to develop more useful and less speculative ways to use peer-to-peer protocols.

The third lesson for 2023 is that traditional finance continues to adopt cryptocurrencies despite efforts by regulators and lawmakers to stop it.

Asset managers that filed BTC and ETH exchange-traded fund filings with the U.S. Securities and Exchange Commission (SEC) this year include Franklin Templeton and BlackRock, as well as Grayscale , an early player in the space, which created the earliest BTC OTC fund in 2013. Grayscale applied to convert its Bitcoin Trust into an ETF in 2017, but withdrew its application after receiving negative comments from the SEC . Today, the SEC continues to extend its response deadline, indicating that it cannot find sufficient reasons to reject these ETF applications.

Meanwhile, under a new set of cryptocurrency accounting rules released a few days ago by the Financial Accounting Standards Board, U.S. companies that hold cryptocurrencies will be required to record their tokens at their most recent price or “fair value.”

The “adoption” problem is one of the main reasons why cryptocurrencies are misjudged dead. I made this point in the 2018 revised edition of my book The Ascent of Money, and it should stick:

Bitcoin is portable, liquid, anonymous, and scarce. It is designed to be “digital gold.” It’s easy to understand that $6,000 is still a bargain for this new store of value. To date, about 17 million Bitcoins have been mined. According to Credit Suisse, there are 36 million millionaires in the world with a combined wealth of $128.7 trillion. If these millionaires collectively decided to hold just 1% of their wealth in Bitcoin, the price of Bitcoin would be over $75,000—and even higher if lost or hoarded Bitcoins are taken into account. Even if millionaires only held 0.2% of their assets in Bitcoin, the price of Bitcoin would be around $15,000.

This range prediction was almost exactly right. In November 2021, the Bitcoin price peaked at $63,621. A year later, the Bitcoin price bottomed out at $15,460. The current price of around $40,000 is about the middle point.

If you believe, as I do, that law-abiding citizens should not have their trading activities subject to government scrutiny by default, then you should be excited about the rise in popularity of Bitcoin.

We read a lot about the First Amendment these days—a feature of the Constitution that Harvard students recently discovered when they were researching anti-Israel slogans—not to mention the Second Amendment, which tends to come up at Republican primary events. But free speech and the right to bear arms weren’t the only freedoms the Framers cared about.

The Fourth Amendment provides:

The people shall have the right to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, and no warrant shall issue, but upon probable cause, supported by oath or affirmation, and particularly specifying the place to be searched, and the persons or things to be seized.

One of the most compelling papers I read this year was “Electronic Cash, Decentralized Exchange, and the Fourth Amendment” by Peter van Valkenburgh of Coin Center .

Valkenburgh argues that the undermining of our Fourth Amendment rights began with the passage of the Currency and Foreign Transactions Reporting Act in 1970. This law and subsequent amendments, along with other related statutes, are collectively known as the Bank Secrecy Act (BSA).

The BSA requires banks to keep records of cash purchases of negotiable instruments, submit cash transaction reports with a daily total of more than $10,000, and report suspicious activities suspected of money laundering to relevant agencies. The reports that U.S. financial institutions are required to submit are called Currency Transaction Reports and Suspicious Activity Reports (SAR). Banks are also compensated for their compliance.

To some, the legislation was a clear violation of the Fourth Amendment. “I am not ready to consent that the United States has been led by evil powers to pursue a course calculated to remove all constitutional obstacles to its application to the government’s pursuit of criminals,” Justice William O. Douglas wrote in a dissenting opinion.

But Douglas—a progressive figure with a strong commitment to civil liberties—was in the minority. The BSA was upheld by the Supreme Court in California Bankers v. Shultz (1974) and US v. Miller (1974), establishing the principle that if a person hands over financial information to a third party such as a bank, that information is no longer private.

Today, this third-party principle is challenged because our electronic data is now in the hands of another third party: big tech companies. For example, since Carpenter v. US (2018), the government needs a warrant to obtain an individual’s cell phone location history.

Nevertheless, the scope of the BSA has continued to expand as the proportion of cash transactions in total transactions has declined and the government has increased its monitoring of financial transactions after the 9/11 terrorist attacks, with the number of SARs soaring from 60,000 in the 1990s to 3.6 million in 2022.

The possibility of truly peer-to-peer transactions created by blockchain technology poses a fundamental challenge to this financial surveillance regime. As Valkenburgh admits, Bitcoin is not a true "crypto" currency because the identities of transactors can still be deduced from the unchangeable ledger records.

However, innovative technologies like Tornado Cash are making truly anonymous peer-to-peer transactions possible. Unless the software developer is a third party and collects user data, there will be no third party involved in the entire transaction process.

Valkenburgh concluded, “As the world increasingly turns to fully intermediary and surveilled payment technologies like Alipay, WeChat Pay, or so-called central bank digital currencies (CBDCs), true decentralized finance is essential to preserving human dignity and autonomy. Anonymous electronic cash and decentralized exchange software are the ultimate goal of all cryptocurrency networks.”

You don’t need to know Senator Elizabeth Warren or SEC Chairman Gary Gensler personally to guess that they would strongly oppose this argument. They and others would inevitably call for imposing BSA compliance obligations on encryption software developers as well as individual users of that software. However, their approach would surely be unconstitutional under the Fourth Amendment because it would amount to a warrantless search and seizure of private information.

The reasons why the government is likely to win this battle are obvious. As long as people like SBF exist in the world, and as long as terrorists can benefit from unscrupulous cryptocurrency operators, the government will continue to claim that while the Fourth Amendment is to be respected, it can be violated when necessary.

But what the government can’t do — even if JPMorgan Chase CEO Jamie Dimon wanted to — is outlaw cryptocurrencies entirely and allow a shrinking number of U.S. banks to benefit from a monopoly on financial transactions.

Once again, Merry Crypto Christmas to all of you. Hang on for the rest of your wonderful life! Just don’t count on the Fourth Amendment to protect you.