Lack of transparency: Is crypto market change imminent?

Regardless, change is coming, and it’s critical that leaders in this industry drive that change in a responsible way.

Looking back at the development of the crypto industry in recent years, the yield on US government bonds rose by nearly 70 basis points in October over a 10-year period, from 3.65% at the beginning of October to 4.30% at the end of the month. In this rapid rate hike and subsequent explosion of the US dollar, the Bank of England was forced to intervene to support the gilt market, while the Bank of Japan continued to intervene to support the yen. It is only a matter of time before the Fed's chicken game ends.

Fittingly, Wall Street Journal reporter Nick Timiraos finally puts the point across what most market participants have come to agree on: the damage the Fed has done is excessive and it needs to slow down. The Fed admits they must stop wrecking global markets, but they can’t explicitly say they will turn around because that would satisfy the stock market that the morally dangerous “ Fed put option” is still in play.

So the Fed will still try to talk tough, but ultimately is setting the stage for the inevitable dovish turn. The market agrees, bonds have rallied sharply, stocks have surged. The consensus now is that the last 75bp rate hike is a few weeks away, as the market thinks we have reached the ceiling for rates.

Of course, this doesn't mean that the market is completely out of the woods. But it does allow investors to re-select winners and losers rather than style drifting into a macro playbook. Moreover, while higher absolute rates will ultimately make certain investment strategies more difficult (such as arbitrage and leveraged buyouts), it opens the door to other opportunities. For example, certain long/short trades become more attractive when investors can offset the negative carry on shorts with the positive carry on high-yield bonds.

One place this is happening is with stablecoins. Tether (USDT), the leading USD stablecoin, has been popular among visitors who don’t believe stablecoins are adequately backed. Regardless of the likelihood of success, the risk/reward is undeniable and increasingly attractive.

Tether trades at $1 and (theoretically) cannot go above $1, but if the USD peg breaks and there aren’t enough liquid assets to redeem it, USDT could be worth a fraction of its perceived value. Borrowing USDT at 8-12% and shorting USDT is difficult when interest rates are below 1%, IG bonds trade at 3%, but Treasuries are at 4%, IG bonds at 7%, and HYs at 10%+, offsetting the 10% negative carry on high yield longs becoming more palatable.

This is exactly what we are seeing on digital asset exchanges today. Demand for USDT has increased (especially from TradFi investors), so lending rates have risen, and short rates have increased. This does not mean that Tether is riskier today than usual, quite the opposite. In fact, Tether keeps the interest it earns on its float, and with short rates around 3%, $68 billion in cash is now earning over $1 billion per year in interest. The fundamentals are stronger, just as it has become easier to finance shorts.

Confocal Points: Aptos, SBF, and Lack of Transparency

Aptos launched its much-anticipated mainnet last Monday. However, the release has been met with a lot of skepticism. Developers from the Meta (Facebook) blockchain project Diem created Aptos, which has been called the “Solana killer.” The project has already been plagued by inconsistent communications (Discord community communication channels frozen) and significantly low transaction throughput in just one week. But more importantly, it has been a lightning rod for criticism of VCs, who continue to fund digital asset projects at insane valuations with favorable unlocking schedules that allow them to quickly sell to retail and the digital asset exchanges that serve and support this VC community. Worse, it is difficult to distinguish between the two in many cases, as there is a lot of overlap and conflict of interest.

If you consider the following, Aptos (APT) might actually win the award for the most predatory launch since the Internet Computer (ICP):

1. There are clear conflicts and overlaps of interest between the largest investors and the exchanges that list tokens.

2. Intentionally vague token economics.

Aptos raised ~$350M from a group of investors including FTX, Coinbase Ventures, and Binance (along with a16z, Multicoin, and Jump). Not surprisingly, on October 19, 2022 (just 1 week after the token generation event), the APT token was listed on FTX, Coinbase, and Binance. It’s rare for any exchange to list a token so quickly before it has any functionality, utility, or demand , let alone 3 exchanges that are widely considered to be “tier 1” exchanges. Even more shocking is that no token economics were available until less than 24 hours before the listing. Still, this last-minute release leaves a lot to be desired.

Of the 1 billion total supply (broken down below), only 13% is thought to be in circulation. Presumably, the 2% airdrop to testnet users (~20 million) is part of the ~125 million community portion designated for ecosystem-related projects like grants, incentives, and other growth initiatives. Beyond that, we know nothing about the actual float. Does the 2% airdrop consist of the entire circulating supply (excluding tokens given to market makers)? Will the foundation sell tokens to the listing to diversify its funds? From the initial 125 million, how many tokens will be allocated to ecosystem projects, and what is the timeline for that allocation?

Furthermore, the “lockup” is not a lockup at all. While investors and core contributors will not vest for at least a year, both vested and unvested tokens can be staked to earn a yield (7% per year), and these stakers’ rewards are vested and can be sold immediately. Additionally, there is a 1 week pre-mine prior to the token generation event. At an 80% stake ratio, the foundation and community earn another ~60 million tokens per year, but there are no details on the distribution mechanism. By now, it should be clear that these token economics are too ambiguous to be useful to anyone. They are a complete predator for retail investors who trade new APT tokens on exchanges without being able to discover more information.

There has been a fair amount of criticism about the release, but honestly, it doesn’t go far enough. These practices have been going on for years. Arca and several others frequently point to them as an effort to encourage greater transparency — but to little avail.

Even more telling is that the same exchanges that list tokens, FTX, Coinbase, and Binance, are asking the SEC to provide more regulatory clarity. It is disingenuous to publicly call on the SEC to establish clear rules that protect investor rights while providing listing support for projects that lack transparency and disclosure details. Exchanges that have investment arms have a clear conflict of interest and should be held to a higher standard and not regulated.

With this in mind, it’s no surprise that Sam Bankman-Fried is starting to receive heat for his recent proposals for digital asset regulation and new industry standards. On the surface, SBF has earned his stripes and reputation. It’s great that he’s using his large platform and influence to try to implement change. He’s not asking to be the de facto leader of the market, but he’s become one of them and is rising to the challenge. But, on the other hand, the hypocrisy of constantly begging for change when you’re one of the biggest beneficiaries of the current “no rules” environment is a bit too much for some market participants to stomach.

Regardless, change is coming, and it’s critical that leaders in this industry drive change in a responsible way. But it’s not too much to ask them to self-regulate. Perhaps if they play by the rules they expect before clear rules are in place, it will lead to more favorable regulation and a less divided community.