For Democrats, it was a moment of truth. For Republicans, it was “fake news.”
Among some members of the crypto commentariat, there was a very different reaction to The New York Times’ recent scoop on Donald Trump’s tax returns – a bombshell story to kick off a week of even bigger bombshells about the now COVID-afflicted U.S. President. Rather than challenge the story, they challenged the response to it.
The CEO of cryptocurrency exchange Kraken, Jesse Powell, said it was “fake outrage” and defended citizens’ rights to minimize the state’s incursions into their private property with “legit deductions.” National Football League star and prominent bitcoiner Russell Okung said “Focusing on Trump’s tax returns feels so ...trivial.” And the popular Twitter handle of @DrBitcoinMD suggested the best response would be to abolish the Internal Revenue Service and end taxation altogether.
With eyes wide open to the inevitable Crypto Twitter backlash, let me say these libertarian-inclined takes are wrong-headed. The outcry over a person of such power and privilege paying less to help fund our government than pretty much every other American is not just understandable; it’s a catalyst for badly needed change in the very economic system that the crypto community rightly rails against.
Also, whether we like it or not, taxation – defined broadly as a means by which a community collectively redistributes resources toward defending its common interest – is vital to any governance system. And that includes blockchain governance systems.
Think beyond the functional transaction of a government taking 20% of your paycheck to pay for roads, armies, courts and so forth. Instead, view a nation, or a blockchain’s user base, as a community that needs someone or something to set, enforce and interpret the rules by which its members engage in economic exchange. Without those rules, a community ceases to function, or even to exist. By extension, taxation is unavoidable.
The relevant question, then, is not whether we should pay taxes but how? What is the optimal balance between private interests and public interests? What is fair? Or, better put, how do we make that system reflect our shared interests and not those of the administrators of the taxation regime? Our goal should be to make tax a service, not a means to accumulate unidirectional power.
On this, crypto may have some answers.
Paying for system security
To more deeply explore the parallels between nations and blockchain, we can think of cryptocurrency miners as occupying both the executive and judicial branches of government.
Miners police the ledger and ensure it’s secure for everyone else to use. They also act as judges interpreting the underlying protocol’s “laws,” a process that plays out when there’s a fork in the code. For carrying out these functions, miners use costly energy resources (in proof-of-work mining) or incur opportunity costs in having to lock up funds (in proof-of-stake systems).
And the legislative branch? That’s the developers who write the code that defines the blockchain protocol’s governance rules. They also find bugs – somewhat analogous to unintended legal loopholes – and thus keep users safe from exploits and failures. Doing so, they expend resources in terms of time worked and ideas shared.
The question of how to reward developers has always been tricky for blockchain governance, because most blockchains are open-source projects and because the wrong incentives could create perverse outcomes. (See ICO scams.) Hence the debates over Zcash’s otherwise well-intended 20% developer reward. And the concerns in 2015 about a VC-funded Bitcoin Association’s potential for conflicts of interest that led MIT Media Lab’s Digital Currency Initiative to take over responsibility for some Bitcoin developers’ salaries. (Disclosure: I took a job at the DCI immediately after that and am still an unpaid adviser there.)
Still, some form of reward to these various “governors” of the system is necessary. This leads to questions not only about who to compensate but about how to obtain the resources for that, and from whom. There are many options.
Most blatantly, taxes can be imposed by directly extracting individual users’ property. For traditional governments, this presents itself as income and property taxes, as well as sales taxes and usage fees for government services. In blockchains, it appears as the transaction fees demanded by miners and validators.
Tax can also be imposed more subtly via an increased money supply, which dilutes the value of users’ property by way of inflation while generating seigniorage income for whichever entity enjoys initial ownership of the currency. Currency-issuing governments monetize their debts this way, but it’s also how Bitcoin users are taxed when miners are rewarded with 6.25 bitcoins for securing a block.
Conflicts and compromises
Given the reality that resources are always limited, decisions over the various design options for these taxation systems are inherently political.
Should a progressive income tax or a regressive sales tax be used, or a combination of the two? Or should we do away with all taxes and instead fund the security system through monetary dilution and managed inflation? (Many crypto libertarians seem opposed to both choices, which leaves us nowhere.)
Similar debates exist in blockchain development. Is a proof-of-work system, with its tendency toward expensive industrialized mining, preferable? Or is proof-of-stake, which is criticized for a bias toward the richest members of the community, better?
The main point, though, is that doing nothing is not an option. The security of the system must be paid for, which means users must be taxed, one way or another.
So we have to compromise. And for that, questions of fairness are vital.
The word “fair” is sometimes maligned for meaning a socialist-leaning version of “equal.” But, to me, it speaks to finding a balance that attracts sufficient consensus to assure the sustainability of the system. It’s the optimal design for breeding trust.
Right now, consensus within the U.S. is as weak as anyone can remember. There’s similarly a lack of consensus among the various crypto tribes competing to be the dominant system. And while they might not use the word, much of that reflects disagreement on which “taxation” systems work best.
The nice thing is that it’s much easier for blockchain users who disagree with a particular taxation model to vote with their feet, to sell one token and buy another, than it is for a citizen of a conflicted nation to emigrate to a better-managed one. In a blockchain, there’s no state power employing its monopoly over legitimized violence to coerce you to stay or go.
So, there’s a lot the crypto community can add to debates over governance models. Just don’t buy into the myth that taxes are unnecessary.
A must-attend Ethereum event
The Ethereum Foundation’s plan to create a new governance model is reaching a critical juncture with the first “Beacon Chain” phase of its long-awaited Ethereum 2.0 upgrade supposedly coming soon. It arrives at an intense moment in the blockchain’s history, as interest and investments in Ethereum-based decentralized finance, non-fungible tokens and stablecoins have exploded.
To mark it, CoinDesk is putting on a star-studded virtual event on Oct. 14. Ethereum founder Vitalik Buterin will provide the opening keynote, and I’ll be sitting down (virtually) with Commodity Futures Trading Commission Chairman Heath Tarbert to get his take on how regulators will view Eth 2.0 services like staking and what they make of DeFi.
If you’re at all interested in what the future of Ethereum, as well as Dapps, DeFi, NFTs and stablecoins, please register.
Bitcoin and inflation expectations
As noted in prior editions of Money Reimagined, it’s been hard to nail down a consistent theme for investors on bitcoin’s direction this year. At one point, amid the initial COVID-19 shock, bitcoin seemed correlated with gold because both collapsed while a panicked world rushed into dollars. Then, as the Federal Reserve slashed interest rates and bought assets to create bank reserves, the pair recovered in unison as the dollar lost ground.
But soon thereafter they parted ways as bitcoin formed a closer correlation with stocks. More recently, as the market has digested a Fed shift to a more lenient stance on inflation, BTC-gold is back in vogue. It’s all a bit frustrating: whereas bitcoin was once prized as an uncorrelated asset that could add unexpected alpha returns, it’s now in the worst of both worlds: an asset that keeps changing its dancing partners.
This may all be a function of the denominator. Everything is based in dollars, and it’s the dollar that’s moving around against everything. So bitcoin, also quoted in USD, ends up running in lock-step with everything else. We shouldn’t over-analyze occasional departures from trends here and there.
Still, the bitcoin economy is tied to a narrative. And that prevailing narrative is about the looming failure of fiat money: the idea that profligate governments and their complicit central banks will lose control of their currencies’ value, fomenting out-of-control inflation. I personally think consumer-price inflation won’t appear for some time, but do believe the disjuncture between a booming stock market and a deeply depressed real economy is a sign of the kind of financial dysfunction that will make bitcoin attractive regardless of what the Consumer Price Index (CPI) actually says.
Still, given that I’ve been looking for some other indicator that might capture the meta bitcoin narrative, I was happy to get the chart below from my colleague Omkar Godbole. It reminds us not to look at inflation itself, but at how the market is pricing inflation expectations. What people think about future inflation and how about Bitcoin’s place in the world seem quite aligned.
The inflation expectations measure here is not a survey of people’s opinions; it’s hard-coded into the market. The 10-year breakeven inflation rate quantifies the difference between the yield on the ordinary 10-year U.S. Treasury note, whose interest rate coupon is fixed, and the yield on 10-year Treasury Inflation-Protected Securities (TIPS), whose payout rate is adjusted according to changes in the CPI. As the willingness to protect against inflation grows, the price on the 10-year TIPS also rises, which by definition makes its yield fall. The difference between the lower-yielding TIPS and the higher-yielding fixed-coupon Treasury note of the same duration thus becomes a nifty measure of inflation expectations over 10 years.
If you accept that this correlation is meaningful, there’s actually not that much good news for bitcoin bulls here. Inflation expectations are generally rising on the back of the Fed’s aggressive stimulus and, yes, that seems to align with a recovered bitcoin price. But let’s put this into perspective: the TIPS breakeven point is still below its January peak, shortly before the U.S. entered its current COVID-driven recession in February (marked in the chart by the gray color.) And even then, at 1.8%, that expected rate is below the Fed’s long-term target inflation rate of 2%. The Fed would love to see inflation above 2%. So, if bitcoin is supposed to be a bet against an inflationary blowout, it still has a long way to go.
Still, some caveats: a) As always, correlation is not causation. This chart could be meaningless. And b) I think of Bitcoin as a form of black swan protection. It’s insurance against the kind of event that isn’t reflected in traditional markets’ prices until it's too late, because to bet on it is to assume something so profoundly disruptive that it undermines everything. (Think back to the failure of the mortgage market to absorb the realities of the housing crisis in 2006 and 2007.)
And that brings us back to narrative. There’s a story to tell that the geopolitical framework of the global economy is cracking. The COVID-19 virus, a global economic recession and the potential end of U.S. democracy are a dangerous cocktail. No traditional, quarterly-return, Fed-obsessed institutional investor is going to bet on such a meltdown. Yet, for ordinary people, bitcoin offers a way to do so. If you believe, with conviction, in that narrative, bitcoin’s “meh” moment is a buying opportunity. Both the bullish and the bearish cases are ultimately stories we believe or not.
The global town hall
SURGICAL MONETARY POLICY. If we’re going to talk about the kind of long-term paradigm shifts that are relevant to cryptocurrency and blockchain technology’s outlook, it helps to map out long-term secular trends. So, I’m grateful to the Singapore-based writer who identifies as Pondering Durian for a great take on Bridgewater Associates’ founder Ray Dalio’s analysis of the rise and fall of empires through history.
Dalio observes eight indicators of an empire’s status over time: education levels, whose upturn is shown to be a leading indicator of the emergence of an empire; competitiveness; the country’s role in global trade; the status of innovation and technology; its economic output; the presence of a financial center; its military strength; and the extent of its reserve currency status.
What’s striking is that reserve currency is the lagging indicator, the one that comes last. This makes sense because, thinking of the dollar’s role in the global economy, it enjoys what seems like an unbeatable, self-fulfilling position the U.S. wields to exert its influence all over the world. (See the BitMEX item in Relevant Reads.) But as Dalio points out, eventually, the weight of all those other deteriorating factors gets too much and the reserve currency status also gives way.
The charts in Pondering Durian’s piece include an aggregate of all indicators intended to show the overall measure of imperial power over time. One shows a distinct downturn in the United States’ once unprecedented strength, coupled with a powerful rise in China’s, to the point where they seem about to cross. It affirms the point we’ve been making here: that complacency about the dollar’s perpetuation is dangerous.
The writer then makes the next step and points to a story that “has flown surprisingly under the radar” in Western media: the emergence of China’s digital currency known as the Digital Currency Electronic Payments (DCEP) system. Here, Pondering Durian says, is where China is poised to leapfrog the West in money technology, which in itself could challenge U.S. hegemony. Interestingly, the case being made is not that the DCEP will supplant dollar usage abroad per se, but that it will make China’s capacity to manage its domestic economy so much more efficient than anything that the Fed, under its current design, can do.
Taking an analogy from health care, the writer says it’s all about “precision monetary policy”: the capacity for the central bank to fine-tune the economy by directly managing the money in people’s wallets, rather than having to run policy through the cumbersome and imprecise mechanisms of interest rates and the banking system. This is not about China looking to directly engage the U.S. in trade wars, battles of geopolitical influence, or even try to get its currency on the world stage. It’s about building an empire the way the U.S. did: by improving its own domestic economy and then turning that to its advantage. This is why the U.S. needs to pay attention to the DCEP – why, in fact, it can learn from it.
BETTING ON CIVIL WAR? I really don’t want to get too gloomy, but something about the past week seems to compel it: A ridiculously dysfunctional presidential debate that did little more than present the U.S. as a laughingstock; a U.S. President who suggested he may not accept a peaceful transition of power if election results run against him; and a Supreme Court nomination process that could stir up the deepest angst of America’s culture wars coming at an unimaginably difficult moment.
If you have any doubt the United States is going through a kind of shared manic depression experience, then take a look at this new survey by Engagious, the Sports and Leisure Research Group and ROKK. The three research outfits recently started periodic surveys to produce what they optimistically called their “back to normal barometer,” but this result suggests things are heading exactly in the wrong direction.
It found that 61% of Americans believe the U.S. could be on the verge of another civil war; two-thirds “strongly agree” with the notion. It also found that 52% of consumers have stockpiled food or essential goods in anticipation of social unrest tied to a resurgence of COVID-19 and/or the election. These are not the numbers of a healthy society. They should be relevant to any decision about what to do with one’s money.
Crypto Trading Platform BitMEX ‘Attempted to Evade’ US Regulations, CFTC, DOJ Charge. Bombshell news of the week. U.S. regulators brought serious charges against BitMEX CEO Arthur Hayes, a prominent figure in crypto circles, as well as others from his groundbreaking and highly successful crypto derivatives site. Nikhilesh De reports on a story that, once again, illustrates just how long the U.S. arm of the law is when it comes to its unique position in global finance.
Should DEXs Be Worried After BitMEX? DeFi Founders Weigh In. The aggressiveness and cross-departmental nature of the BitMEX enforcement action naturally has people wondering whether U.S. regulators have their eyes on other Wild West corners of the crypto world, in particular the DeFI craze. It’s a legitimate question, though, whether decentralized exchanges, which aren’t supposed to have custody of their customer’s assets, are safe from this because of their decentralized design. William Foxley reports.
Coinbase Has Drawn a Line in the Sand for Its Activist Employees. One way to thrust your crypto company into the eye of a public that doesn’t pay much attention to the sector: wade into America’s culture wars. Coinbase CEO Brian Armstrong’s statement on his IPO-destined company’s intent to be a “mission-driven company,” free from the need to take a stance on controversial issues, was one such move. It got a lot of attention, both pro and against. Here, executive editor for operations and strategy Pete Pachal offers a thoughtful take on the minefield Armstrong is attempting to navigate.
The Standard About to Revolutionize Payments. It’s not a given that the transformation of money and payments will be solely driven by the crypto community or even by the slightly less edgy innovation industry of fintech. As CoinDesk columnist JP Koning points out, the stodgy world of ISO standard-setting is poised to deliver a change that could have a profound impact on payments and money.