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Top Stories of the Week - 7/7

Weekly Top Stories 07/07/23 — Galaxy Research

This week, we discuss BlackRock’s entrance into the Bitcoin ecosystem, the V2 launch of Blur’s NFT marketplace, and the ongoing evolution of MakerDAO, crypto’s oldest DeFi protocol. Subscribe here to receive Galaxy's Weekly Top Stories, and more, directly to your inbox.

Larry Fink Enters the Chat

BlackRock CEO says “bitcoin is an international asset” that is “digitizing gold.” Speaking to Fox Business on Wednesday, Blackrock CEO Larry Fink spoke at length about iShares’ application for a spot-based Bitcoin ETF. “We’re a believer in digitization of products… ETFs was a big revolution from the mutual fund industry… and we do believe that if we can create more tokenization of assets and securities… it could revolutionize again finance.”

Fink noted that ETFs “democratize the cost of investing” and “we want to make crypto more democratized… and make it much cheaper for investors. Right now, the bid/ask spread for crypto is very expensive, it does erode a lot of the returns that you speak about, because it costs a lot of money to transact bitcoin, and it costs a lot of money to get out of that. We hope that our regulators look at these filings as a way to democratize crypto.”

Fink said he had previously been skeptical “because its early uses were for illicit activities… but I do believe the role of crypto is digitizing gold, in many ways. Instead of investing in gold as a hedge against inflation, a hedge against the onerous problems of any one country, or the devaluation of your currency whichever country you’re in… let’s be clear, Bitcoin is an international asset.”

Our take

BlackRock is the iconic “institutional investor.” It is the world’s largest purveyor of ETFs, the king of democratizing access to investing, and the cornerstone of most investment portfolios. The firm’s promotion of Bitcoin heralds the realization of one of crypto’s longest running mantras: “the institutions are coming.” Now it’s official – the institutions are here. And this institution, BlackRock, is the maven of mainstream adoption.

The entrance of institutional capital into Bitcoin has long been inevitable. There is no future where Bitcoin is wildly successful and the world’s largest financial institutions are not heavily involved (Fidelity, the third largest asset manager, has been in the space for years). But many in the Bitcoin community are rightly skeptical about the implications of giant pools of capital (much of it politically connected) taking an interest in Bitcoin. What happens when these market access vehicles are successful and bring in millions of new owners with no knowledge of Satoshi, self-custody, decentralization, or the other attributes that make Bitcoin what it is? Boiling it down further: mainstream adoption, do we want it?

In an iconic October 2019 post, a user asked the r/Bitcoin subreddit what was the biggest threat to Bitcoin. Many responses pointed to 51% attacks, a way for large amounts of hashrate to force blockchain reorganizations. But Greg Maxwell, longtime bitcoin developer and former CTO of Blockstream, offered a different response: the biggest threats to Bitcoin are ignorance and apathy.

A far bigger risk to bitcoin (than 51% attacks) is that the public using it won’t understand, won’t care, and won’t protect the decentralization properties that make it valuable over centralized alternatives in the first place… a risk we can see playing out constantly in the billion dollar market caps of totally centralized (blockchain) systems. The ability demonstrated by systems with fake decentralization to arbitrarily change the rules out from under users is far more concerning than the risk that an expensive attack could allow some theft in the case of overly-eager finalized transactions. - Greg Maxwell (Oct. 4, 2019)

So-called mainstream adoption will bring waves of new entrants to Bitcoin, and the risk is that they “won’t care, and won’t protect the decentralization properties that make it valuable over centralized alternatives in the first place.” Users simply seeking financial exposure who are not dogmatic about Bitcoin’s essential characteristics may support their dilution or removal, either explicitly or passively by outsourcing their voice to their institutional asset managers.

Will those asset managers defend Bitcoin’s core properties? Some in the Bitcoin community pointed to the fork-choice language in BlackRock’s ETF filing as cause for concern:

With respect to any fork, airdrop, or similar event, the Sponsor shall, in its sole discretion, determine what action the Trust shall take. In the event of a fork, the Sponsor will, as permitted by the terms of the Trust Agreement, determine which network it believes is generally accepted as the Bitcoin network and should therefore be considered the appropriate network, and the associated asset as bitcoin, for the Trust’s purpose. - BlackRock iShares Bitcoin Trust Filing, Page 9 (Jun. 15, 2023).

In practice, all forks are different and it’s difficult to proscribe a set of fork-choice rules ahead of time. Custodians need flexibility to make sure they choose correctly, and BlackRock’s language is boilerplate for custodial agreements. Nonetheless it highlights the possibility that a large asset manager like BlackRock could influence Bitcoin’s governance, potentially in ways that are detrimental to Bitcoin itself. This was a lesson from the 2017 BCH fork in which exchanges took a range of approaches, many of them harmful or foolhardy.

This is a wall of worry Bitcoin must climb to achieve any of the lofty goals set by its biggest proponents. Whether Bitcoin is to match or overtake gold, become a world reserve currency, or capture the monetary premium by demonetizing stores of value like real estate, institutions are going to be involved. Bitcoin was never the project we thought it was if Bitcoiners cannot maintain Bitcoin’s properties with the entrance of vast amounts of new users and capital. Instead, Bitcoin as we know it will have been a niche project, useful for many, but not world-changing, destined to be a minor monetary asset for small amounts of disenfranchised capital and tecno-libertarian nerds. That would be a waste because Bitcoin’s potential is so much greater.

To reach that greater mountaintop, Bitcoin needs mainstream adoption, and while the tools for self-sovereign bitcoin adoption are widely available, it’s unrealistic to believe that the masses will run a Bitcoin node, operate lightning channels, or even stamp their seed phrases into a metal plate. The masses will enter through market access vehicles like those provided by BlackRock and others – Bitcoiners need to contend with that. To convert ETF-buyers into node-runners, Bitcoiners need to do something more.

One way to promote and protect Bitcoin and its values is to ensure that its value propositions are powerfully and consistently conveyed and passed down to new generations of Bitcoiners. If the memes and narratives that convey Bitcoin’s fundamental values do not remain strong, refined, and internalized, then the features that express those values may not remain part of the protocol. Crucially, these narratives must be accessible to and resound with everyone from retail traders to pensioners, investment advisors to institutional allocators. Toxic fundamentalism promoted by zealots simply will not do. In fact, it is counterproductive. That doesn’t mean there aren’t red lines that bitcoiners must protect and defend: the freedom to transact; the right to self-custody your own keys; the freedom to route transactions and build blocks. But bitcoiners must adopt more inclusive attitudes and language to ensure their messages are heard by the masses they hope to onboard.

Luckily, or perhaps inevitably, many of these institutions are indeed populated with actual Bitcoiners. Fidelity is the iconic example – you need only read their public research to know they understand Bitcoin’s core value proposition – but the truth is that Bitcoiners populate the digital assets teams across the big banks, financial services companies, and asset managers. These Bitcoiners are on the front lines of promoting Bitcoin’s values to the next generation of adopters, and it’s essential that they succeed.

Bitcoin’s values need to be championed in ways that are widely accessible if they are to persist. If we lose those values – decentralization, self-custody, permisionlessness, censorship resistance, etc. – then we squander one of the greatest opportunities for economic freedom and empowerment the world has ever known, and that would truly be a shame.

- Alex Thorn

DAI USDC Collateral Drops

Maker’s real-world assets (RWA) efforts help push DAI’s USDC collateralization into the single digits. USDC collateral backing MakerDAO’s DAI stablecoin in its Peg Stability Module (PSM) fell below 10% after Maker purchased an additional $700 million worth of U.S. Treasury bonds in June as part of its real-world assets (RWA) initiative – specifically the Monetails Clydesdale vault. USDC collateral in the PSM peaked at 64% in March of this year following USDC’s depegging after the failure of Silicon Valley Bank. In addition to USDC in the PSM, Maker also custodies an additional $500m of USDC with Coinbase where it earns a yield of 2.6%. Now, Maker’s exposure to RWAs totals over $2.0bn, which represents ~44% of the total collateral supporting DAI.

Circle’s blacklisting of USDC addresses in 2022 and then USDC’s depeg in March of this year accelerated Maker’s efforts to reduce their reliance on the stablecoin, which has primarily been achieved by investing in other RWAs like U.S. Treasuries. In addition to diversifying USDC centralization risks, Maker has been able to earn better yields and pass that yield onto DAI holders through the Dai Saving Rate – which was recently raised in June from 1% to 3.49%.

As Maker moves closer to the implementation of its Endgame plan, it will continue efforts to improve DAI’s collateralization to more productive assets such as yield-rich RWAs. Maker passed a new executive vote on June 30 to invest another $1.2 billion in U.S. Treasuries through a partnership with BlockTower, $150 million of which has already been allocated.

Our take

Maker has made meaningful progress in addressing long-standing centralization and censorship criticisms related to its reliance on USDC as it diversifies its exposure from USDC into yield-generating RWAs such as US Treasuries. This shift has allowed Maker to diversify its centralized collateral composition while generating yield for the Maker protocol and for DAI holders. Rather than fully eliminating the risks associated with accepting centralized collateral like USDC, Maker believes that DAI can maintain sufficient decentralization by diversifying the composition and location of its RWA collateral.

As Rune Christensen, Maker's founder, emphasized in a recent podcast interview, "there is only demand for dollar-pegged stablecoins... and to achieve a dollar peg, real-world assets must be utilized." Maker stands out as one of few DAOs capable of adapting and evolving to changes in the space, despite its highly contentious and political governance process. Maker faces one of its most significant challenges as it revamps the protocol's governance process and embarks on a multi-year restructuring outlined in its Endgame Plan.

With the focus on RWA initiatives, DAI now stands out among other “decentralized” stablecoins with yield generating opportunities including through the DAI Savings Rate. However, Maker’s push into RWAs inevitably exposes DAI to other forms of centralization risks, which opens the door for other, more decentralized, censorship-resistant stablecoins to emerge – perhaps those that more closely follow Rune Christiansen’s original vision of a truly decentralized stablecoin.

- Lucas Tcheyan

Blur V2: The Hero or Villain?

Blur, the leading NFT marketplace by volume, released their v2 smart-contract for the platform while updating their airdrop point system. This upgrade strategically targets capital efficiency, featuring gas optimization mechanisms that promise to save users up to 50% on gas fees - an average cost reduction of around $16 per purchase. Further refining the user experience, Blur's revamp introduces trait bidding – a new system designed to reward users who place bids on NFTs with rare traits. While this new feature is enabled for all collections, only a select group currently benefits from the additional trait bidding points system. Trait bidding expands the marketplace's dynamics, allowing collectors who value specific traits to accrue more points through their bidding activities. This mechanism rewards participants who are willing to invest more in coveted traits, effectively creating an intriguing high-stakes game for affluent users.

Our take

Blur's introduction of a new method for earning airdrop points marks a significant development in its reign as the foremost NFT marketplace, primarily fueled by the allure of airdrop farming. However, this move prompted concerns among some of Blur's top users, triggering a potential shift in the platform's dynamics. Specifically, a user responsible for a staggering 13% of Blur's total bidding liquidity - equivalent to $14.8 million – withdrew all their ETH from Blur's bidding pool. This exit sent ripples through the marketplace, resulting in a 17% decrease in Blur's bidding liquidity just hours following the trait bidding announcement. Notably, the same user later re-invested a significantly smaller sum back into the platform. While this initial decrease might appear minimal, a continued trend of Blur whales withdrawing their liquidity could signal the start of the platform's waning dominance. A contracting liquidity pool on Blur would pave the way for rival NFT trading platforms, such as OpenSea Pro, to assert their presence and regain market share dominance.

Historically, Blur's airdrop farming point system focuses on users bidding and listing NFTs around collection floor prices. This approach, while beneficial for airdrop farmers, has had significant repercussions for key blue-chip NFTs, negatively impacting their perceived market value. Notably, BAYC and Azuki experienced substantial decreases in their floor prices as a direct consequence of Blur whales manipulating liquidity around the floor price (although a notably deficient way to calculate the market cap of a collection of illiquid NFTs, the common method has been to multiple the floor price – the last lowest price paid for any item in a collection – by the collection size). This resulted in a significant reduction in collection value, with the market caps of BAYC and Azuki decreasing by 36% and 61% respectively. In the existing bear market conditions, the dynamics of Blur's bid incentive system incentivizes mercenary capital to erode a project's floor price without the need for genuine holders to sell. This creates a death spiral where floors price lower, so bids lower, resulting in floor prices lowering again (prices always trend lower). Ultimately, Blur thrives on being the marketplace with the lowest floor prices and backs this environment with a $100mn token airdrop incentive.

Blur's destructive dynamic poses a significant threat to the broader NFT ecosystem, which is struggling to pull itself out of a bear market. However, trait bidding could mitigate floor price risk for collections by incentivizing users to refrain from solely bidding on and exploiting floor priced NFTs. If airdrop farmers shift their focus to hunting rare traits, we could see a notable decrease in selling pressure on floor prices. Whether Blur users adopt trait bidding remains to be seen—whales will only steer away from trading around floor prices if Blur's increased point incentives outweigh the risks bidding on volatile trait floors. Overall, while Blur has increased NFT liquidity in the bear market, its legacy also includes causing harm to the perceived value of major collections.

- Gabe Parker

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