Ethereum upgrades as Capitol Hill intensifies

Hartmann Capital Newsletter, Friday August 6, 2021

In this issue

Market by numbers

Bitcoin lagged the broader rally in crypto asset markets this week as Ethereum took the lead in advance of EIP1559.

EIP-1559 London fork implemented, and a look ahead to Proof-of-stake 

Ethereum rallied in dollar and BTC terms this week as the network was upgraded to the new London hard fork, implementing EIP-1559. ETH rallied from 0.06 BTC to 0.07 BTC before settling back slightly this morning, but remains 18% on the week in USD.

EIP-1559 will not likely result in lower gas fees for users, but it is likely to smooth out demand and increase certainty of getting transactions included in mined blocks. With EIP-1559, the base fee will increase and decrease by 12.5% after blocks are more than 50% full. A priority fee, or tip, can be designated to have a transaction prioritized. This goes to miners, but the base fee is now “burned” during a transaction.

In the first few days, over 4,800 ETH (~ $13.4 million) has disappeared. This doesn’t make ETH deflationary yet, with daily issuance around 17,000 ETH paid to Ethereum’s proof-of-work (PoW) miners. The fee burn does, however, add to supply pressures as more ETH gets staked in anticipation of Ethereum 2.0’s (eth2) proof-of-stake (PoS) transition, privately and in staking protocols such as Lido Finance.

Now that EIP-1559 is live, we can perhaps begin to look forward to the implementation of the Beacon Chain and PoS, sometime in 2021. ETH 2.0 is already running in parallel to the current chain, and validators who have staked a minimum of 32 ETH are already earning fees. The transition to PoS is, however, fraught with hurdles, and many are skeptical that it can be achieved within the planned time horizon.

Nevertheless, if PoS comes to Ethereum, mining will be expected to result in 0.5% to 1.7% annual inflation. With EIP-1559, it is possible that Ethereum becomes deflationary. How will ETH behave when the demand for staking and other uses meets a shrinking supply?

The SEC gets serious about crypto and a fight develops in Congress 

The cryptomarkets climbed what in TradFi is called a wall of worry, with US regulators and legislators both targeting digital assets in speeches and in law. SEC Chair Gary Gensler, who should know better as he has taught a very well received university course on blockchain, delivered a very serious warning shot to crypto markets this week.  Though his comments were specifically labelled as not the views of the SEC, he was very clear that increased enforcement, at the very least, is on its way. In his opinion, the Howey Test very clearly reveals many tokens to be securities.

It doesn’t matter whether it’s a stock token, a stable value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities. These products are subject to the securities laws and must work within our securities regime.

Labelling many tokens securities has the result of making crypto exchanges likely to fall under SEC regulations for securities exchanges.

To the extent that there are securities on these trading platforms, under our laws they have to register with the Commission unless they meet an exemption… If a lending platform is offering securities, it also falls into SEC jurisdiction.

Besides increased supervision, registration and enforcement, Chair Gensler thinks new regulations are needed:

We need additional Congressional authorities to prevent transactions, products, and platforms from falling between regulatory cracks.

The SEC is not at all unanimous in this, however. SEC commissioner Hester Peirce, again speaking only for herself, clarified that truly decentralized finance may not fall under the SECs scope:

If you want to make a case that you’re something different than the CeFi or TradFi system, then you have to show that you’re doing something radically different, which from my perspective requires decentralization.

The CFTC, who regulate derivatives and futures trading, fired back that the SEC may not have sole or any jurisdiction in certain parts of crypto. CFTC Commissioner Brian Quintenz tweeted:

In any event, further enforcement is on its way, it appears.

Meanwhile on Capitol Hill, a new tax bill threatens both miners and DeFi protocols with new tax reporting requirements. 

It probably makes sense to have centralized exchange report trades to the government for tax tracking. It does not make sense to involve miners, and it is arguable whether or not decentralized exchanges are capable of doing so.

There are senators who understand that this tax Bill would chase much of crypto offshore. This is still a story in progress, and there is hope that a few aware senators can get the offending language amended or removed before the vote on Saturday.

Neither decentralized nor censorship resistant? Bitcoin fork BSV suffers another 51% attack

Craig Wright claims he’s Satoshi and that BSV – Bitcoin Satoshi’s Version – is the true Bitcoin. Judging by the price it’s pretty clear that most of the crypto world does not agree, with BSV at pretty much all time lows against BTC.

One of the reasons for this poor performance is BSV’s vulnerability to attack. This week saw what is now at least the third reorg of the blockchain using a 51% attack. In any chain, transactions are at the mercy of the majority of hashpower, who can collude to impose their own will on the chain. Mining resources are highly concentrated on the BSV chain, and colluding is apparently quite easy.

So if BSV is clearly not decentralized or censorship resistant, why should you care? Well, the main reason is any uncertainty surrounding Bitcoin forks is often contagious. It’s always worth remembering that BTC fought hard to avoid the situation that BSV finds itself in, yet often gets tarred with the same brush.

This week’s blog: “Protocol Hacks and Governance Risks”

In the third part of our series on crypto asset risk management, we take a deep dive into risks specific to smart contracts and their development. Hartmann Capital has developed specific strategies for managing and even hedging protocol risks, and also monitors negative events for opportunities, short and long. 

Hartmann Capital Weekly written by Head of Communications, Rasheed Saleuddin, PhD, CFA


Disclaimers:

This is not an offering. This is not financial advice. Always do your own research.

Our discussion may include predictions, estimates or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this presentation. Please keep in mind that we are not obligating ourselves to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events.