The spirit of pro-crypto regulation
The original goal of crypto was transparency, but it has become anything but. We have a word for the opposite of transparency: fraud. And that is precisely what the SEC’s new “Cyber and Emerging Technologies Unit” is tasked with fighting. Moreover, the SEC is dropping long-standing cases against high-profile crypto companies. This is an ironic and welcome turn of events. For years, the crypto believers have seen the SEC as a mortal enemy, bent on obstructing their mission to build a new financial paradigm. But now the attitude has flipped. The change in spirit is because: to combat fraud is ultimately pro-crypto. Punishing fraud forces crypto back to its principles, which are:
- Openness: Anyone can pull back the curtain.
- Fairness: Anyone can participate on even footing.
- Algorithms: Code is law and supersedes human intervention.
To conduct a business the “crypto way” is to operate out in the open. There is famously no need to trust an intermediary when sending a Bitcoin because every transaction is automatically verified by a simple computer program. When conducting business, the “crypto way” balance sheets are public, customers do not pass through gatekeepers, and the result of every action can be traced back to a line of open-source code.
Of course, there are gradations to how closely a business follows this ideology. But the principles are clear. And “fraud” is the reversal of each. Rather than open books, there are smoky backroom secrets. Instead of fairness, sweetheart deals and insider information. And publicly stated policy gets ignored in favor of ad hoc decisions.
If an alien economist read the original Bitcoin whitepaper from 2008, they would rightly conclude that any business aligned with “crypto” would be the least fraudulent of all, almost by definition. Why did the history of crypto take an unexpected turn? The headlong plunge into fraud has everything to do with human nature and nothing to do with the foundational ideas of the sector.
Forcing humans to forego greed and follow rules is precisely what regulation is for. And now regulators can help crypto by encouraging it to stay true to itself. Purging fraud is a return to its roots.
Free Money
The late Charlie Munger famously quipped: “Show me the incentive and I’ll show you the outcome.” It is a fundamental axiom to any sound economic theory that, in the end, incentives matter. For markets, the bedrock incentive is simply to buy low and sell high. But crypto makes the situation strange. With most crypto projects, you do not need to buy in order to sell. Digital assets are just that — “digital.” This means people can print their “cryptocurrency” out of thin air. And so the incentive takes a weird turn: sell high after other people buy.
The “NFT” craze was an example of this. Marketing teams could create thousands of near-identical digital tokens, essentially for free, and then open them up to external buyers. Nothing prevented the NFT creators from giving themselves stacks of their own inventory for free and selling it on a 0-cost basis.
But NFTs were just an early harbinger of where we are today. Things have changed. Whereas NFT markets moved at the slow pace of high-stakes blackjack, we now have the 24/7 penny-slots called “meme token.” Blockchain platforms make it so cheap and easy to create new cryptocurrencies that, at the height of the fever, there would be over 70,000 new cryptocurrencies created in a single day. These tokens get printed by the billions, often worth fractions of a penny, and the markets make it all too easy for retail speculators to gamble small batches of money in high frequency. And these small batches add up to big exits for the people who are behind the curtain.
The result is not surprising. With an unfettered ability to create new assets in under 30 seconds, an entire servicing industry sprung up to seize on this bizarre rush for endlessly proliferating digital gold. And what ensued was a parade of the same old scams in a brand new crypto venue: coordinated pump and dumps, too-good-to-be-true Ponzi schemes, brazen insider trading.
Scams are destined to happen. The strange thing with crypto, though, is the attitude toward them. Fraud happens so repetitively that crypto culture has become numb and cynical. After all, we asked for an open, uncensored financial platform. Bad actors are inevitably going to take advantage. Tragedy of the commons. The resigned attitude is so prevalent that even when heads of state pull off obvious pump-and-dumps, it barely registers more than a shrug in mainstream news. For contrast, when the Obama administration chose to invest in the (now defunct) Solyndra, the nation was rocked by the political scandal. But the $TRUMP coin pump-and-dump, which profited an estimated $100M while retail lost billions — hey, that’s crypto for you, so get used to it.
Back to Basics
The irony is that this sad state of affairs is not what makes crypto “crypto.” The techno-libertarian ideology of crypto was bent on removing the human element of fraud from finance. Transparent, impartial algorithms are meant to level the playing field and make finance fair for everyone.
Either crypto should live up to its principles, or else we should treat it the same as traditional finance.
The first necessary step for regulators is to punish outright fraud. Crime should be illegal, even if performed on a new platform. But regulators also have an opportunity to set up a framework to keep crypto projects true to the nature of crypto. If a project or company does not follow these principles, they should be forced to function as what they are: conventional finance.
The guiding framework for crypto regulation should simply adhere to the original idea behind Bitcoin, which was to remove centralized human power in favor of fair algorithms.
What needs to happen:
- 0% of any new digital assets should not be given away to insiders. If an entity has a vested interest in a crypto company or project, they should not receive any tokens for free. Their incentive should come from actual revenue for services.
- Because no tokens get acquired for free, liquid markets must be bootstrapped with open and fair auctions. The auctions themselves are algorithmic, and ensure that everyone plays the same game by the same rules.
- Any new asset offering must be announced publicly in advance of the opening bell. Blockchains are as public a technology as we have ever had, and they should be used to publicize upcoming initial offerings. Stealthy launches where insiders can take advantage of low prices are anti-transparent and anti-crypto.
- At least 51% of cash liquidity across all markets for a cryptocurrency should be out of human reach. This liquidity is entirely under the control of automated market algorithms and will be available for sellers in all circumstances. The guaranteed liquidity protects against the “dumps” that often follow “pumps.”
If this seems fanciful, then we have not fully comprehended the paradigm shift with crypto. Crypto makes things easy that used to seem impossible. Think at the level of the revolution with e-mail or AI. With crypto, it is possible to make an initial public offering of a new asset to a global 24/7 market for free in under 1 minute. And that is precisely why regulation needs to meet this technology where it is.
At Nirvana, we have proven that this framework is viable. In an environment where virtually all new cryptocurrencies come out of the gate with an unfair advantage to insiders, we made sure that our asset was fairly and organically distributed. That is to say, whoever holds it paid for it. Moreover, 100% of the market liquidity is under the control of an algorithm. The market structure is fair, automatic, and — most importantly — public. There is no institution in the back of the house with perverse incentives to manage “order flow.”
The goal is to create a truly “crypto” asset. One which is fair, open, and durable. It works differently than conventional assets because the crypto ethos is not conventional. Rather than enriching insiders, the purpose is to be a store of wealth for everyone. I hope it catches on. And even more that regulators understand the opportunity to help shape finance for the internet age.
