🐋 Crypto June, a rollercoaster ride

The regulators bite, the financial industry fights back

Good morning and welcome to the Whale Capital Newsletter!

This newsletter offers, in simple language, bytes on the development of blockchain technology and digital assets as a new financial asset. In today's issue we talk about:

  • Crypto June, a rollercoaster ride

  • 🎓 Whale Crypto Academy: The Blockchain Trilemma (Part 2: Scalability)

  • 🔍 Did you know?: It is easier for you to win the Euromillions 8 times in a row than to guess the password of a Bitcoin account

  • 🔗 Use case: Polygon (MATIC), scalable blockchain

But first, a review of the market  

🗞️ Brief News

  • Asset management firm BlackRock joins a long list of applicants for a Bitcoin ETF with the SEC. ARK investment is among those still awaiting news, and Grayscale has appealed its rejection. LINK

  • Deutsche Bank applies for a digital assets license amid a growth drive. The bank has requested regulatory permission to operate a custody service for digital assets. LINK

  • Crypto Exchange backed by Citadel Securities, Fidelity, Schwab begins operations. EDX Markets will not directly manage clients' digital assets or directly serve individual investors. LINK

  • Crypto company Ripple obtains a payments license in Singapore to operate in Singapore, at a time when cryptocurrencies are facing restrictive policy in the United States. LINK

  • Valkyrie, the latest ETF issuer to reapply for a Bitcoin ETF. After the SEC deemed the applications filed by several funds for a Bitcoin ETF as inadequate, they have refiled. LINK

Crypto June, a rollercoaster ride

In recent weeks, the crypto industry has witnessed a series of shocking events that have shaken the markets and sparked a major debate about digital assets’ regulation. Amid this turmoil, large financial companies have raised the crypto flag, managing to return the market to its place.

In today's article, we will analyse the timeline of what happened, from the allegations by the U.S. Securities and Exchange Commission (the SEC), to the counterattacks and the subsequent market recovery.

Evolution of the market capitalisation of the top 30 cryptocurrencies in light of recent events. (Source: Whale Capital)

On June 5th, the SEC filed a complaint against Binance US, the American branch of one of the world's largest exchanges, and its CEO, Changpeng Zhao. The accusation focused on the offering and sale of tokens that the SEC considers securities and included a detailed list of the 12 affected tokens. According to the complaint, Binance US had violated federal securities laws by offering these tokens without the proper registration, and had allegedly lied about its operations.

The next day, June 6th, the SEC filed another similar complaint against Coinbase, another leading cryptocurrency exchange. The complaint again alleges the marketing of tokens considered securities without properly registering them, and includes 13 affected tokens. With these complaints, the SEC seeks injunctions and monetary penalties against these companies.

To understand the scope of these complaints, it's important to know the role and power of the SEC. The SEC is the principal regulator of the securities market in the country and is tasked with protecting investors and maintaining the integrity of the markets. Through a test called the "Howey Test", the SEC determines whether an asset or financial contract should be classified as a security and, therefore, whether this asset is subject to its regulation.

According to the Howey Test, an asset is considered a security if it meets three criteria:

  • There is an investment of money.

  • There is a scheme, company, or team behind it.

  • There are expectations of profits derived from the efforts of others.

In the event that an asset is considered a security, the companies that market it must not only report it and stick to the restrictions on how it can be sold, but they must also register as a broker or securities agency. This is something neither Coinbase nor Binance have done yet.

Following the Howey Test's framework, the SEC's complaints include a detailed description of the reasons why the different tokens have been labeled as securities. The common basis of the complaints falls on the way the project team behind the token originally issued and promoted the token, especially during the so-called ICOs (Initial Coin Offerings). Thus, the SEC considers that:

  • There is an investment of money; the issuance of the token was done through exchange for money or another asset.

  • There is a scheme, company, or team behind it; there is a company, foundation, or team that not only organised the initial issue, but actively promoted it and set a schedule for the project's progress and action.

  • There are expectations of profits derived from the efforts of others; the investment in the token is marketed under the promise that the progress in the development of the project will increase its demand, and therefore offer profits to investors. This condition often comes tied to the purpose and use of the token.

In 2019, the SEC published a guide in which it attempted to explain its token classification criteria. In this document, it made a clear distinction between assets designed to be a payment currency, like Bitcoin, and those that represent a right to a service, like Ethereum. In the case of the former, the SEC did not consider them securities, as they did not fit the Howey Test. However, for the second group, it stressed that much of its decision would come from the evaluation of ICOs and the project promoter's approach when promoting the initial sale of the tokens. Leaving a clear indetermination.

With these premises, the current list of tokens that the SEC has declared as securities is already at 49, and includes very popular projects, like Ripple (XRP) and Telegram (GRAM), which were reported in the past.

Interestingly, behind these latest complaints, there are several tokens, such as ATOM and MANA, which the SEC has declared securities and only charged Binance for their marketing, when Coinbase was also offering them, which again calls into question the lack of criteria on its part.

Consequences of the Regulatory Assault

In response to these complaints, on June 9th, American investment platform Robinhood made an announcement that dropped the market by more than 7% that day. Robinhood stated that it would stop supporting some of the crypto assets that the SEC had just labeled as securities, as it would otherwise imply greater restrictions for its platform. The affected tokens were Cardano (ADA), Polygon (MATIC), and Solana (SOL), which fell sharply in the days following the announcement.

Facing these regulatory attacks, Binance and Coinbase have responded with legal counterattacks, where they denounce the lack of criteria and demand clearer laws to adhere to. Concurrently, this past week Coinbase achieved a major victory in the Supreme Court, which sided with them in a historic decision. The Court denied a government request for Coinbase to provide information on users who allegedly violated income tax laws. This litigation dates back years, but it sets a precedent that can have significant implications for the future of crypto regulation in the country.

American crypto companies are paying the price for the FTX scandal, a platform that went bankrupt in 2022. American regulators, criticised for their handling of the matter, have opted to take an offensive stance rather than a collaborative one. Unlike in Europe, where MICA is establishing limits and controls that aid the development of companies. The SEC's approach is limiting technological progress and the country's competitiveness, which could have long-term consequences.

The development of the internet showed that network technologies are more valuable the greater coverage they have; the same is true for blockchain. Imagine a global banking network that allowed instant and very cheap transfers; its value would increase if it could be used in more countries. However, to achieve this, countries need to adapt and develop within blockchain technology. At this point, the United States is creating barriers for itself.

But not all have been negative consequences, the regulatory actions had a significant impact on decentralized exchanges, such as Uniswap or Curve, which after the attacks experienced a significant increase in transaction volume. These exchanges operate directly on the blockchain and are not controlled by a centralized entity or company, but by many validators. This way, the SEC has no authority over them. The SEC could fine American validators (if it can identify them), but the rest of the validators remain out of its control, maintaining the integrity of the network. Faced with this reality, many American investors decided to move their operations to these platforms, which on the day of Binance's complaint increased their volume by more than +150% to $3 billion in transaction volume.

The Cavalry Arrives

A few days after the SEC attacks, and when the market was already down 20%, the cavalry arrived led by the giant BlackRock. Much speculation surrounds the timing of the action, and whether everything was orchestrated, but the reality is that the market received it with great enthusiasm. BlackRock, one of the world's largest investment fund managers, with over $10 trillion under management, requested on June 15th to issue an exchange-traded fund (ETF) to invest directly in Bitcoin (spot ETF). And this simple action turned the market around, beginning an escalation that would recover all the losses. After its publication, other giants in the sector such as WisdomTree and Invesco, who had previously made the same requests but were rejected by the SEC, republished their applications.

Why so much optimism?

A Bitcoin spot ETF is an exchange-traded fund backed by actual Bitcoins rather than futures contracts. This means that the ETF operator (in this case BlackRock) must purchase and store Bitcoin to back the value of the ETF shares. The advantage of a spot ETF is that it more accurately reflects the price of Bitcoin and is not subject to the price fluctuations and risks associated with futures contracts.

A Bitcoin spot ETF would make it easier and safer for investors who until then could not invest directly in Bitcoin, either due to technical or regulatory difficulties. Furthermore, it would lead to greater integration of Bitcoin with the traditional financial system and greater demand for the asset, which in turn would result in an increase in Bitcoin’s price.

So far, the SEC has not approved any Bitcoin spot ETFs due to its concerns about market volatility, lack of regulation, and the risk of price manipulation. In response to this, BlackRock has added a "surveillance-sharing agreement" to its petition.

A surveillance-sharing agreement is an information exchange agreement between different entities, usually stock exchanges or financial markets. This type of agreement allows large-scale information exchange to facilitate the detection of suspicious transaction patterns, detection of illegal practices, and prevention of price manipulation.

What now?

Once the SEC receives an application to issue ETFs, it must follow a set procedure. It has 75 days to review it and provide comments, and 180 days (which can be extended to 240) to issue a final approval or disapproval notice.

The SEC has already provided comments to BlackRock and the other applicants about their requests, asking for more detail on the surveillance agreements. In response, BlackRock has said that it will work with Coinbase, the exchange with the highest volume of Bitcoin-dollar transactions in the US. The SEC must give its final answer before February 23, just one month before the next Bitcoin halving.

In the midst of this counterattack, other traditional companies in the financial sector have jumped on the crypto ship. Deutsche Bank applied to the German regulator for a license to offer digital asset custody, and Citadel, Charles Schwab, & Fidelity launched a new exchange in the United States. Big news indicating greater acceptance and adoption of blockchain technology in a sector with a high impact and ability to benefit from the technology.

The entry of heavyweights like BlackRock and the support of other industry giants suggest that instead of stifling innovation, these challenges could accelerate the inclusion of digital assets in the traditional financial system as more countries adapt and develop their blockchain infrastructure. Therefore, despite the regulatory tension and current barriers, we see that both the commitment of large companies and the willingness to adapt and resist from decentralized projects show a promising and unstoppable future for blockchain technology.

🎓 Whale Crypto Academy: The Blockchain Trilemma (Part 2: Scalability)

In collaboration with José García Rosillo, Head of Research at Whale Capital

In today's issue we continue with the second part of the Blockchain Trilemma and focus on scalability. If this is your first time here, refer to the last article d where we introduced the Blockchain Trilemma and decentralization topic.

The name blockchain or "chain of blocks" comes from the basic functioning of the ledger that govern these networks. When we talk about blockchain we are talking about a program that manages users balances in a decentralized ledger. Depending on the project, the entries in this book are different; there are networks like Bitcoin, where the book essentially only keeps track of account numbers and Bitcoin (BTC) balances in each account. While other ledgers (or protocols) like Ethereum, can store in the same account number tokens and files of many types - as if you could store euros and dollars in the same bank account. In addition, it also allows you to store photos, videos, programs or any type of digital information.

When an user sends a token, a photo, or executes a program from their account number, that movement translates into a transaction that validators must process to update the balances in the ledger. This process is what gives the name blockchain to the technology. On the one hand we have the current accounting book, and on the other hand all the pending transactions to be validated. The objective of the network is to process all pending transactions in order to update the book. To do this, the validators take groups (or blocks) of pending transactions, verify them, and once such blocks are validated, they are added to the list of transactions already processed. At that point, a chain of blocks is formed as illustrated in the below image.

Process of building a blockchain. Each transaction is a ball that must fall into a block. (Source: Whale Capital).

The blockchain is made up of all the transactions that have already been verified by the validators (or miners), and it is the record of transactions that allow updating the accounting book. Hence, if I had 10 BTC in my Bitcoin account and in the blockchain there is a transaction where it is seen that I sent 10 BTC to another address, when I check the balance of my account in the book it will be nil (if no one has sent me anything in the meantime, of course).

The scalability of a blockchain refers to its ability to handle a high volume of transactions efficiently, quickly and without congesting the network. In short, it implies the ability of a project to grow and adapt as the transactions in its accounting book increase without compromising its proper functioning.

Scalability is a fundamental aspect to the success and widespread adoption of a blockchain, since a network that cannot handle a large number of transactions could become slow, expensive or even unusable.

However, it is not easy to achieve a fast and scalable network. When developers design them, they must calibrate certain aspects that determine its scalability but that can largely sacrifice functionality and/or security:

  1. Block size - Refers to the amount of data that can be included in a single block of transactions. If the block size is small, the number of transactions that can be processed at a time is limited, which could cause congestion in the network. Increasing the block size can allow more transactions per block, improving scalability and processing speed, but also increasing the size of the chain, making it heavier, which would require more memory, bandwidth and make the communication between validators difficult. Some protocols prefer to have smaller chains, in which communication between validators is limited. Thus, instead of requiring the consent of all validators, they only require the proximity of the selected validators. This measure speeds up the validation process, but makes it more vulnerable to collusion.

  2. Time between blocks - Refers to the time it takes the protocol to put one block behind another along the chain. A shorter time interval allows more blocks and transactions in less time. For example, one block every 2.5 minutes (Litecoin) vs. 10 minutes (Bitcoin). Shortening the time between blocks increases the opportunities for attack by malicious agents, sacrificing security.

  3. Consensus mechanisms - The consensus mechanism determines how miners or validators reach an agreement on the state of the network and valid blocks. That is, the process they must carry out in order to be able to add a block of transactions to the final blockchain. Consensus mechanisms based on PoW, such as Bitcoin's, require solving computationally intensive puzzles that limit transaction speed for the sake of security and decentralization. On the other hand, consensus mechanisms based on PoS, such as Ethereum's, randomly select validators without solving riddles, which allows greater scalability and transaction speed, but may be detrimental to security and decentralization.

Currently, scalability is one of the hottest topics in layer 1 blockchain infrastructure projects, such as Ethereum, which in several occasions of high demand has seen its processing capacity limited, making users to pay more than $100 for a simple transfer. That is why various solutions are being explored, including "rollups". A rollup is a layer 2 scalability technique that groups or "rolls up" multiple transactions off-chain and then publishes them on the main chain. This allows for greater network performance since most data is transferred off the main chain, decongesting it. In today's "Use case" section, we analyze Polygon, an Ethereum scaling project that, with this innovative rollup technique, is solving scalability problems while maintaining network security.

In other payment networks, such as Bitcoin, the scalability problem mainly comes from the inability to process payments quickly while maintaining network security. It is not feasible to propose Bitcoin as a payment method if transactions take more than 10 minutes to confirm. For this, various scaling solutions have been proposed, some of which include the implementation of secondary layers such as Bitcoin's Lightning Network. This project allows transactions outside the main chain to relieve the Bitcoin network. So users operate with a parallel balance that is only updated on the Bitcoin network from time to time, saving all intermediate transactions.

In line with what we were discussing in the previous issue and in relation to the Trilemma; increasing scalability entails a decrease in the other two properties of the trilemma, i.e. security and/or decentralization. The goal of developing scaling solutions is for this decrease to be as small as possible.

In conclusion, the scalability of a blockchain is essential for its adoption, as it largely determines its ability to handle a large number of transactions without significant congestion or delays. However, there are currently few major networks with scalability capacity that have not largely sacrificed centralization and/or security. It is an ongoing challenge for the progress of the industry in which much of the current technology developments are focused and that we closely follow at Whale.

We will continue to discuss this in the next issue. Don't miss it out!

🔍 Did you know that…?

Did you know that it is easier for you to win the Euromillions 8 times in a row than to guess the password of a Bitcoin account?

Bitcoin works with the concept of public address and private key. Although the operation is a bit more complex (we'll leave that for another issue where we'll explain the custody of digital assets), we're going to explain how a Bitcoin accounts work in a simplified way.

Every Bitcoin user has a public address that allows them to receive payments. Addresses work like a bank account number; It identifies your balance and you can share it with others when you want to receive a payment. In turn, each account is protected by a private key or password. Private keys are similar to the access keys of a bank account, but with the difference that they cannot be changed. The private key, in addition to protecting, allows you to sign the transactions from your account and, therefore, controls the movement of funds. That's why the private key must always be kept secret! Anyone who has access to a private key can access and transfer funds from that account.

Anyone can get a Bitcoin address. The process is free and automatic. Although the ideal is to generate your address offline, there are many websites that allow you to do it online (careful, not all of them are legitimate). Bitaddress.org is one of the pioneers. Bitaddress assigns you a Bitcoin address from random information that you enter (entropy), so that no one can ever enter the same information. Once the process is completed, we obtain, for example, the following address;

Public address and private key of a Bitcoin account. (Source: bitaddress.org)

The assigned Bitcoin address has been: 16rowcWi8psTQvNH1y7mJ6AKjMH2bhBuhH 

I can check the balance in any Bitcoin blockchain explorer, like blockchain.com and check that the current balance is 0.

Anyone can check the balance, you yourself if you access that link. However, if anyone sends me bitcoins, the only way they would be able to access the account and move them would be by using the private key associated with the account, which is unique, irreparable and which only I should have; L3VjRkQTjff3waB4ACXFt4d1ha8cKakwgiqSpdupr8TquX5oSVwC

In this case the account is empty and it doesn't matter having shared the password, but imagine that you could access accounts like these (34xp4vRoCGJym3xR7yCVPFHoCNxv4Twseo), with more than $7.5 billion in BTC. Knowing that so much money is protected by an electronic password, it makes sense that there are people trying to guess it in order to access and take the funds.

But can the private key of an account really be guessed?

The only way to guess a Bitcoin private key is by trying one by one the different possible combinations. Bitcoin uses 256-bit private keys, where each bit can take the value of 1 or 0. Meaning that there are 2256 possible combinations: an incredibly high number, approximately 1077.

To put this into perspective; You would need 1021 cups to manage to empty all the oceans. The Sahara Desert has approximately 1021 grains of sand. And the Earth has 10^50 atoms. This means that it is much easier to find a particular atom of the Earth than to guess the Bitcoin password.

If we compare this to playing the lottery. In the case of Euromillions, there are approximately 280 million possible combinations. Each time you play you have 1 in 280 million, or approximately 30-9 . It is easier for you to hit the Euromillons 8 times in a row, than to guess a Bitcoin private key.

To have a 50% chance of randomly guessing a private key, you would have to try approximately half of the possible combinations. This would be equivalent to trying a private key every nanosecond for more than 1054 million years. Even combining the most powerful computers in the world, it would take billions of years to try all the combinations at that rate.

But also, if this trial-and-error process were online, Bitcoin has an additional protection: the time lockout. After multiple failed attempts to enter a private key, Bitcoin temporarily locks the account. At first just for a few seconds, but increasing exponentially for minutes and hours. This makes any brute force attack computationally unfeasible.

In conclusion, the probability of randomly guessing a Bitcoin private key is statistically 0. An extraordinary advance in information technology, unthinkable today, would be required to have a realistic chance. This is why, as long as you keep your private key offline and secret, your Bitcoin funds cannot be safer. The probability is on your side!

🔗 Use case: Polygon (MATIC), scalable blockchain

Written by José García Rosillo, Head of Research at Whale Capital

Polygon is a blockchain platform designed to make transactions and decentralized applications (dApps) from other blockchains such as Ethereum faster, more efficient and more profitable. In this issue we will present Render Network, founded in 2017 by OTOY, a technology company specializing in real-time graphics software and visual effects on computers.

Why does Polygon Matic emerge?

Polygon Matic emerges when Ethereum becomes the most used blockchain for dApps and smart contracts. As a consequence, Ethereum transaction processing capacity reaches its limit, making these transactions extremely expensive and slow.

Ethereum is the most used blockchain for developing dApps and smart contracts. However, its ability to process transactions is limited, which can result in high fees and network congestion. This is where Polygon comes into play.

How does it work?

Polygon achieves its main objective by creating secondary blockchains, also known as "sidechains", which connect to Ethereum's main blockchain. These sidechains are designed to handle faster and cheaper transactions, thus freeing Ethereum's main chain from excessive load.

Diagram of how Polygon's blockchain interacts with Ethereum.

Polygon uses a consensus mechanism known as Proof of Stake (PoS) on its sidechains, which is very efficient and has great scalability. Thanks to the technology behind its consensus mechanism, decentralization and security are minimally reduced. Hence, it would be fair to say that Polygon inherits Ethereum's security and decentralization.

Key benefits and features:

1. Improved scalability: Polygon addresses one of Ethereum's biggest challenges by allowing higher performance in terms of transactions per second. This facilitates the massive adoption of decentralized applications (dApps) and related use cases.

2. Interoperability: Polygon provides infrastructure for interoperability between blockchains. This means that both assets and data can move fluidly between different blockchains, increasing efficiency and connectivity across the ecosystem.

3. Low transaction costs: By leveraging sidechains, Polygon enables fast and affordable transactions compared to Ethereum's main chain. This is especially beneficial for users looking to avoid high gas fees.

4. Development simplicity: Polygon offers a developer-friendly platform, with tools and libraries that facilitate the creation of dApps and smart contracts. It is also compatible with Ethereum, allowing developers to leverage the existing network and access a large user base.

5. Active community: Polygon has built a strong and active community that includes developers, investors, and enthusiastic users. This creates an environment conducive to collaboration, growth, and continued adoption of the platform.

For this reason, globally recognized companies such as Nike, Adidas, Starbucks, Disney or Meta have chosen Polygon to launch their digital products.

Companies with Web3 products built on the Polygon network. (Source: Polygon daily)

In short, Polygon Matic is an innovative scaling solution that addresses scalability challenges in the blockchain ecosystem with high possibilities of becoming the scaling solution that prevails over the years.



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See you in the next issue!

Whale Capital is the digital consultant of the fund Global Digital Asset Fund (GDAF), a professional vehicle established for investment in digital assets. GDAF is an alternative fund (NAIF) only available for Professional and Qualified Investors under the criteria of the European ESMA regulation. If you want to request more information you can do so through the following link.

DISCLAIMER: Nothing written here should be considered financial advice. This Newsletter is strictly educational in nature and is not investment advice or a solicitation to buy or sell assets or to make financial decisions. Please be careful and do your own research (DYOR).