Notes 5/22: Bitcoin Price, Tornado Cash’s TORN, and Proof of Reserves in Texas

Bitcoin price remained stagnant over the weekend and continues to trade sideways in the $26,000 range. As of this writing, it is at $26,904.77, roughly unchanged from its price a day earlier.

A Tight Range

The days of frothy trading in the cryptocurrency’s ecosystem, when its price regularly notched up double-digit gains and set records, are over. According to Glassnode, bitcoin’s trading price range last week was just 3.4% – its tightest since January this year.

But recent trading patterns might still spring up a couple of surprises. Glassnode tweeted that such tight trading is generally followed by volatility and big moves in bitcoin’s price.

And what might induce this volatility?

The immediate trigger is Congress’s debt ceiling debate. A default by the US government on its interest payments would be a signal that even the world’s safest financial instruments – US Treasury securities – are not immune to risk. A default muddies the arguments against the inherent riskiness of crypto trades.

Of course, the opposite scenario is also a possibility. Bitcoin price could crash further in such an event because the stablecoin rails that facilitate much of crypto trading are backed heavily by treasury securities.

Bitcoin Price’s Waning Utility

In discussions and explanations about bitcoin price, an implicit assumption is that its daily movement matters for constituents in the cryptocurrency’s ecosystem.  

Bitcoin price volatility generates revenues and profits for investors, traders, and miners. If there are enough such stakeholders, the cryptocurrency’s price movements are useful. But that is not a given.

Macroeconomic events like the debt ceiling debate or the Fed’s interest rate hikes are important only insofar that they drive investor funds towards the cryptocurrency’s illiquid ecosystem.

However, the tight trading range in bitcoin’s price last week occurred despite a plethora of market-moving events. This means that macro catalysts for bitcoin price are also fewer.

Since April, the number of members and catalysts in bitcoin’s ecosystem has crashed. The outflow of whales and money from bitcoin-related funds has accelerated since the beginning of this year.   

The recent logjam in its network also provided sufficient profits for bitcoin miners to tamp down their trading activity for revenues. According to investment firm, NYDIG, the share of transaction fees in their revenues has jumped to 40% after they spiked earlier this month.

Bitcoin price, then, does not serve much purpose right now. If it occurs, the cryptocurrency’s next major move could be a decisive one for its survival.  

Tornado Cash Is Torn  

While bitcoin is floundering in uncertainty, Tornado Cash’s TORN token – a coin as worthless as they come in crypto – is busy racking up volatility.

The token’s price crashed by 40% over the weekend after a hacker took control of its decentralized autonomous organization (DAO) – a crypto governance mechanism that is actually a window-dressing to conceal games and profiteering conducted by investors in a platform. DAOs are decentralized in name only and the market for their tokens, much like that of those for similar ones traded in crypto markets, is illiquid.

In the latest instance, the hacker usurped control of Tornado Cash’s DAO through a fake proposal and “maliciously minted” one million TORN tokens, worth over four million dollars. [Note: Those figures should be marked with asterisks because all crypto numbers are airy nothings]. Yesterday evening brought about a reversal and TORN jumped by 10% after the hacker, in a fit of benevolence, submitted a proposal to undo the weekend attack.

A Useless Token

TORN is a special case because it belongs to Tornado Cash – a smart contract that was sanctioned by the Treasury Department last August. The DAO, whose members are unknown, disbanded immediately afterwards, and this is its first appearance since then.

The TORN token is a piece.

In other DAOs, tokens come with voting powers and important decision-making rights that can set the future direction of a protocol. But Tornado Cash claims to be decentralized and is a smart contract, meaning no one owns it or is accountable for it. In practical terms, this means that the TORN token has no defined use case.

According to CoinGecko, its biggest trading volumes are against Tether and Binance’s BUSD – two stablecoins that have been investigated and charged by regulators for fraudulent practices. Three-fourths of the overall supply of TORN tokens is distributed between three wallets, meaning decision-making is centralized among three actors. The wallet distribution also makes it relatively easy to manipulate the token’s prices.  

One could argue that the hacker, in expending energy and skills to exploit a worthless token, was the one who was hacked by a worthless crypto token.

Proof of Reserves in Texas

Legislators in Texas seem to be sleeping on the job.

The Lone Star state recently passed a bill mandating ‘Proof of Reserves’ for cryptocurrency businesses operating in the state. The House Bill 1666 is just four pages long and is a hurried product.

The bill does not allow for commingling of customer assets with those belonging to the businesses themselves, but it does allow the creation of an omnibus account – in which customer assets are mixed into one big holding.

Reserves in Crypto

More importantly, it allows for reserve holdings to be maintained in a ‘digital asset corresponding to the digital customer’s obligation.’ This means that crypto businesses are allowed to hold reserves in crypto tokens. That is a red flag of alarming proportions.

The crypto ecosystem is infamous for its volatile prices and illiquidity. This means that the reserve’s value will constantly fluctuate. Stablecoins like Tether and USDC, that have lost their pegs to the US dollar, introduce another accounting vulnerability for such reserves.

Except bitcoin, the regulatory status (and, indeed, existence) of most cryptocurrencies is uncertain. This means reserves of a crypto business could be wiped out in an instant. In fact, one could argue that the entire concept of reserves in crypto could be extinguished after regulators train their guns on the ecosystem.

The Binance Example

As an example, just look at crypto exchange Binance’s Proof of Reserves (PoR). It is a mess of unknown tokens and customer balances. Mazars, the auditing firm responsible for its attestations, washed its hands off checking the exchange’s numbers last year. It is not difficult to see why. The math does not add up.

With a customer balance of approximately 3.02 billion tokens, Binance’s stablecoin BUSD is the biggest component of the exchange’s PoR. Binance claims to have four billion tokens in its reserves. PoR rules dictate that they should have 1:1 backing for their cryptocurrencies, meaning there should be a total of, at least 7.02 billion BUSD tokens available to make this math possible. But the diluted market capitalization of BUSD, as of this writing, is 5.49 billion.

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