Financial Crisis: Death By A Thousand Cuts

Speaking 10 years after the Global Financial Crisis of 2008, Hank Paulson worried that, while banks were not over-leveraged, governments had no room to stimulate growth because they were already spending and borrowing record at record rates and interest rates couldn't go any lower. Another 5 years on, and the era of cheap money is over, inflation has rocketed and suddenly there's a crisis of confidence in banks, not governments. What the hell happened? Well, it's the same old problem: greed and stupidity are winning, but this time it's everywhere, all at once. 

The result is a broader crisis in confidence - or the lack of it. No matter where investors turn unexpected holes are appearing. A string of crypto collapses culminating in the discovery of a vast fraud in FTX and the ensuing crypto-contagion that bled into the banking system via Silvergate; the SEC finally calling time on numerous unregistered crypto-securities programmes, again stressing real world investors and funding providers; the Truss-Kwarteng 'mini-budget' producing unaffordable mortgages and declining property prices amid flat-lining business investment and other trade problems in Brexit Britain, now the basket-case of the G7; Russia's invasion of Ukraine driving energy price explosion and rampant inflation, to which central banks have responded with rapid interest rate rises that in turn cut the market value of long term bonds held by banks with needy depositors, like SVB, First Republic and other lesser US banks that Trump exempted from proper scrutiny. And then there's the perennial doom-spiral that is Credit Suisse. 

Where will it end?

Who knows. Buckle up and try to enjoy the ride.

Is The Production Cost Floor Another Flaw In Cryptocurrencies?

The fact that one of the largest bitcoin miners has just filed for bankruptcy underscores the significance of the fact that the BTC price has hovered around the average mining cost of approximately $17,000 since November 9. When added to the fact that both the trade volumes and the price of the supposedly 'trustless' cryptocurrency have been flattened by the implosion of numerous cryptoverse intermediaries in the past few months, it seems there are a number of very important 'externalities' that the bitcoin protocol and blockchain are unable to address and the market has failed to appreciate.

Of course, Core Scientific's filing follows several warnings, and the bankruptcy of another miner in September, as explained by Coindesk in the latest coverage. But the fact that this filing comes amidst the market doldrums related to the FTX collapse and speculation on Binance makes it particularly significant.

How do you calculate the cost of mining a bitcoin?

One industry 'Bitcoin Mining Profitability Calculator' assumes the following (presumably not necessarily for the major miners):

Mining metrics are calculated based on a network hash rate of 6,363,326,225 GH/s and using a BTC - USD exchange rate of 1 BTC = $ 16,810.56. These figures vary based on the total network hash rate and on the BTC to USD conversion rate. Block reward is fixed at 6.25 BTC. Future block reward and hash rate changes are not taken into account. The average block time used in the calculation is 617 seconds. The electricity price used in generating these metrics is $ 0.12 per kWh. Network hash rate varies over time, this is just an estimation based on current values.

Of course, the mere quantity of energy consumed in mining bitcoin is itself a significant problem to be solved.

When considering the drivers of the base mining cost (or the Production Cost Floor or Bitcoin Electrical Cost, as calculated by the analyst Charles Edwards), it's worth noting that the bankruptcy filings for NASDAQ listed Core Scientific (CORZ) explain that 45% of a proposed $72m rescue package hangs on a #BTC price of $18,500. This suggests that Core's actual mining cost per bitcoin is higher, presumably because of higher energy costs relative to other miners, but also the cost of its financing arrangements.

Core Scientific seems to have effectively borrowed over $600m in convertible notes, bank facilities and DeFi loans, and in the context of a bankruptcy this must affect Core's own base mining cost. But this should extend to other miners, given the Core's 10% market share; the fact that another miner, Compute North, filed for bankruptcy in September owing about $500m; and the sector as a whole has $2.5bn in fiat currency borrowings. Borrowing must also be directly related to the miner's own view on how much it needs to weather market troughs and possibly to protect a desired base price (not to mention that fact that the Bitcoin protocol halves mining rewards periodically with the next halving due in 2024, on current forecasts).  

What's harder to factor in is the wider risk of contagion due to lenders' overall credit risk exposure and potentially increasing finance costs or even withdrawal from the sector in certain circumstances...

In other words, a more sophisticated base mining cost calculation is fraught with uncertainty. 

At best, therefore, the base mining cost is merely one factor to consider as a guide to the future of miners and bitcoin.

Can the mining sector (and bitcoin) recover?

Core Scientific says it hopes to win the support of key creditors and continue mining.

Continuing market hype also suggests that Bitcoiners are still ploughing in time and advertising spend to stoke demand, which may increase trading volumes and prices. 

Energy/electricity costs should fall, if and when Putin finally accepts defeat in Ukraine... but when will that be? 

Will lender appetite persist amid the ongoing contagion from the FTX (and Binance?) fallout?

Time is indeed money when it comes to the $2.5bn in real world commercial debt outstanding among miners. 

Stick all that in your protocol!

When all is said and done, it seems to me that the claimed ideological 'purity' of bitcoin as a 'permissionless', 'trustless', 'fully decentralised' 'currency' is actually vulnerable to the following 'externalities' (either in the sense of affecting outsiders but not being reflected in the market price and/or being apparently outside the perception of bitcoin proponents/fans): 

• the centralising effect of intermediaries, such as crypto exchanges, custodians and decentralised finance (DeFi) providers;

• wilful misconduct by intermediaries (resulting potentially in active distrust of bitcoin itself); 

• the sheer scale and quantity of energy required to mine each bitcoin;

• rising energy costs;

• limits on computing efficiency; 

• existing and proposed regulation; 

• competition from other cryptocurrencies or types of token (e.g. stablecoins);

• (over) borrowing/investment by miners; and

• 'news' or commentary concerning each of the other externalities listed above. 

That's not to say bitcoin is necessarily 'worthless', but it is not the idyllic ecosystem that fans claim it to be; and can't really be dubbed 'successful' until it's value is not subject to the wild swings we've seen to date nor at risk of being significantly undermined by any of the above externalities.

No, Really, Bitcoin Is Not "Money": Debunking Yet Another Bitcoin Sermon

Another day and another Bitcoin boost, this one so irritating I've been inspired to negate virtually every line... At this stage, surely the only reason why anyone holding or mining Bitcoin would lure new buyers is to get their own Bitcoins out. Rational justifications don't bear scrutiny, so the boosters' pleas tend to be couched in semi-religious rants that only require you to believe - as an act of faith. But try watching the WeWork documentary without thinking about FTX... That doesn't mean I'm down on distributed ledger technology in general. DLT has its use-cases, but its deployment should be approached like any other tech project, not a cult.

Debunking another Bitcoin sermon

Bitcoin is not "money". At best it might be a means of settling a trade between two parties (A and B), so long as each of them has an absolutely certain way to exchange their Bitcoin immediately with another party (C and D) for the agreed value of their trade in fiat currency. That might be possible in certain institutional scenarios - although even institutions got caught up in FTX - but very risky as a retail payment method, mainly because the price is so volatile. 

Bitcoin does not remove counter-party risk. Ask Celsius or FTX customers. And it's futile to claim it removes counter-party risk between A and B in the above example, when that risk remains between A/C and B/D - not to mention the wider cryptoverse, as still being illustrated by the collapse of FTX. 

Bitcoin transactions do happen faster than many types of retail and other payment methods which are settled over one or more days, since each block of transactions is completed in 10 minutes. But speed itself does not make Bitcoin appropriate as a retail payment method (as opposed to a potential settlement mechanism, as mentioned above). 

Bitcoin does not have an absolutely "incorruptible history", which could only be judged in hindsight anyway. Even if it initially seemed unlikely that any one miner or group of miners could create a new branch or 'fork', rising energy costs and periodic reductions in rewards have been driving concentration among miners (explained further below).

While the Bitcoin protocol itself may be 'trustless', that's actually a shortcoming or 'externality' that others have struggled - and consistently failed - to solve, at greater and greater cost as the ecosystem has grown. Ironically, therefore, it is kind of true to suggest that Bitcoin "is an impenetrable fortress of validation" (yet) "trusted third parties are security holes". The point is that Bitcoin does not exist in a vacuum. [For some reason I'm reminded of the Lewis Grizzard book: "Don't bend over in the garden, granny, you know them taters got eyes."]

Again, to blame "centralised exchanges and custodians" as "destroying everything that makes Satoshi's invention great in the first place" is effectively conceding that Bitcoin is worthless in any 'currency' other than Bitcoin itself. In other words, for all other practical purposes Bitcoin is worthless without a way of exchanging or holding it; so if exchanges and custodians 'destroy everything great about Bitcoin' then it must be worthless.

It's obvious and goes without saying that Bitcoin "is not a company. It can't go bankrupt. It has no CEO that can be influenced, arrested, or corrupted." This is just gaslighting. The same can be said of the USD. The fact is that the Bitcoin protocol must have a way of interoperating with the rest of the world and that necessarily involves contact with third parties and other forms of value, at which point Bitcoin's supposedly utopian benefits suddenly become externalities that must be addressed before Bitcoin can be useful. Success in negotiating and regulating that real world interface explains the relative strength, lack of volatility and broad acceptance of the USD and other major fiat currencies, compared to Bitcoin.

Similarly, it's a bit bizarre to say that "Bitcoin's monetary policy is set in time, not by decree. It can't be changed. It can't be argued with. It is unrelated to demand, unrelated to energy usage, and independent from politics." Miners are rewarded in Bitcoin, so it becomes critical to know the cost of mining each Bitcoin, as it would not be worth mining them if the costs could not at least be covered. Currently, the cost of mining a Bitcoin is considered to average out at $17,000 depending on where the miner buys the vast amount of energy required to mine each 'block' (itself a source of significant political controversy). At time of writing the USD price of Bitcoin was $17,220.25 (and, oh look, as at mid-October there were 276,000 Bitcoin mining rigs that had never been installed). The Bitcoin protocol dictates that mining rewards halve periodically and, on current forecasts, in 2024. Yet the maximum 21 million Bitcoins isn't due to be mined until 2140... Given that the Bitcoin protocol only launched in 2009 that's an awful lot of time and opportunity for it to grind to a halt.

But, sure, if Bitcoiners can stoke demand, the USD price of Bitcoin will rise again and profits can be extracted. Or energy costs might fall, efficiencies improve and/or mining might decline to constrain supply in the face of constant demand. Such factors would explain why miners have borrowed during past Bitcoin market troughs. But that's also left miners and their lenders with $2.5bn in loans that are exposed to wider market contagion following the collapse of FTX...  

In other words, the purity of the Bitcoin protocol is actually vulnerable to: the misconduct of exchanges, custodians and decentralised finance (DeFi) providers (and resulting distrust), rising energy costs, limits on computing efficiency and over-borrowing by miners. 

Now comes the crescendo of the sermon, which involves repeating a few truths from above...

We've already seen that Bitcoin is CERTAINLY NOT "an answer to the moral failings of fiat money and our fiat monetary institutions". Indeed, I agree that "Crypto" as an industry "is a reincarnation of ... failing [fiat money] institutions, replacing the friendly faces of clean-shaven bankers with the shy smiles of unkempt teenagers." 

The point is that Bitcoins are not divisible from the Crypto industry, any more than a 10 pound note is divisible from the wider fiat financial system. It doesn't matter whether "Bitcoin is honest, fair, and truthful" on its own, since it is not used or useful in splendid isolation.

Perhaps other implementations of DLT that do not purport to be any form of payment method (or e-money or security) may be divisible from the Crypto industry; but equally we should not be fooled into thinking that they do not have their own externalities and challenges in integrating with the 'real' world. Their implementation should also be approached like any other tech project rather than merely requiring a cult-like belief in their intrinsic benefits.

Bitcoin is as much a victim of the "game of liquidity and purchasing power" as any other commodity, and in some ways more so. Only the financially strong miners have survived, and to the extent that we have any idea who or where they really are, they appear to be based in the world's largest totalitarian regime: 

Due to the cryptocurrency’s design focus on privacy, there is no indicator of how many new coins are created from which location – hence why the figures provided here look at PC processing power, and not Bitcoin themselves. In 2021, the world's top Bitcoin mining pools all came from China, with five pools being responsible for over half of the cryptocurrency's total hash. 

The final tout is a promise of personal sovereignty, much favoured by Trumpsters and the Brexidiot Alt Right: 

"If you don’t hold your own keys, you don’t hold bitcoin—but IOUs. If you don’t run your own node, you have no say in Bitcoin—you are beholden to someone else’s idea of Bitcoin. For bitcoin to be your money, you have to hold your own keys, and you have to verify with your own node." 

Of course, anyone not holding their own keys or running their own node should be worried by this statement. 

But even if you have the skill, time and resources to rush home and engage with the process of holding your own keys and operating your own node, we have already seen that this process will not magically deliver "deep stability and autonomy" or make you "a sovereign individual" anywhere outside the Bitcoin protocol itself. In fact, depending on the real world's view of your identity and circumstances it may mean you're excluded from the 'real' world altogether, like those caught up in the Hell that is FTX group or North Korean hackers.

So why would somebody write such an overblown puff piece tempting newbies to exchange their cold hard cash for Bitcoin?

Probably so that they and their Bitcoin buddies can cash theirs out.

This Year's Misadventures In The Cryptoverse

Looking back over the posts on these pages over the past few years (and my Twitter feed!), readers may wonder if I've focused on anything other than Britain's political woes. Fortunately, I've been distracted by numerous legal developments, covered extensively on The Fine Print, Keynotes, Ogier Leman's "Insights" pages, LinkedIn and, most recently, Mastodon. A prominent theme is commentary on attempts to introduce legal certainty and controls into the volatile world of cryptoassets, alas too late to avert the string of collapses that have peaked (so far) with FTX... Contagion still lurks and has crossed into traditional financial firms, including Australian pension funds. Two main thoughts leap out from the morass:

• Tech evangelists should stop pleading for ‘light touch regulation’ and explain any significant externalities associated with their technology which need to be addressed. There may be no ‘choke points’ within the energy guzzling Bitcoin protocol itself but consider the role of crypto-exchanges, wallet custodians and decentralised finance (DeFi) operators that enable lending, trading and so on: FTX demonstrated that greed and stupidity still lurks around crypto-tokens, so the tech still needs regulatory tools to guard against related human misconduct; and

• Similarly, the fact that major venture capital firms invested in FTX while receiving investments through FTX's trading arm - and their due diligence seems to have 'missed' the complete absence of ‘traditional’ governance/controls - raises questions about (a) potential tracing claims by FTX clients' assets into the VCs' funds; and (b) whether FTX was effectively an unincorporated association with an array of corporations designed to encourage the idea that it was a 'traditional' corporate group, such that the participants may have unlimited liability... 

The last point should also be considered by those proposing formal recognition of  'decentralised autonomous organisations' (DAOs) which also tend to involve related companies and other 'body corporates' for various purposes.
Well, at least that's off my chest.