“…basically risk-free” — Raoul Pal, 2022
If one were to single out a single idea responsible for the absolute shitshow that was “crypto” in 2022, you could hardly do better than “yield”.
Yielding products were behind every monstrosity that collapsed once the bull market ran out of steam.
Terra Luna, Celsius, 3AC, BlockFi, FTX. Check, check, check, check, check.
“Degens” shoved their money into every yield instrument you could possibly imagine, from yam farms to SBF’s balance sheet.
As of now, the industry is barely recovering from this yield binge and it’s not clear we’ve gotten to the bottom of this hangover.
Turns out most of the yield out there was simply mispriced risk and everyone is paying the price for it.
Bitcoiners have been especially vocal about the pitfalls of those financial machinations but the siren song of “utility” scammers hasn’t gone silent just yet.
Various interests continue to prop up their flavor of “DeFi” during this bear market in an effort to collect mindshare, capital, and of course scam you out of your bitcoins.
Stacks is one such project that’s gone to great lengths to market to Bitcoiners and have muddied the water just enough to attract a decent amount of attention.
It’s time to find out what the yield is.
How does it work?
Something that has arguably worked to Stacks advantage so far is the good ol’ Bitcoin affinity schtick enabled by its Proof Of Transfer protocol.
A lot of people I speak to haven’t really bothered getting bogged down into the actual details, so let’s start with a short technical primer on Stacks mining.
To participate, Stacks miners must commit BTC to addresses specified by the Stacks protocol. Those addresses are derived from submissions taken from a pool of STX “stackers”.
Every round, a random function decides on the next block leader based on the weight of each miners’ contribution to the sum of bitcoins committed towards “stackers” addresses.
Your odds of writing the next Stacks block is proportional to your BTC commitment.
Those bitcoins earned by “stackers” are commonly referred to as the “PoX yield”. Of course, make no mistake, “stacking” is just cringe marketing for staking.
Now, seeing as STX is not a monetary asset or a store-of-value, this yield is the only reasonable incentive for a user to hold STX balances.
The “utility token” or “gas” framework applies here, as with most shitcoins in existence. The thesis is pure fiat psyops of course and it has played out exactly as one would expect. Consider ETH’s “ultra-sound money” pivot.
Stack’s pitch is a tad different, though equally suspect: STX as a bond earning its holder BTC yield.
As we find out in the next section, this yield is crucial to Stack’s Proof-of-Transfer consensus.
The MEV Catch-22
Most of you have heard about MEV (Miner Extractable Value) by now.
If you haven’t, the premise is simple: decentralized applications relying on a blockchain’s ordering network can, and often will, leak value that can be captured by whomever controls the inclusion and/or prioritization of transactions into blocks (the miners).
Remember that miners are incentivized to secure the Stacks chain by way of STX rewards. In a vacuum, miners are expected to compete for those rewards by bidding a certain amount of BTC based on the expected STX reward.
Although the “winner” is selected via the Stacks algorithm, the actual auction takes place on the Bitcoin chain.
If you’ve been following so far, it might have already dawned on you why that is a major (read: existential) issue.
Considering that every miner’s bid is public, the proposed Stacks strategy of miners merely outbidding each other has a significant game-theory hole.
This hole manifests itself in the form of MEV.
This is because the STX reward can be captured in a much more cost-effective way by an interested Bitcoin miner: rather than enter into a bidding war, he can simply opt to exclude his competitors’ bid from his Bitcoin block.
While this has not yet played out in practice, the incentive for Bitcoin miners to exploit this MEV opportunity trumps the intended Stacks auction strategy. As far as I’m aware, at least this much as been acknowledged by Stacks promoters and researchers.
In essence, the inevitable outcome of this dynamic is that the STX yield could, one day, vanish faster than you can say LUNA.
In time, any Bitcoin miner looking to improve their margins should be expected to capture this MEV. It’s economically rational for them to do so given that they can bypass the more costly auction mechanism.
What happens when illusionary yields go bust?
I’d say it’s likely STX holders won’t fare much better than Do Kwon devotees.
The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version. All financial innovation involves, in one form or another, the creation of debt secured in greater or lesser adequacy by real assets. — John Kenneth Galbraith
From where I sit it’s hard to look at Stacks and not see the similarities with other house of cards that have already blown-up.
The recipe is simple: sell someone a bond (STX) of questionable value in exchange for unsustainable yield.
During the “discovery” phase, STX, like any shitcoin, benefits from speculation as well as the incentive for holders to remove their share of the supply from the market by staking it in exchange for BTC yield.
Early adopters make a killing due to the information asymmetry and dump their tokens on unsuspecting “investors” as long as the lure of the yield persists.
New entrants aren’t as fortunate. Once the STX reward bounty grows large enough, it becomes easy pickings for Bitcoin miners which causes the entire thing to unravel.
This is the Catch-22 that befalls every STX holder.
The more value accrues to STX, the more likely it is to collapse. When it does, the exit door will be very very small and a new generation of suckers will be left holding the bag.
If Bitcoin miners also mine Stacks does that not mean it’s secure?
Cunning readers will have noticed that the scenario whereby Bitcoin miners secure the Stacks chain isn’t exactly novel. If my thesis plays out, Stacks would indeed devolve into yet another merged-mined blockchain.
The security, and downsides, of such merged-mining remains debated. Some observers have suggested that STX could, perhaps, be appreciated as a bootstrapping mechanism for an eventual merged-mine chain.
I find the claim dubious at best. The misallocation and eventual destruction of capital required for that to happen does not appear to be a very worthwhile tradeoff.
Smarter and more interesting characters have written extensively about the sustainability or security of merged-mine blockchains so I won’t get into that here.
That said, the prospect of Stacks turning into one is rather dire for any of its advocates. The end result would be so far removed from the original project that it’s worth reconsidering the latter’s value proposition.
The STX token could, maybe, retain non-zero value purely via market speculation but I find hard to reconcile with the current pitch made to prospective investors.
