Things You Might Have Missed | 2020 Recap

This is part one of my series reviewing 2020. The other entries can be found here: Part 1, Part 2, Part 3, Part 4, Part 5.

Headlines in 2020 were dominated by a handful of topics: the fight for racial equality, the US Presidential election, and (most of all) Coronavirus. Just about every industry was affected by those things, and cryptoassets were no exception. But there was so much going on beyond that, and so much beyond the industry-specific headlines about DeFi’s growth and Bitcoin’s arrival as a macro asset as well. And so, in the first entry in a series recapping 2020, I want to talk about some of the smaller stories and themes that you might have missed or forgotten along the way.

Developer Funding

Sustainably funding Open Source projects has always been difficult, and that didn’t change with the creation of cryptoassets, despite many projects literally creating money that could be put towards their long-term development. Instead, the situation got even more complicated. As Nic Carter points out in his excellent piece discussing Bitcoin’s patronage system, development funds built from pre-mines or block rewards harm a project’s credible neutrality and frequently result in infighting, corruption, and malinvestment.

Far from enhancing the prospects for these networks, these funds are a source of bickering, self-dealing and graft.

Still, these projects need funding and for some, the easy access to freshly printed money in the form of block rewards sounds too good to completely ignore. That’s why we saw Bitcoin Cash flirting with the idea of introducing a Dev Tax last year.

The idea first emerged in January, when the network’s largest mining pool proposed that 12.5% of BCH block rewards should be directed to an ecosystem fund. It was immediately clear that the tax was contentious, and so it was no surprise that the proposal failed to make it into the network’s upgrade in May.

However, the idea came roaring back later in the year as part of a separate dispute between Bitcoin Cash’s two main development teams: Bitcoin Cash ABC and Bitcoin Cash Node. When it became clear a fork was likely anyway, the ABC team decided to reintroduce the Infrastructure Funding Proposal, this time looking to funnel 8% of block rewards to an address controlled by them. Again, the proposal was unpopular — so unpopular that the Bitcoin Cash ABC chain was pronounced dead on arrival after the network’s November chain split.

Presumably, after two decisive losses, this idea of block reward funding in Bitcoin Cash will be put to bed for some time, though it will be interesting to see how quickly it resurfaces if no alternative approaches are found.

Around the same time that the 12.5% Development Tax was first proposed for Bitcoin Cash, the Zcash community were also making important decisions about the future of their protocol and how to fund its development.

Since its launch in 2016, Zcash has allocated 20% of block rewards to the project’s founders to ensure they have the resources and incentive to keep working. This Founders Reward was split between the non-profit Zcash Foundation, who received 2.2% of total block rewards; Zcash’s for-profit developer, the Electric Coin Company (ECC), who received 5.75%; and founders and employees of that company, who received more than 10% of block rewards in total.

The Founders Reward was set to end at the time of the network’s first halving, which took place in November 2020, and that presented an issue to the Zcash community. While the funding model was highly controversial, Zcash relies heavily on the specialised knowledge of the ECC to develop and maintain the protocol, so there were strong arguments for continuing block reward payments beyond their original endpoint.

Discussions about the best way to fund development while increasing decentralisation began in 2019 and led to a number of important changes for Zcash. The relative importance of the Zcash Foundation and community has been increased, the Zcash trademark has been moved from the ECC’s control to the Foundation’s, and in January 2020 a new era of developer funding was agreed upon. Under the new model, which took effect from November’s halving and hard fork, 20% of block rewards continue to be set aside to fund development, but the distribution of those funds is quite different. Now, the ECC will receive 7% of block rewards, the Zcash Foundation 5%, and 8% will be used for third-party grants allocated by a committee. Together, these changes give Zcash at least a few years of stability and certainty, and they’re an indication that community discussion and governance can, in some cases, be a solution to the thorny problem of developer funding — something that will be incredibly important for many DeFi protocols in the years ahead.

Still, Bitcoin’s great success in 2020 shows that, sometimes, the best approach to developer funding is to not have one at all. Bitcoin’s future development relies on those that use and benefit from it to give something back. To some, this may seem like a dangerous approach that could backfire in a couple of ways, and Bitcoin has certainly faced (unwarranted) criticism in the past for being coopted by one of the handful of companies that initially stepped up to fund its development. It’s now clear, however, that those concerns can be laid to rest. Over the last couple of years, and particularly in 2020, sources funding Bitcoin’s development have increased dramatically, and even ecosystem-benefitting public goods like BTCPay Server are now receiving financial support.

Last year, we saw Square Crypto, BitMEX, and OKCoin expanding their grants efforts, as well major players like Kraken, Coinbase, Gemini, and investment firm Paradigm upping their game and choosing to support Bitcoin development. We also saw the emergence of two entities that will allow US citizens to make tax-deductible donations to Bitcoin development. The first of these is the Human Rights Foundation’s (HRF) Bitcoin Development Fund, which will allocate 95% of donated funds to developers working to increase Bitcoin’s privacy and 5% to the HRF’s human rights advocacy efforts. The second is Brink, an independent non-profit looking to support and mentor new Bitcoin developers through a fellowship program and fund existing developers through grants.

Clearly, Bitcoin comes into 2021 in a strong position in terms of funding and development, and I’m sure the situation will only improve as the companies now allocating funds to Bitcoin realise it would be beneficial to contribute to the protocol’s maintenance.

If you want to keep an eye on all the grants given out in 2021 and the years ahead, take a look at the Bitcoin Grants page on WORDs Bitcoin Journal or Polylunar’s Bitcoin Grants Tracker.

Protocol M&A

One of the things that I think a lot of people are looking forward to seeing is how mergers and acquisitions work in the context of decentralised cryptoassets. In 2020, we got a hint of what they might look like and how messy they can be.

On Valentine’s Day, Justin Sun’s Tron Foundation and Steemit Inc., the company behind the social media platform of the same name and major contributor to the Steem blockchain, announced a ‘strategic partnership’. Sun had reportedly purchased the company — and crucially all the STEEM tokens it controlled — for almost $8m, with the long-term intention of moving Steem’s products and users to the Tron blockchain.

Steem’s users were immediately concerned. When Steem launched, Steemit Inc. had controversially accumulated a vast number of tokens that became known as their ‘Ninja-mined Stake’. Prior to Sun’s acquisition, Steemit Inc. had promised to use these tokens to fund development and never to interfere in the blockchain’s governance system, which uses a token-weighted vote to elect 21 ‘Witnesses’ that produce blocks and run the chain. Steemians were unsure if that arrangement still stood or if the company’s tokens would now be used to elect favourable Witnesses, so they made a plan. A little over a week after the partnership announcement, the existing Witnesses voted almost unanimously to freeze a large number of tokens owned by Tron and Steemit.

Sun retaliated with a scheme of his own. He reached out to Binance and Huobi for help, convincing them to join his exchange Poloniex in using their customers’ tokens to elect Steemit and Tron Witnesses into power, giving him control of the network and allowing him to unfreeze his tokens. The response to this was overwhelmingly negative: Steemit employees quit, Steem users were outraged, and Binance and Huobi quickly backtracked and withdrew their votes.

With the exchanges no longer voting, the Steem community thought they had a chance to reclaim the chain. A voting war followed, with both sides doing everything they could to maximise their influence in Witness elections — including purchasing additional STEEM. Eventually, though, it became clear that a more permanent solution would be necessary, and the Steem community chose to fork away and create a new platform called Hive, which wouldn’t issue any tokens to Justin Sun or anyone who’d voted for one of his Witnesses.

Unsurprisingly, Sun retaliated. Steemit posts mentioning Hive were censored, and 8 accounts tied to Hive supporters were frozen, locking up 17.6 million STEEM worth more than $3m at the time. Finally, 6 weeks later, Steem conducted a hard fork to seize $5m worth of STEEM from 65 accounts accused of opposing Tron’s acquisition and organising the Hive fork.

The whole saga was one of the most dramatic things we saw all year, and there’s obviously a lot that can be taken from it about the role of exchanges in Proof of Stake systems, about the inadequacies of dPoS, and about how crypto-M&As might play out. Clearly, in an environment where disputes can be solved much easier by forking than by talking, any party looking to instigate some kind of merger must be very careful to ensure a constructive outcome rather than a destructive one, or they could end up with a lot less than they paid for.

Perhaps a different approach is needed to meld cryptoassets together, using a looser relationship to gently nudge communities towards one another and encourage collaboration without obviously threatening autonomy, leaving both sides feeling like winners rather than victims that need to break free. This certainly seems to be the approach of DeFi protocol Yearn, which announced a flurry of collaborations, mergers, and partnerships towards the end of the year to give us an idea of how a DeFi conglomerate could be built.

In the space of just a few weeks, Yearn announced plans to join forces in some way with C.R.E.A.M, Pickle, Hegic, Cover, Akropolis, and SushiSwap. But, rather than properly combining these different projects under the Yearn umbrella, they will all continue to work separately with their own tokens while sharing resources, talent, and future objectives, and they will all leverage each other’s offerings to enhance future products. The SushiSwap deal is particularly interesting, as Yearn will add SUSHI to its treasury and participate in governance. Perhaps we’ll one day see them push a vote on a more formal merger — that certainly seems like the logical endpoint for these kinds of moves.

I’m sure the next couple of years will show many more examples of mergers in the DeFi space using all kinds of mechanisms to bring different protocols together. However they go, whether they’re as explosive as Tron’s attempt or as casual as Yearn’s, they’re certainly going to be interesting to watch.

Token Governance & Activist Investors

Both of the topics so far have touched on the idea of governance, which was a major theme through much of last year. Governance has certainly been an aspect of some cryptoassets in the past — Tezos jumps to mind as a good example — but it never really mattered because nothing was actually worth governing. But, with the emergence of useful DeFi protocols that generate real revenue, that changed in 2020.

The Yield Farming craze of the DeFi summer saw dozens of protocols distribute governance tokens in an attempt to incentivise usage while decentralising control. These tokens give their owners a degree of influence over important parameters like interest rates, collateral types, and protocol rewards, as well as over a protocol’s treasury and future developments.

Last year, DeFi governance was a bit of a mixed bag. On the one hand, there were the traditional concerns about voter apathy and whales holding too much influence, but on the other hand, we saw some genuinely engaged users and fairly significant decisions passed by on-chain votes. And, whatever you think of the efforts thus far, it’s undeniably exciting to see DeFi acting as a relatively low-stakes sandbox to test new governance methodologies and mechanism. The experiments of the next few years could result in some truly significant findings that alter the distribution of power in the future.

In the short time that governance tokens have been popular, we’ve already seen a few interesting tidbits that will likely play out in a larger and far more dramatic way in the future. For example, we saw the arrival of Protocol Politicians as different parties argued why token holders should delegate their voting power to them on platforms like Compound and Uniswap, where a large number of tokens are required to submit a proposal. An even clearer example of political campaigning came as SushiSwap elected signers for its multisig following Chef Nomi’s departure.

Another interesting area to watch is meta-governance, where protocols accumulate voting power in other protocols and use it to influence decisions. Yearn adding SUSHI to its treasury to enable voting would be one example of meta-governance, and the influence it has accumulated the Curve DAO is another. November saw both the launch of PowerPool, an index protocol specifically built to accumulate voting power in other protocols, and the first meta-governance proposal in Index Cooperative’s DeFi Pulse Index, which was originally launched as a simple index tracking the performance of top DeFi assets. In the future, these kinds of protocols could be massively influential, using their power in multiple different DAOs to create self-serving harmonies, so they’re worth keeping an eye on.

Important governance-related activities weren’t limited to trendy DeFi projects and the wave of governance tokens powering them. One of the year’s most interesting and overlooked stories was Arca’s attempt as an activist investor in ICO-era prediction market protocol Gnosis.

Throughout much of 2020, investment company Arca, who invested in Gnosis in 2017, were in discussions with Gnosis about dramatically overhauling its operations and returning a substantial portion of its treasury to GNO token holders. At the time, the market cap of GNO was significantly lower the total value of Gnosis’s treasury, something that shouldn’t really happen. Arca’s intention was to remedy that situation and make money in the process.

In September, the discussions became public after The Block published Arca’s pitch deck, in which they accused Gnosis of having “strayed from their initial promises and disappointed their community with the products it has delivered”.

In Arca’s view, ICO participants provided Gnosis with an interest-free loan of $12.5m on the basis that they would deliver a specific product, in this case a prediction market. On their way to finally delivering that, Gnosis used the funds to work on several unrelated products that may have benefited the Ethereum ecosystem or Gnosis’s shareholders, but did nothing to deliver value to token holders, resulting in the depreciation of GNO. At the same time, purely because of the rising price of ETH, Gnosis’s treasury had swelled to more than $75m, and Arca feels this money had been used irresponsibly. In their opinion, Gnosis had an overly large team and an extremely high burn rate despite generating no revenue. They even used some of their funds to make undisclosed investments or to participate in Yield Farming.

Arca strongly believes in the rights of token holders, arguing Gnosis owes certain responsibilities to them and that those token holders should have a claim on the company’s treasury. Therefore, Arca believed Gnosis should make a tender offer for circulating GNO. Essentially, Gnosis would use most of their treasury holdings to buy GNO from token holders at a set price, well above the market value at the time. Gnosis would be left with enough money to operate at its current rate for another year or so, hopefully instilling a sense of urgency that might make them focus on producing a profitable product, and anyone who chose to hold on to their tokens because they believed in the team’s ability and vision would be airdropped additional tokens that were unsold after the ICO.

Gnosis didn’t take too well to the proposal, with its co-founder passing it off as an attempt to make an “easy flip” on GNO and saying Gnosis was progressing along a different path, one that led to the announcement of GnosisDAO in late November. The DAO would put token holders in control of 150,000 ETH and 8m GNO, representing 83% of the team’s ETH treasury and 93% of their GNO holdings, according to Gnosis. Remaining funds would provide Gnosis with a 2-year runway, after which they would rely on the DAO to keep them going.

While certainly a big step in the right direction, Arca believes Gnosis still have more to give. Their analysis suggests Gnosis are withholding millions of dollars from the DAO and argues that any assets “purchased by Gnosis through venture bets or ICOs, and all revenues created via farming and trading, should accrue to the GnosisDAO rather than Gnosis Ltd since all of this was accomplished using investor capital raised through the GNO ICO”. Because of this, their previously off-chain activism could be brought on-chain, with the investment company creating a proposal in GnosisDAO’s Governance Forum to fund a full audit of Gnosis’s treasury and to reallocate assets purchased using investor money from the company to the DAO.

Even if those actions don’t make it through community governance, it seems Arca has already succeeded in its primary goals. The pressure applied by Arca and the threat of potential legal action almost certainly played a part in driving change at Gnosis, even if they don’t want to admit it. Those changes have converted a failing, worthless token into one truly backed by treasury assets, creating a price floor that the Gnosis community can hope to build on in the future. That is the power of focused and well-intentioned activist investors, and I’m sure we’ll see many more examples of it in the years to come.

The Rise of Cryptobanks

One of the great innovations of Bitcoin is that it empowers users to take full control of their funds and self-custody them, rather than relying on institutions to do that job for them. However, many individuals simply won’t want to take on the responsibility and hassle of ‘being their own bank’, and so cryptobanking has always seemed something of an inevitability (in fact, Hal Finney was even discussing the idea of Bitcoin Banks back in 2010). And, while we’ve seen various crypto-businesses like exchanges and lending platforms growing into what could be thought of as protobanks over the last few years, things really stepped up a gear in 2020.

Perhaps the biggest news relating to cryptobanking was a July announcement by the US Office of the Comptroller of the Currency (OCC), which opined that national banks and federal savings associations could custody cryptoassets on behalf of their customers. This was a major clarification in the rules around cryptoassets that could open the doors for some big-name banks to dip their toes into the world of Bitcoin and cryptoassets, and it wouldn’t be surprising to see some major custodian acquisitions as a result of this.

While significant, this guidance wasn’t necessarily helpful to any budding cryptobanks, as it doesn’t make it any easier to attain a banking licence — which remains extraordinarily difficult with significant capital requirements and multiple barriers to entry. Instead, they might want to set up as a Special Purpose Depository Institution (SPDI) in Wyoming, a structure created with cryptobanks in mind. That’s certainly that approach that crypto exchange Kraken and startup Avanti chose to take in 2020.

Kraken Financial launched in September and became the first bank to receive the SPDI charter and first newly chartered bank approved in Wyoming since 2006. The exchange intends to use Kraken Financial to reduce its dependencies on third-party banking providers, who have historically been frosty towards crypto companies, and to expand their offerings to customers, who may soon be banking directly with Kraken, spending with a Kraken debit card, or trading traditional asset classes on Kraken. Notably, though, Kraken won’t be able to do anything like extend credit as the SPDI requires they maintain full reserves at all times.

Shortly after Kraken acquired their banking charter, Caitlin Long’s Avanti Financial was approved by the Wyoming State Banking Board. Avanti aims to become a kind of bridge between the world of dollars and the world of cryptoassets, and they’re working with technology provider Blockstream to develop a new stablecoin called Avit.

And despite the difficulties, some crypto and blockchain companies have decided to file paperwork with the OCC in an attempt to become a national bank. The best example is probably the Bitcoin payments company BitPay, who filed an application for the BitPay National Trust Bank late last year.

At the same time that various companies from within the industry are looking to become banks or expand the range of financial services they offer, a number of traditional firms are moving in the other direction as they look to increase their support for cryptoassets. PayPal made cryptoassets available to purchase on their platform for the first time in October, with plans to enable crypto spending across its network of 26 million merchants in the near future. In Singapore, DBS — the largest bank in the country — launched a digital assets exchange in December, while Japanese Bank SBI Holdings and Switzerland’s SIX Digital Exchange announced a joint venture to launch a digital asset exchange, issuance platform, and central securities depository in the country in 2022. In Europe, Gazprombank — the banking arm of Russian energy giant Gazprom — launched institutional cryptocurrency services in Switzerland in October, while reports emerged in December that both London’s Standard Chartered Bank and Spain’s second-largest bank BBVA would be offering cryptocurrency services from early 2021. Meanwhile, Sygnum, a Swiss cryptobank that received its licences in 2019, continued to grow in strength throughout 2020, expanding its offering to include a stablecoin tied to the Swiss Franc and what they describe as a blockchain-based alternative to listing shares on a stock exchange.

There’s still a long way to go before cryptobanks are developed enough to rival traditional banks in all areas, but things are moving in the right direction and there’s clearly a lot of momentum here after a major year in 2020. I’m certain that 2021 and the years that follow will bring many more developments.

Ethereum’s Big Year

OK, so the major success of Ethereum in 2020 can’t really be classed as a story you might have missed, but it is easy to forget how just different its strong year-end was from its troubled start.

Ethereum actually came into 2020 on its back foot, having made a slightly embarrassing omission from its December 2019 hard fork dubbed Istanbul.

Since its launch, Ethereum has always planned to transition from Proof of Work (PoW) to Proof of Stake (PoS), and to encourage that transition the developers added a feature known as the ‘Difficulty Bomb’ that would kick in at a certain block height and make it increasingly more difficult for miners to discover new blocks. However, Eth2 and Proof of Stake have taken much longer to develop than initially expected, and so the difficulty bomb’s fuse has been extended multiple times in previous hard forks. But that didn’t happen in Istanbul, and Ethereum’s block times were starting to increase as a result. By February, the delay between blocks could have topped 30 seconds, resulting in significantly more congestion and higher transaction fees. To avoid that, Ethereum was forced to hard fork for the second time in a month at the start of January.

I don’t want to make too big a deal out of this because mistakes do happen, but scrambling to solve a problem created because of their own overly ambitious timeline wasn’t a good look for Ethereum, and it probably wasn’t great to provide Bitcoiner trolls with so much fodder.

Someone more superstitious than myself might have considered the difficulty bomb snafu to be a bad omen for Ethereum in 2020, and they might have thought themselves proved right as the community descended into controversy one month later.

In February, Ethereum’s core developers unexpectedly approved a controversial change to Ethereum’s mining algorithm, leading to community dissent and threats of a chain split. Programmatic Proof of Work, or ProgPoW, is an ASIC-resistant algorithm designed to reduce miner centralisation and prevent a miner-led fork in the run-up to Ethereum’s transition to Proof of Stake. The change was first discussed in 2018 after mining giant Bitmain released Ethereum-specific ASICs, but it never appeared to receive the kind of support necessary to be included in an update. As a result, Ethereans were shocked when it was approved and scheduled for the next hard fork in a core dev call. Vitalik Buterin even described the proposal of being ‘ninja approved’.

The division over the update led some to worry that it could result in a chain split, and this was highlighted in a petition signed by some of Ethereum’s heaviest hitters. The petition read:

A stated goal of ProgPoW is to avoid contentious forks while transitioning to proof-of-stake, yet it is at odds with its own aims if activation increases the likelihood of that undesired outcome.

All the drama ensured ProgPoW would not be included in the next fork, guaranteeing Ethereum would remain a single, united chain for the time being.

At a glance, the ProgPoW saga looks like a bit of a mess and an indication that Ethereum’s core developers are somehow out of touch with the rest of the community, but there are some positives to take away from it. Yes, it’s a learning experience that will improve the governance and approval process for updates in the future, but more interestingly (and counterintuitively) it may be an indication of Ethereum’s maturation.

In his podcast The Breakdown, Nathaniel Whittemore suggest the rejection of ProgPoW was Ethereum’s first act of ‘Protocol Conservatism’. The idea here is that crypto protocols can afford to be a bit more experimental and are free to introduce non-essential changes early in their life, but there comes a point where they develop a truly valuable use case that must be protected above all else, meaning the status quo will always be prioritised from that point on.

“When you get to the point where there is something that’s worth protecting, your bias as a community becomes to protect that thing rather than to potentially threaten or disrupt it. In some cases, change is going to be a threat, and in those cases, that creates a new type of conservatism which might have felt very odd and out of place even just a couple of years ago before DeFi.”

In the year or so running up to this ProgPoW squabble, Ethereum found its use case in the form of DeFi, and now any significant changes must present obvious benefits and receive significant support, or else they are simply not worth taking the risks over.

Of course, Ethereum does have significant support to make one very major change, and that is to transition to Eth2, an all-new blockchain running on Proof of Stake with a sharded design. The first phase of Eth2’s rollout is the launch of something called the ‘Beacon Chain’, which will form the backbone of the new system. For years, people have wondered when this critical piece of infrastructure would finally be released, and after a number of testnets and practice launches throughout the year, it finally arrived in December 2020.

It all began with the release of the deposit address in early November, which is where ETH holders sent their funds if they wanted to become stakers on the new chain. The beacon chain was scheduled to launch on December 1st, but at least 524,288 ETH would have to be staked for that to happen.

While Vitalik was quick to show his support by depositing 3,200 ETH in the address, others weren’t so fast. For a long time, ether trickled slowly into the address, leading some to doubt the new chain would launch on time. However, with one day to go before the deadline, a flurry of new deposits pushed the total well beyond the threshold, ensuring the launch would go ahead on time. After that, the ether kept coming. By the end of the year, nearly 2.2m ETH were deposited in the contract, showing strong support and belief in Eth2.

The launch of the beacon chain on December 1st was a major event for Ethereum, representing years of hard work by many people. Of course, this is just the first part of a multi-year, multi-phase project, and things only get more complicated from here, but it’s a brilliant first step and it has gone off flawlessly.

Ethereum has incredible momentum behind it going into 2021, and while there are clear challenges ahead — mostly related to scaling to meet the demands for DeFi — the future looks very promising indeed.

Disclaimer

Anything expressed here is my own opinion stated for informational and educational purposes; nothing I say should be taken as investment or financial advice. Any projects mentioned are not recommendations and may be highly experimental and therefore risky. Please evaluate your own risk tolerance before trying them out.

I may own some of the cryptoassets mentioned.

At the time of upload (February 2021), I own:

• Long Term Holdings: Bitcoin (BTC), Ether (ETH)
• Short-Medium Term Holdings: Aave (AAVE), Alpha Finance (ALPHA), Terra (LUNA), THORChain (RUNE), SushiSwap (SUSHI), Uniswap (UNI), Nexus Mutual (NXM), Yearn.Finance (YFI)
• Stablecoins: USDC