I Created My Own Crypto, Here's Everything I Learned

DoodleToken, Defi, Stablecoins, Ransomware, Regulation, CBDCs & the Future

Hey all, Jason here.

I’m writing this intro from the rural Dutch village of Emmen, where we’re visiting friends this weekend (thankfully, no flooding here). I’m excited to announce I’ll be partnering with (and attending) Fintech Meetup again next March — please see the details below.

The newsletter this week is a bit of a different format. I’ve been voraciously reading all things crypto-related recently, and this is me digesting that info. If you’re missing your news analysis, don’t worry, it will return next week!

Also, as they say, I didn’t have time to write a short letter, so I wrote a long one. If this gets clipped in your email client, you can read it online here.

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I Fell Down the Crypto Rabbithole. Here’s Everything I Learned & the Questions I Still Have.

So, I’m a bit of a late adopter when it comes to crypto. I’ve spent my 10+ year career in mainstream consumer financial products — mostly lending. And while we might call the companies I’ve worked for “fintechs,” the services and products they offer are familiar; their relationship to the regulatory establishment is (mostly!) well defined.

Much of the innovation in fintech has centered around taking processes that had taken place offline and digitizing them, automating them, and improving the UX. And that journey isn’t done — if you’ve applied for a loan or mortgage lately, you likely know manual identity verification processes and gathering and uploading PDFs to prove income or employment are still quite common.

This is all to say, I haven’t been paying super close attention to the crypto sector during this time. (In this piece, I will use “crypto” as shorthand to include cryptocurrencies, tokens, smart contracts, blockchain, etc.) 

In case you haven’t noticed, things have been moving at warp speed in crypto-world. And I don’t just mean the rising (and falling, and rising again) price of bitcoin over the past few months.

Yes, consumer interest has spiked, with Coinbase IPO’ing and popular platforms like Revolut, Paypal, Cash App, and Robinhood making crypto widely available. Institutional interest has ramped up, with wealth management units and trading desks at white-shoe firms like Goldman Sachs and Morgan Stanley taking notice. And platforms to make defi (and its attractive yield) more accessible have begun to proliferate, with services like MonieApp and Linus targeting consumers directly. Compound Labs recently launched its Treasury product, enabling consumer-facing services to embed high-yield, defi-powered accounts.

Jumping in the Deep End

So, I decided to take a deep dive into the wider crypto world. I’m not positioning myself as an expert, though I did talk with several as I researched this piece. If there are any errors, omissions, or you disagree, I welcome polite, civil feedback (the crypto world can be tough!)

Also, this isn’t meant to be an explainer of the history or basics of crypto; if you’re looking for some background info on crypto, I highly recommend this podcast from a16z; for a defi explainer, try this or this Bloomberg Odd Lots podcast.

All Currency is “Trust”

It’s easy to suffer from the misperception that the dollar is and always has been the ultimate currency, especially as an American. But, as any student of history knows, this isn’t the case and isn’t likely to remain the case.

Image via Marketcap.com.au / The Burning Platform

What, once Nixon ended the gold standard in 1971, gives a US dollar its value? A common answer is that it is backed by “the full faith and credit of the US Government.” But that’s a fancy way of saying “trust.” Trust in the continued existence and stability of the government, and in the responsible management of monetary and fiscal policy to foster stable prices and, thus, the dollar’s viability as a store of value.

To the extent that someone’s political or investment thesis is skeptical of that, seeking another store of value is not unreasonable.

DoodleCoin vs. DoodleToken

I wanted an understanding deeper than reading and talking to industry experts could provide, so I set out to create my own cryptocurrency: DoodleCoin (this is both a play on the infamous Dogecoin and a nod to my labradoodle pup, Lito).

Turns out, I’m not the only person who has wanted to do this. There are (somewhat technical) step-by-step directions on how to create your own cryptocurrency, running on its own blockchain. The easiest way is forking (copying) the source code of Litecoin and, basically, finding and replacing “Litecoin” with whatever you want to name your cryptocurrency.

Ultimately, I ran into issues getting this to re-compile correctly on my ancient MacBook Air, which definitely isn’t configured for software development. And, besides, getting this to run in production would require setting up multiple nodes to actually process transactions on my new blockchain.

So, like many projects facing challenges, I pivoted: DoodleToken!

What’s the difference? A cryptocurrency like Bitcoin, Litecoin, or Dogecoin operates on a distinct blockchain - the distributed ledger that processes and tracks all transactions in the currency. Tokens, on the other hand, operate on top of an existing blockchain infrastructure, like Ethereum. ERC20 is a popular type of token which operates on the Ethereum blockchain.

A token could conceivably represent anything — an ownership share in a company, a barrel of oil, voting rights, a drink you owe your friend (or membership in a labradoodle fan club).

So, I used this service to generate my own ERC20-compliant token, DoodleToken:

While generating the token itself is free, there is a “gas fee,” which you can think of as a transaction cost; basically, paying nodes on the Ethereum network to process the transaction to create the tokens.

Once successfully created, I was able to send my DoodleTokens via the Ethereum Mainnet to other wallets (no centralized exchange or KYC required):

This Is Amusing, But So What?

Anyone with minimal technical knowledge can create their own coin or token — which has driven an explosion of “altcoins” (or, less charitably, sh*tcoins). While there are plenty of real projects developing differentiated technology, the number is no doubt dwarfed by jokes, get rich quick schemes, and outright scams.

Initially, I viewed this plethora of cryptos as inherently unsustainable, thinking it would be the equivalent of having tens of thousands of currencies around the world. Lex Sokolin, Head Economist at ConsenSys, a blockchain company, explained tokens should be thought of differently, saying:

“There will be millions of tokens, as there are millions of businesses. Most tokens live on computational blockchains or smart contract platforms as ways to interact with applications and governance. Winners are those that are used for use cases and functions, like with any business or commercial venture.”

Dogecoin, originally started as a joke-critique of cryptoculture, rocketed to prominence during the pandemic, garnering mentions from Elon Musk and making real-life millionaires. Last week, the co-creator of Dogecoin disavowed crypto writ large, calling it “an inherently right-wing, hyper-capitalistic technology built primarily to amplify the wealth of its proponents through a combination of tax avoidance, diminished regulatory oversight and artificially enforced scarcity.”

Jackson Palmer @ummjackson

I am often asked if I will “return to cryptocurrency” or begin regularly sharing my thoughts on the topic again. My answer is a wholehearted “no”, but to avoid repeating myself I figure it might be worthwhile briefly explaining why here…

More importantly than anyone being able to create a coin or token, anyone with an internet connection can buy, sell, or trade between thousands of cryptocurrencies and tokens. In the US, most of this activity takes place via exchanges or consumer services like Coinbase, Binance, Robinhood, or Cash App. A centralized exchange, and the requirements that go along with that, make the process more user friendly, but isn’t required.

The idea of decentralization — that you could move a store of value from entity A to entity B without a trusted intermediary (a bank, credit card network, stock exchange, etc.) — was the principle underpinning the original cryptocurrency, Bitcoin. The decentralized nature of these evolving technologies is the most interesting aspect, but also the most threatening to establishment financial institutions and regulators alike. (story continues below….)

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So, What is Crypto Good For & How Is It Being Used?

Bitcoin was originally envisaged as a decentralized payment mechanism — thus the name crypto-currency. A mechanism to exchange values between two parties without a ‘trusted intermediary.’ The hardcoded cap on the number of Bitcoins that could be created would enforce scarcity and preserve value in a way that governments often have difficulty doing.

12 years on, attitudes towards and uses of Bitcoin have evolved, and it is more popularly thought of as “digital gold” than something you’d use to make a purchase. While some merchants made headlines by announcing they’d accept Bitcoin for payment, in practice, its highly volatile value and tax treatment in the US as a commodity makes it a less than ideal payment instrument.

El Salvador made headlines recently when it announced it would adopt Bitcoin as legal tender. The argument President Nayib Bukele put forth for the move was the high cost of remittances sent to El Salvadorans; the country is already officially “dollarized,” meaning the US dollar is legal tender and is used to pay salaries and pensions.

A more interesting case can be made for crypto in countries where national governments have lacked the discipline or capability to maintain stable currency and prices. The perennial poster child for this is Argentina:

Data and image via Google Finance

And this is the official exchange rate; the “blue dollar” (black market) exchange rate is ~175 Argentine pesos to the dollar.

In a climate where inflation expectations are high, there is a disincentive to save; if you are saving, it’s rational to seek a stable store of value. But Argentines are officially limited to saving a maximum of $200 in USD per month. In this scenario, an alternate like crypto, whether Bitcoin or a USD-linked stablecoin, understandably becomes more attractive. This requires a graymarket workaround, like Binance’s P2P marketplace in the country, which even enables in-person meetups to exchange cash for crypto:

Screencap via Binance.com

Stablecoins

Stablecoins seek to solve the volatility issue associated with floating cryptos like Bitcion by linking their value to another asset, typically a traditional currency. For instance, each USDC (literally USD Coin) represents one US dollar and is said to be fully collateralized and redeemable. USDT, popularly known as “Tether,” is another USD-pegged stablecoin, though it has faced its share of controversy and rumor about the existence of reserves backing it.

With the price volatility issue potentially addressed, stablecoins offer the promise of truly peer-to-peer, decentralized transfer of value, or a new “payment rail.” This is particularly interesting for international payments which, despite the rise of services like Wise (formerly TransferWise), remain complicated, slow, and expensive, with transactions often routed through multiple correspondent banks. Traditional payment networks like Visa have taken notice and are beginning to develop and experiment with the technology.

Merely calling something a “stablecoin,” however, does not make it so. Recently, the unfortunately named “SafeDollar,” a so-called algorithmic stablecoin that was suppose to be pegged to the US dollar, went to $0 after a weakness in its design was exploited to drain around $248,000 in value from coin holders.

Non-Fungible Tokens (NFTs)

If you’re anywhere near the financial or creative worlds, it’s hard to have missed the NFT craze of recent months, the most extreme example of which is an NFT from digital artist Beeple that sold for $69 million. Even American Express is getting in on the craze, offering cardholders the chance to purchase NFTs of digital images produced by rapper SZA.

The speed and intensity with which NFTs have gained attention is reminiscent of the ICO craze of 2017. Unlike ICOs, which served as de facto equity offerings for often spurious projects, a number of interesting applications for NFTs are already being developed, particularly linked to digital rights management for assets like songs, videos, books, and photography.

Decentralized Autonomous Organizations (DAOs) 

Think of a decentralized autonomous organization (DAO) akin to a group that is bound to follow a set of rules and that is operated automatically according to those rules without human intervention. Tokens issued by the DAO can give the holder governance or voting rights in the organization on proposed changes to the code. Forbes (via Wikipedia) defines a DAO as:

“an organization represented by rules encoded as a transparent computer program, controlled by the organization members, and not influenced by a central government. As the rules are embedded into the code, no managers are needed, thus removing any bureaucracy or hierarchy hurdles.”

High-Yield Accounts

Another application of crypto that has gained much attention in traditional banking circles lately is so-called high yield accounts. Services like BlockFi began as solutions to match crypto savers with crypto borrowers, much like a traditional bank. Unlike a traditional bank, because of the high returns on crypto trading and arbitrage opportunities, depositors can earn interest at rates as high as 12%.

Decentralized finance, or defi, protocols are another method of matching savers with borrowers. I reached out to the team at a16z-backed Compound Labs to ask how defi protocols can drive such high yields, and they explained (emphasis added):

“The high yields in DeFi are mainly driven by the near-insatiable demand for leverage and liquidity in crypto markets. Professional and retail traders typically use protocols like Compound to borrow stablecoins, which are inherently more useful than traditional dollars based on their ability to natively interact with hundreds of different products, applications, and protocols in the Ethereum ecosystem. These protocols also operate much more efficiently than traditional banks and lending facilities. Compound’s smart contracts execute autonomously with no humans in the loop taking a cut of the generated interest, so the entirety of the net interest margin is paid back to suppliers of capital.”

Although the dashboard is shown in dollars, Linus converts user deposits into USDC and places them in liquidity pools, per its FAQ

While centralized services like BlockFi are geared towards users who already hold crypto, a newer class of companies, like Monie and Linus, position themselves as high-yield savings accounts for those looking to earn a better rate of their USD savings than a normal bank would pay. They don’t make very clear how they achieve this yield; eg, that a user’s US dollars are converted, typically into USDC, and then lent to institutional investors directly or placed in “liquidity pools.”

Monie compares itself to a traditional USD, FDIC-insured bank account. Screencap via Monieapp.com

With Compound’s announcement of its Treasury product, these types of defi-powered yields are likely to increasingly show up in mass consumer products. Neobank Current has already announced plans to integrate Compound’s offering. I asked Alex Johnson, creator of excellent newsletter Fintech Takes, if we should expect to see other fintech or establishment banks offering defi “savings” accounts:

“I doubt that traditional banks will integrate into the DeFi ecosystem, at least in the short-term. The high-APY “savings accounts” enabled by DeFi yield farming won’t sustain as more investment flows to these tokens. It’s a clever wedge for Compound Labs and Current, but it’ll change too fast for banks to get their arms around. I’m still waiting to see a sustainable DeFi use case that will motivate banks to get off the sidelines.”

Speculative Asset & Outright Scams

Many casual users engaging with crypto do so more as a lottery ticket than from some deep belief in the technology or out of fear of debasement of their national currency. While Bitcoin is by far the most well known cryptocurrency, there are literally thousands of cryptocurrencies. With little regulation or enforcement in how these coins are promoted, altcoins have become a haven for scammers and pyramid schemes, where sometimes even those buying in to a given project or coin acknowledge it might be a scam — just so long as they get out before the price collapses. Even Shark Tank investor Mark Cuban lost his entire investment in a token called Titan, an algorithmic stablecoin, though this appears to have been more of a crypto ‘bank run’ than outright scam.

I asked Alex Johnson if users trading cryptos through mass consumer consumer apps like Robinhood or Cash App think of it as investing or gambling, and he had this to say:

“Can I cheat and say both? I do think that most customers understand that these are investments and that they may lose value (most apps have disclosures to this effect), but I think the “innovation” that Robinhood and Cash App and others have ushered in is making investing feel like a fun, high-stakes game. In the old world, you had to get an MBA from an Ivy League school and a job on a Wall Street trading desk to experience the adrenaline rush of trading complex, volatile financial products. Now everyone can experience it.”

Ransomware, Crime, Money Laundering

Crypto has drawn considerable negative attention for its role in criminal enterprises, particularly in recent ransomware attacks like the one that took down Colonial Pipeline. While it’s true that these kind of payments would be nearly impossible to facilitate through the traditional financial system, the transparent nature of the blockchain has enabled law enforcement to hit back. In the Colonial Pipeline case, the FBI was able to rapidly recover more than half of the ransom paid. 

Much ink has also been spilled over the risk of money laundering tied to cryptocurrencies. But the reality is that, at the moment, a much greater proportion of money laundering and financial crime happen within the traditional financial system. Despite elaborate legal frameworks requiring financial institutions to spend billions, AML controls in the traditional financial system are estimated to impact less than 0.1% of financial crime.

Central Bank Digital Currencies (CBDCs) 

Central bank digital currencies aren’t crypto. While many CBDC projects leverage similar technology, they are, by definition, centralized. China’s project to create a digital currency has probably garnered the most attention, often presented as a threat to the dollar’s international dominance or as a tool to monitor the Chinese population.

I asked Richard Turrin, author of "Cashless: China's Digital Currency Revolution," about how China might use the capabilities a CBDC provided, and he had this to say:

“This is a very broad question to answer. It may surprise you but China's CBDC gives it few new powers. 

The most touted feature that CBDCs have according to the west is the ability for greater surveillance. This comment is frankly, not factually correct. The Chinese gov't has the ability to surveil the existing digital payment networks, so CBDCs give it marginally greater capabilities than what it already possesses. 

Clearly CBDCs will give economic planners greater access to real time economic data which should make their jobs easier, a good thing. 

The biggest capability that the CBDC possesses is the ability to digitize payment streams that are not yet on the payment platforms. There are many payments like salaries that are not paid through WeChat or Alipay, they will be paid someday with CBDC.”

The use cases and opportunities for CBDCs vary by region; for instance, the Eastern Caribbean Central Bank is piloting a digital currency, DCash, which it hopes can serve as a bank account and increase merchants’ acceptance of electronic payments. In the US, a country with a well-developed financial system which is already highly digitized, the value proposition of a CBDC is less immediately clear. 

CBDCs seem less a challenger to cryptos than to the establishment financial institutions and payment networks that serve to intermediate transactions as trusted parties.

Risks & Regulations

The focus of US regulators to date has been applying existing laws and frameworks to crypto. The strain and shortcomings of this approach have already become quite clear.

While many critics characterize cryptos as “unregulated,” that isn’t quite the case. In the US, virtual currencies are considered commodities, which are regulated by the Commodity Futures Trading Commission, while cryptos deemed to be securities would be regulated by the SEC. Crypto derivatives, like futures, also come under regulation by the CFTC. For businesses bridging the US dollar financial system to the crypto ecosystem, much of the focus has been on AML/KYC compliance and proper licensing as a money services business (MSB).

Regulatory areas that are arguably underdeveloped include consumer/investor protection, prudential risk, and system risk.

Consumer & Investor Protection

Inarguably, there are inadequate disclosures and safeguards in place for your typical consumer and investor. Beyond the outright scamcoins discussed above, there are also schemes that target holders of established cryptos, like the South African brothers who vanished with $3.6Bn of Bitcoin users had deposited on their platform. Or cases like Coinseed, which was accused of swindling users out of $1 million in an unregistered ICO.

Perhaps more importantly, emerging platforms that promise high interest rates and look and feel like a regular savings account — but without the FDIC insurance — need a closer look and clearer guidelines from regulators about how they can position and advertise their products.

Prudential

Some companies and protocols in the crypto ecosystem are clearly engaged in the business of banking — matching “savers” or “depositors” with borrowers (either institutional or via liquidity pools) — but without the oversight of any regulator nor the safety net of deposit insurance. One such company, Cred, already went bankrupt amidst allegations of poor investment decisions, self-dealing, and conflicts of interest.

In the case of stablecoins, why should putting a US dollar into a reserve account and issuing a token that represents it deserve lighter touch regulation, particularly when customers’ funds are at risk? This regulatory arbitrage is coming under increased scrutiny, with multiple US regulators beginning to discuss how stablecoins should be regulated.

Systemic

With a total market cap of about $1.3 trillion as of writing, cryptocurrencies themselves don’t pose a systemic risk to the global financial system. That said, use of leverage to magnify bets increases risk, with some offshore exchanges allowing 100-to-1 leverage on cryptocurrency trades. This increases potential upside and downside for individual traders, but, in a down market, can also lead to forced liquidations, magnifying volatility across the market as a whole. 

As connections between the traditional and crypto financial systems deepen, and more institutional and consumer money enters, the possibility of crypto posing systemic financial risks will increase.

Regulators Will Have A Difficult Road

Regulators may find they have a difficult time putting the crypto genie back in the bottle. Businesses that operate exchanges for buying or trading are a logical first target for regulators. Even so, Binance, the world’s largest cryptoexchange by volume, ostensibly has no geographic location nor headquarters. Binance has come under increasing scrutiny in recent weeks, with regulators from the UK, US, Thailand, Germany, Japan, and Italy targeting the exchange. Binance typically claims not to offer services in countries when it comes under scrutiny, though customers residing in them are often able to access Binance via a VPN.

Further, with emerging defi protocols that power trading and lending, there is no entity to regulate — no bank, no exchange. Once they’ve been created and are running, their decentralized nature makes them near-impossible to regulate directly. While laws or regulations could be crafted targeting end users, such measures would be extremely difficult to enforce.

We’re in the “dotcom boom” moment

If you’ve made it this far, congratulations.

I think the comparison of evolving crypto technologies to the early days of the web and the dotcom boom of the late 90s is apt. There is a palpable excitement bordering on mania — a true gold rush energy. With VC dollars pouring in and seemingly everyone making money on crypto, it certainly feels like we’re in a bubble.

Like with the dotcom bust, I expect we’ll look back on this time and see laughable, ridiculous excess — but also the creation of foundational technologies and companies that become the next Google, Facebook, and Amazon.

We should let the legacy of the recent past inform how we approach the crypto future. In the early days of the internet, techno-optimists evangelized about the promise and potential of the companies they were pedaling. And, no doubt, their products and services provide unparalleled convenience, connectivity, and productivity. But they’ve also become monopolies that dominate our day-to-day lives, selling our attention to the highest bidder while enabling misinformation and exacerbating economic inequality.

Let’s not repeat these same mistakes when it comes to crypto.