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Bitcoin Enters the Second Year of Bear


Bitcoin peaked on November 14th 2021, making it more than a year ago since the bear market began.

The bull was defined by the rise of decentralized finance (defi). The bear has so far been defined by a cleaning up of some of the not real-defi elements of defi.

Luna is one of the most spectacular collapse in this space since MT Gox in 2014, with it being the first time that a project which wasn’t known to be an outright ponzi, falling pretty much to zero in about two days.

That collapse was brutal, with $40 billion wiped out in the Luna token and about $20 billion in UST.

UST's collapse, June 2022
UST’s collapse, June 2022

This direct $60 billion evaporation was followed by the downfall of Three Arrows Capital, Voyager, Celsius, BlockFi and more recently FTX.

All in all, at least $80 billion vanished, maybe $100 billion, or about 10% of the crypto market cap and all from a project that was not part of either the bitcoin or ethereum ecosystem.

It being outside of those two systems answers the question of how it was missed because no one really pays attention to anything outside of bitcoin and eth, expect the occasional dogecoinings.

A better question then is how did this project become so big and so quickly? The answer may well be that since this had never happened before, we did not have a culture that highlights the extreme risks of cryptos outside bitcoin and eth.

The first note we got was in reactions to one of our articles pointing out back last summer that while bitcoin and eth will probably be fine regarding what was then the price related volatility from the mining ban in China, some cryptos like Shiba Inu might never recover.

Some ridiculed that statement in regards to Shiba, showing the new arrivals may have not quite had sufficient distinction between something like DAI and something like Luna.

The yield in ethereum based defi therefore, and the yield in Luna, may have been seen as similar, even though ethereum dapps went through significant scrutiny, grew very slowly, and had open source ‘audits’ when they were starting off, in addition to formal audits.

So Luna caught us by surprise, particularly these pages, and mainly because we did not care about it at all to even have a surface look as nothing had come to our attention that they were doing anything innovative or noteworthy.

That should change, now. Clearly anything that happens anywhere in crypto can affect all cryptos, and therefore any project that crosses say $10 billion should face scrutiny.

In addition, we should start and ingrain some mantra that bitcoin and eth are risky yes, but anything outside it is extremely risky, untested, and can go to zero.

Bitcoiners have already started doing as much and they’ve always had their distinction between bitcoin and shitcoins, but their message has fallen on deaf ears because they’ve ignored eth, and you can’t just ignore eth.

Instead, and especially during bull, we should emphasize that a new project is extremely experimental, untested, and failure should be expected until proven otherwise.

Such warning is routine in these pages when we cover new dapps because it is true obviously. Bugs in particular should be expected for a very new project, and therefore one should operate on the assumption they will lose everything when trying a new dapp until time shows that maybe it is sufficiently safe.

Hence ethereum dapps tend to grow slowly until some time has passed. UST instead went from $200 million in February 2021 to $20 billion in May 2022, gaining $20 billion in basically months when DAI took more than a year to reach $1 billion.

That’s the difference between the eth ecosystem and cryptos more widely. There are processes, learned from hard lessons, that make eth safer, though still overall risky but not to the extent one can reasonably expect the potential of a complete wipeout as one should with any new crypto project.

The New Crypto Era

So why did something like Luna take so long? Why didn’t we have notice before to be on guard about new crypto projects not just as a matter of curiosity and to see if there’s any new innovation, but also because they might cause harm to all crypto?

The answer is probably because until 2020, crypto was simple. The focus of any new crypto project was to address scalability, with the design overall being pretty much the same, the differences being deep in the pipelines in regards to pruning mechanisms or validator choices and so on.

All such projects had a free-floating crypto, on a blockchain, and they were called new bitcoins because there wasn’t any fundamental difference.

2020 brought a fundamental new innovation in crypto, it brought lending and borrowing, and with that it brought immense complexity compared to the pre-2020 era.

In a period of just months, you had Curve, Compound, Aave, flashloans, and then in parallel you also had immense innovation and experimentation in stablecoins, things like MiM.

That one of them failed is not surprising because failure is expected, but that it grew to be so big before failing is surprising in some ways and yet it isn’t because we’ve clearly made the mistake of considering cryptos as islands instead of crypto as one wholistic space.

There was no failure in the eth ecosystem and that is a testament to the hard earned lessons. It is something that should be celebrated, though no guard let down, because we had such a huge number of fundamentally innovative projects and yet they all stood and withstood what has by now been trial by fire.

These lessons have however not been incorporated in crypto as a whole, clearly. And that failure is first and foremost of the project leader, Do Kwon, as well as any VC that may have backed him.

He should have gone much much more slowly with the project, he should have been warned to do so by those around him, and he should have made it clear that it was a project which should be expected to fail.

Because rather than a simple design, this was very complex, completely new, fully untested, and fundamentally experimental.

There should have even been a cap, but this assumes the coder or project leader is genuine. What if they instead don’t care if it burns everything down?

Well, we burn their project first, in theory. In these pages where the eth ecosystem is concerned and even more widely we have a ‘deal.’ It’s not binding, it’s more just a statement we put out there that if we cover a project, then we see that as first review and since it has been noteworthy enough  to have such review, coders should audit it because obviously such project at scale can affect the entire ecosystem.

That applies for all credible media, and clearly now should apply to all crypto as the risk of a bad project growing is a risk to the entire crypto space.

Now whether coders do or do not do these audits we don’t know, but there’s a process, there’s a statement at least, an intention, some order, which clearly was not the case for crypto more widely.

Exchanges in particular have a duty, not necessarily in the legal sense but certainly in the cultural sense, to undertake such audits.

We think Coinbase does for ethereum based projects. Binance clearly doesn’t because they have listed UST and we presume they did so without quite looking at it much at all.

Prior to this Luna collapse, blaming Binance or any other exchange is not too fair. Plenty had happened in crypto and a burning of so much value by the downfall of a crypto-blockchain had not happened, so we can’t demand hindsight.

But we can from now on demand they undertake some at least basic due diligence and preferably full on code audits of a project they list or demand the project produces them from a credible code auditor.

Because Luna was the first and so we learned something, but something like it should not happen again and even if conceptually it is unavoidable that there may be such failures, we should try as much as we can to minimize it as much as possible.

The ethereum ecosystem generally has done it, so it can be done. This Luna downfall is the crypto’s equivalent of the DAO hack. All coders in the crypto ecosystem therefore, and all cryptonians currently in it, need to gain an understanding that coding crypto is basically playing with fire and therefore certain processes have to be in place, including caps on the speed of growth.

The good news is that, at least generally speaking, such projects do not tend to launch quite during the mania phase when saying something like failure should be expected for a new project would get you shouted out from the room.

Instead they launch when it is still acceptable to even routinely say that such failure should be expected.

It is therefore entirely possible to both require and force ‘proper’ behavior in the entire crypto space because any and every open source project should understand it is effectively the duty of Nakamotos to bring it down if they can as, especially in the crypto space, such vulnerabilities can not be allowed.

A New Understanding

And that’s what the second bear year brings: a new understanding that any new crypto project can be a threat to the entire crypto space.

Such understanding is routine in ethereum of course. We want the new dapps, we want innovation, but we really really want intense scrutiny and preferably when the project is small.

This now has to apply to the entire crypto space, which is vast, but it can be done as such projects have to list and therefore those listing them have to scrutinize.

Now there are also crypto projects that are actually outright ponzis, Bitconnect being an example, and there isn’t much we can do about them except point out they are a literal ponzi, rather than a ponzi just as a swear word.

These projects however shouldn’t be listed and usually aren’t. The threat instead is more from experimental projects that can even be genuine but turn out to not be very robust. At scale, their failure can cause immense damage.

Which is why no such project should be allowed to grow without first proving itself. Such limitation has to come from the coders themself first and foremost, but it can also be forced culturally with the incentives there for everyone to do it as such failure at scale is obviously very damaging.

With that, crypto can be strengthened. We don’t think it is any good to say bitcoin/eth and then all the rest, because during bull no one will listen, but they probably will listen to the pointing out that a new crypto project should be expected to fail until proven otherwise.

That’s how we can bring some order and due process to the entire crypto space, and if not avoid then at least minimize the chances that some new project – however innovative it might be – causes so much damage.

To achieve that, we need to get rid of this notion that outside of bitcoin and eth they can do whatever they want with even Coinbase stating they’ll start listing neutrally – without judging the project – when we have to judge and we have to bring some discipline to the entire crypto space.

And the good news is, at the risk of repeating, that this has been achieved at least in ethereum so far, and therefore it can be done.

If it is, then Luna is not necessarily a blessing in disguise, but there is a silver lining in as far as it provides a clear example as to why crypto projects have to go slowly.

That makes the second year very different from the first. Some new hard lessons have been learned, and therefore there will be new processes, at least culturally.

In addition something like Luna should have failed a lot earlier, but it has now disappeared, so we’re on the other side of that.

FTX, and some other centralized entities, provide clear lessons in the dangers of getting involved in lending and borrowing in a custodial way, in addition to basically gambling.

So the bad actors have been cleared out, and they were bad actors, including Do Kwon as he should have had a cap to UST.

That’s a fairly severe punishment in itself for these actors. And therefore hopefully no one will hesitate moving forward to scrutinize them intensely before they get big.

Which makes this second year of bear a different affair. First of all we now know what works and what doesn’t, with there being no problems in defi except the occasional hack of some new project which is obviously expected, while clearly there have been many problems in centralized entities trying to defi.

And secondly we now also know what may have kept this space down and what brought it down as well.

So a lot of the unknown unknowns have become known unknowns. Which means we are probably on the other side of a blackswan, and therefore cryptos are probably on far more robust foundations.



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