Blockwall - May 2024 - What happened in Web3?

Dear Founders, Investors, and Friends,

a little belated, you’ll find our May review and what a month May has been. We believe it's no exaggeration to call it historic.

What began with a simple pro-crypto statement by former U.S. President Donald Trump has resulted in a noticeable shift in Washington's approach to crypto and the industry's role in the upcoming U.S. presidential election.

Let's delve into what exactly happened and how the snowball effect unfolded in May.

Crypto Policy: Changing Tides

"If you are in favor of crypto, you better vote for Trump."

This statement sent shockwaves across the United States' political elite.

During a private dinner at his Mar-a-Lago residence for owners of his NFT collection, Republican presidential candidate Donald Trump openly expressed his support for the crypto industry.

While many in the industry praised the former U.S. President's statements pro-crypto statements, President Joe Biden's announcement highlighted the Democrats' contrasting stance on the matter.

Just before the U.S. House of Representatives was set to vote on repealing SAB 121, a controversial accounting directive issued by the SEC in 2022, he threatened to use his veto should the vote pass.

Much to everyone's surprise, the threat proved ineffective, with both the House of Representatives and later the Senate voting to repeal the directive - including disproportionately strong support from Democratic representatives.

SAB 121

Although Trump's statements surely influenced the Democrats' strategy on handling crypto-related issues in the upcoming election campaign, the rather unexpected decision on SAB 121 was also strongly influenced by American banks.

Why is that?

The SEC Accounting Bulletin 121 requires digital asset custodians to account for digital assets as liabilities and hold them at fair value on their balance sheets. This means that if a bank, for example, custodians $1 billion worth of Bitcoin for their customers, they must also hold $1 billion in cash to offset this 'liability' on their balance sheet.

Obviously, this makes little sense and only leads to banks being excluded from the custody business - a business that turns out to be very profitable for companies like Fidelity, Coinbase, and Anchorage.

This is why the banks ultimately were incentivized to convince their senators that SAB 121 is a detrimental directive that needs to be repealed - which they successfully did.

Despite President Biden's veto of the repeal on May 31st, the vote's outcome sent a clear message to the SEC and the Democrats alike, triggering a series of regulatory successes for the crypto industry, including the recent vote on FIT21 and the approval of spot ETH ETFs, which took the whole market by surprise.

FIT21

On May 22nd, the House of Representatives passed the 'Financial Innovation and Technology for the 21st Century Act.'

As of today, the vote is only performative, as the law does not have a corresponding bill in the Senate yet.

In essence, FIT21 aims to provide a comprehensive regulatory framework for the crypto industry in the U.S. It seeks to offer crypto projects a secure registration process for launching tokens, ensuring clarity and compliance. Furthermore, it aims to clarify the responsibilities between the SEC and the CFTC, addressing under which conditions a crypto asset qualifies as a security. Additionally, FIT21 wants to ensure stricter supervision of crypto exchanges by legally mandating them to keep customer deposits separate from their own assets, thereby safeguarding investor funds.

Although the bill isn't perfect and received some critique from within the crypto industry, it is important to stress that this vote finally paves a path toward a clear regulatory framework for crypto in the U.S.

It also signifies the growing importance of crypto in American politics.

Out of 279 supportive votes, 71 came from Democratic representatives, potentially indicating a change in their approach to crypto regulation.

This time, Biden did not threaten to use his veto. However, the administration does not actively support the bill in its current form, stating that they would want to work with Congress on a more comprehensive and balanced regulatory framework for digital assets.

ETH ETFs

All this political tailwind surely built up some pressure on the SEC, which ultimately resulted in the month's biggest surprise.

Despite the low probabilities that both experts and prediction markets assigned to the approval of the ether spot ETFs in May, the SEC has approved the 19-4b applications - thus clearing the way for a timely launch of the ETFs in the coming weeks.

Only three days before the official deadline on May 23rd, just as everyone had already turned their attention to the August deadline for BlackRock's ETF application, the SEC reached out to the exchanges planning to list and trade the ETFs, requesting updates to their filings.

The extent to which the decision surprised the market can be seen in the discount of Grayscale's ETHE Ethereum Trust to its NAV:

The approval has two important implications.

Even though the SEC hasn't explicitly stated it, the approval of the ETFs effectively declares ETH a commodity - a complete reversal considering the agency's previous attempts to classify ETH as a security.

This, in turn, potentially paves the way for more crypto ETFs in the coming years.

But before that, we need to see how strong the actual demand for the Ether ETFs turns out to be. Once the S1 applications are approved and the products start trading, we'll learn more.

Bitcoin ETF Update

Things also took a positive turn for the Bitcoin ETFs.

After four months full of outflows, Grayscale's GBTC for the very first time recorded positive inflows.

Zooming out, all U.S. Bitcoin ETFs added net inflows of $2.1 billion throughout May, making up for the big outflows that occurred during April.

In addition to that, we finally got a sense of the institutional appetite for Bitcoin, as U.S. institutional investment managers with at least $100 million in assets under management (AUM) filed their 13F filings, thereby disclosing their holdings.

According to the analysis of K33 Research, 937 institutional investment managers held Bitcoin spot ETFs. For comparison: Following the introduction of the gold ETFs in 2004, only 95 were holding those after their first quarter.

Out of the $62.2 billion in total AUM for the eleven Bitcoin ETFs (at the time of filing), around $15.4 billion were held by institutional investors. Compared to $182 billion in cumulative trading volume, the amount of shares held by those investors suggests that short-term trading accounted for most of the buying and selling activity during the first quarter.

Still, some institutions went relatively big into Bitcoin. Bracebridge Capital, the hedge fund that manages the endowments of Yale University and Princeton University, reported owning more than $400 million in Bitcoin ETFs. Other institutional investors, often with small allocations, include established asset managers such as Sequoia Financial Advisors, Cambridge Investment Research, and Hightower Advisors - as well as banks like BNP Paribas and BNY Mellon. Although many thought that a bigger share would be held by those entities by this time, Matt Hougan, CIO of Bitwise, argues that these data points are still positive.

Especially because, according to him, most institutional investors are still in the due diligence phase, and many of those who have already invested have only dipped their toe in the water. One can only imagine how impactful the inflows will become if the allocations reach levels of 1-5% of their and their client’s overall portfolios.

Bitcoin’s Corporate Adoption?

Besides institutional investors, publicly traded companies also seem to become increasingly attracted to holding BTC.

Following the Japanese company Metaplanet, which published their "Bitcoin Strategy" and declared Bitcoin their primary reserve asset in April, at the end of May the NASDAQ-listed healthcare company Semler Scientific followed suit.

Both companies' reasoning for holding Bitcoin over cash is simple:

• First, Bitcoin's limited supply makes it an inflation hedge.
• Second, holding Bitcoin potentially provides a bigger financial upside compared to gold.
• Third, the asset's increased institutional adoption makes it less risky to hold.

Only time will tell whether these moves are just a rewind of 2021, when companies like Tesla made headlines with their Bitcoin investments - selling most of their holdings quickly after - or if we are witnessing the beginning of a longer-term Bitcoin adoption by corporates.

Portfolio Company Update

While we haven’t announced any new closings in May, a noteworthy development occurred in one of our portfolio companies.

Spiko, a French tokenization startup that focuses on improving the efficiency of capital markets through blockchains, has registered its SICAV (Société d'Investissement à Capital Variable), marking a significant milestone as the world's first on-chain SICAV approved and supervised by a national authority in the EU. A SICAV is an open-ended investment fund structure popular in Europe, allowing investors to pool resources for professional management. As we speak, initial clients are being onboarded in a closed setting to gather feedback.

Key events of the last few weeks

1/ Robinhood receives Wells Notice from the SEC. The fintech company reported that the SEC staff has reached a preliminary conclusion to propose an enforcement action against Robinhood's crypto division, alleging violations of securities laws. (Source: The Block)

2/ Robinhood plans to acquire Bitstamp. Based in Europe, Bitstamp is among the world's oldest cryptocurrency exchanges, boasting over 50 licenses internationally. The $200 million agreement is expected to be completed in the first half of 2025. (Source: CoinDesk)

3/ Chicago Mercantile Exchange plans to introduce Bitcoin spot trading. Measured by open interest, the CME is the leading exchange for trading Bitcoin futures. (Source: CoinDesk)

4/ Ethereum developers set target for the next major upgrade. The ‘Pectra’ upgrade should go live in the first quarter of 2025. The update will not only introduce changes to Ethereum staking but also implement the account abstraction solution presented by Vitalik. (Source: The Block)

5/ PayPal launches PYUSD on Solana. According to the announcement, Solana's low transaction fees as well as the so-called token extensions were a reason for choosing the network. (Source: PayPal)

6/ German promotional bank KfW announces its first blockchain-based digital bond. While the bond itself will be issued on a blockchain, the payments associated with it will continue to be processed via traditional payment systems. (Source: KfW)

What we’ve been reading

1. Galaxy: Crypto Use Cases
   In their latest research, Galaxy Digital explores the various practical applications of cryptocurrencies beyond mere speculation. The study highlights how crypto is being used in areas such as remittances, payments, capital markets, and decentralized finance, emphasizing its benefits in speed, cost efficiency, and accessibility. It also examines the role of crypto in enhancing financial inclusion and transparency, as well as its potential in sectors like gaming, social media, and identity verification.
2. Vitalik: Layer 2s as cultural extensions of Ethereum
   In his latest post, Vitalik Buterin discusses how layer 2 solutions are not just technological extensions of Ethereum but also cultural ones. He emphasizes that layer 2s allow for diverse subcultures to emerge within the Ethereum ecosystem, fostering innovation and different approaches to blockchain development. This cultural pluralism strengthens Ethereum by balancing core development with the growth of various sub-communities, each with unique focuses and values.
3. Unpacking the Crypto x AI flywheel: Revolutionizing Blockchain with Intelligence. The Crypto x AI platform Almanak explores how blockchain democratizes AI development by providing decentralized, permissionless infrastructure, countering big tech monopolies. This enables grassroots innovation and enhances fairness in AI deployment. Additionally, the post highlights how AI can transform the crypto landscape by optimizing trading, enhancing security, and managing DeFi strategies. Challenges like blockchain scalability and the cost of on-chain AI execution are acknowledged, but the potential benefits in efficiency and automation are significant.

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