Jameson, as many people in this space may have seen, you wrote an article about fake
Bitcoin.
And from what I understand, the inspiration for that article partially sprung from a tweet
the other day, in which you said that Bitcoin would struggle to be a store of value if everyone
bought fake Bitcoin.
What did you mean by that?
And how did it form the inspiration for your article?
Right.
So at the time, I think I tweeted that when the balance sheet of FTX became a revelation
and that I think they had something like 17,000 Bitcoin and liabilities and basically zero
to one Bitcoin and actual assets.
And at the time, that was a straightforward way of thinking, oh, you know, these scammers
are selling quote unquote Bitcoin to unsuspecting rubes who are buying IOUs just like you would
on any other exchange.
But of course, unbeknownst to them, there's no actual Bitcoin to back it.
And we've been having a lot of interesting debates recently around proof of reserves
and withdrawing from exchanges.
And once I sat down, I really started thinking about it and doing some more research because
I pay attention to Caitlin Long, and she's been harping on this for many years of the
dangers of rehypothecation with all of the contagion and credit risk that has been spreading
over the past few months.
It became clear, I think, that the rehypothecation issue has become much bigger.
And then even I was looking beyond that, I was looking at what may become a potential
problem in the future with basically these quote unquote paper Bitcoin contracts.
And it's really Wall Street shenanigans that have been happening for decades.
And I think this is something that we just need to keep our eyes on because it's already
begun.
It just seems to be a very small volume at the moment, but it's definitely something
worth keeping an eye on.
And I think that we are uniquely positioned to fight back against it, unlike the gold
and silver bugs.
Awesome.
And so if you were going to try and define fake Bitcoin in a sentence or two, what would
you describe fake Bitcoin versus real Bitcoin?
Yeah.
So I mean, real Bitcoin is a cryptographic token that you control the keys to and that
you can verify is following the rules of the protocol.
So this is one of the reasons why my article ended up being so lengthy, as a lot of my
articles do.
But you can look around and say there are many different things out there that are being
sold as Bitcoin.
But if for one reason or the other, you can't deposit that into a wallet that you can verify
yourself, then it's not real Bitcoin.
And then you can get into deeper distinctions around whether it even has the potential to
be real Bitcoin.
And there were some things that I didn't even touch on in the article.
I didn't even go down the rabbit hole of all the different wrapped Bitcoin assets that
are out there.
That's a good point.
So one of the things that you spoke about were knockoffs, i.e. cheap imitations of Bitcoin.
By this, correct me if I'm wrong, you mean, say, competing networks that purport to be
Bitcoin?
Exactly.
I mean, this was a problem really in the 2017 to maybe 2019 era.
And at least from a market perspective, the threat of fork coins that purport to be the
quote unquote real Bitcoin, it seems to have died off over the past few years and people
have moved on to other things.
I would certainly say that the different flavors of wrapped Bitcoin probably have much higher
market cap now than even the aggregate value of all of those fork coins.
And this is where it starts to get really complicated because I think there's probably
at least half a dozen different types of wrapped Bitcoin and some of them are ostensibly higher
quality than others.
But as part of the fallout of this whole recent FTX Alameda debacle, I think it was discovered
that the, I don't even know how to pronounce it, but the Solana based wrapped Bitcoin essentially
was completely unbacked and it's worthless.
I think the exchange rate on that dropped by like 90 plus percent once that revelation
came out.
That's an excellent point.
And then another aspect of fake Bitcoin that you touched on and perhaps you spent the most
time on were IOUs.
For those that aren't familiar with an IOU, perhaps someone that isn't, say, a native
English speaker, what do you mean by that?
Yeah, I mean, it basically means that you have been given some sort of coupon, a token,
not necessarily a cryptographic token, but some sort of database entry or other centralized
digital asset that says that some counterparty owes you a quote unquote real Bitcoin.
And essentially this is what happens whenever you go to a centralized exchange or a broker
and you press buy, is they're executing essentially a database update on their end after it goes
through their matching engine.
And you don't receive Bitcoin, you have to then take another step after that to actually
withdraw that coupon into real Bitcoin on the Bitcoin network.
I guess to kind of shill casa for a second, we do have a buy integration and that while
it's not real time, instantaneous in a few seconds receive Bitcoin, the sort of automatic
result of that is that it sends you an on-chain transaction.
There is no second step that you have to take to get your real Bitcoin.
Awesome.
Okay.
And then in the article, which I've posted in the space, you can find it either in the
comments section or above, you talked a little bit about the relationship between supply
and demand and how real Bitcoin and fake Bitcoin interact with this.
How does fake Bitcoin affect the price?
Yeah, this is where I start to get uncomfortable and outside of my wheelhouse because I'm not
a economist or financial expert.
But I think the closest thing that you can start looking into is all of the shenanigans
that have happened in the gold and silver markets over the years.
And really the main takeaway that I had is that when you start creating markets that
are based on IOUs and you're trading these IOUs that may be fractionally backed or maybe
almost completely unbacked in the case of, for example, cash settled futures markets,
then the trading volume on those things can be completely disconnected from reality because
they don't have to actually physically deliver the asset.
You're essentially creating this completely disconnected market that becomes a lot easier
to manipulate because you don't necessarily have the risk that you'll end up on the bad
side of a trade and end up having to physically deliver an asset that you don't have.
It's quite literally a fiat market.
You're trading these tokens that they may be called gold, they may be called silver,
they may be called Bitcoin, but it's really fiat under the hood.
Well said.
And you also framed this fake Bitcoin issue from the aspect of securing scarcity.
What do you mean by securing it?
Well I think we all know how the 21 million Bitcoin cap is insured.
And I've written extensively about how that works from a technical standpoint with running
the nodes and basically validating all of the rules of the protocol, which in aggregate
ensure that no one is creating Bitcoin at a rate faster than everyone agrees upon.
But the kind of weird rabbit hole that I ended up going down here is that we're essentially
we're creating these layers on top of Bitcoin and when you talk about layered Bitcoin, most
people start thinking about things like lightning and side chains and things that are actual
cryptographic layers.
But you could also think of second layer Bitcoin as being all of these centralized custodians
that they're building on the Bitcoin technology stack.
They're writing applications on top of Bitcoin and then other people are interfacing with
that.
And so what kind of hit me was, well, now we don't have any of those validation rules
at this second layer.
The cool thing about lightning and cryptographically connected second layers to Bitcoin is that
they're actually doing their own types of validation that tend to also ensure that you're
not creating Bitcoin out of thin air.
But with these centralized providers, they're black boxes.
There is no validation.
You don't know what they're doing behind the scenes.
You're trusting that they're not doing any shady stuff.
And so we now have a decade of history of many examples.
It seems almost at least one huge hack every year or two or just revelation that one of
these large centralized custodians, in fact, does not have full backing.
And in some cases, like FTX has absolutely no backing on those coins.
So what does that really mean?
It means that in FTX's case, there was something like 17,000 Bitcoin that at least the users
of FTX believed were a legitimate part of the Bitcoin supply.
But really what had happened is FTX printed their own fake Bitcoin, which nobody noticed
because they were not verifying it by withdrawing it to the safety of their own wallets.
Awesome.
And that's a good segue to my next question.
So I just posted in the space a tweet that Caitlin Long, she pulled a list of all the
exchanges and how much Bitcoin they lost from the article that she wrote.
So was there anything that surprised or shocked you when you were putting together this list
or anything that you hadn't known before?
I had certainly known about all of those historic ones, though I put a tweet in there that I
actually just came across yesterday as I was doing research for this in which a huge hack
of gate.io that apparently happened a few years ago and was never disclosed happened.
And so I think that really hit on what I'm trying to warn people about, which is you
don't necessarily are going to know that an exchange is running as a fractional reserve
for a long time.
This is where it's really hard to quantify at what specific level of fractional reserve
does it become a problem?
I've never operated an exchange myself, so I'm not sure exactly what the normal flows
are, but it's obvious that during times of fear and panic, those flows drastically increase.
And that's often what results in these exchanges that have been operating on a fractional reserve
to finally have to throw up their hands and admit that they can no longer process their
withdrawal requests.
So the same thing happened with Gox back in the day.
There were a number of red flags and warning signs, but ostensibly, Gox operated for most
of its existence as a fractional reserve exchange.
And this didn't come out, I think, until years later after a lot of forensic accounting was
done as a part of the bankruptcy process.
And essentially, it had been hacked so many different times over the years that Carpelle
was basically trying to dig himself out of a hole.
And unfortunately, the increasing popularity and exchange rates of Bitcoin made it harder
and harder for him to dig himself out of that hole until eventually, with the run up and
all time high in late 2013, early 2014, it just hit the point where the reserves got
completely depleted and it could no longer process any of those withdrawal requests.
And the curtain kind of fell.
And so I think that's actually a fairly similar thing that seems to have happened with the
recent FTX drama.
Of course, it was just a lot more convoluted as to how they ended up in this fractional
reserve scenario.
Well said.
It's kind of like that line from The Wizard of Oz, pay no attention to the man behind
the curtain.
In your opinion, having lived through the time of Mt. Gox and seeing FTX right now,
would you consider them, say, a one for one comparison?
Are there similarities or differences?
What have you noticed?
It certainly seems like there was a lot more maliciousness or malevolence on the FTX side
of things.
It's still so early that we don't know all the details.
My sort of takeaway with Gox was that Carpeleus kind of got suckered into buying Gox when
it was already insolvent.
And whether or not he realized it at the time, I never was really clear on.
But I think poor accounting practices were definitely the case at Gox, now SPF seems
to be trying to position himself in the same type of way of like, oh, we just had really
bad accounting and I wasn't clear what was happening.
Maybe that's true.
Maybe not.
It seems a lot less likely given the sophistication of the FTX operation.
But this is going to be a mess that is going to go on for years and years.
I mean, Gox bankruptcy has been like eight years so far.
And I would not at all be surprised if FTX takes as long, if not longer, due to the additional
complexity.
With that being the case, why does it take so long for these things to work out?
If you're somebody that's got Bitcoin sitting in an account at FTX, what are you expecting
to take place?
The problem seems to be unraveling just where the money went and who was actually owed what.
One of the reasons why the Gox bankruptcy took so long was due to a lawsuit by Peter
Vicini's coin lab, essentially they were in position to have this contractual relationship
to kind of be like the American entity or American arm of Gox back in the day.
And so they had some legal claims that most people felt were flimsy, but they did exist.
There were some contracts that happened.
And so essentially, what happens in any of these cases is that you've got a ton of creditors
that are rightfully owed money, and they're not going to walk away assuming it's a non-trivial
amount of money.
They're going to try to get as much of their money back.
And so essentially, you're going to have a case where with FTX, it looks like it may
be a million people are coming out of the woodwork and all saying, no, I want my slice
of the pie.
And the complexity of their claims may vary significantly because I'm sure there's a lot
more relationships in this latest blow up than just simple exchange customers.
We know there are plenty of corporations, startups that were invested in and perhaps
somewhat strong-armed into putting their corporate treasuries into this scheme.
So it seems like it's going to be an order of magnitude more complexity, both due to
the complex corporate structure that Alameda and FTX had with, I think, 100 different entities
and also the just much wider variety of creditors that are going to be involved.
That's a really good point.
And there's also the distinction of FTX being a more sophisticated firm, one of the forms
of fake Bitcoin that you mentioned in the article that we haven't touched on yet.
We don't have to spend a whole lot of time here because it gets really complicated really
quick is derivatives, futures, and options.
So if you could maybe explain a little bit as to why these contracts could suffice as
fake Bitcoin.
Yeah, and I'm not a trader, so I couldn't even explain to you very well how options
or futures trading actually works under the hood, other than to say that at least in the
case of futures, you can have cash settled futures or you can have actual asset settled
futures.
And it seems like cash settled is 99% of what happens.
So when I mentioned these are essentially fiat markets, the market itself in no way
is built upon a foundation of these assets that are being traded actually existing anywhere
between the counterparties that are trading them.
That's really that's why it's called paper Bitcoin or paper gold or whatever.
It's essentially sophisticated accounting and financial gambling strategies.
So from that perspective, because you don't have to actually acquire the asset in order
to sell it, you essentially you can just create these entries for arbitrary units of the asset
and then start trading it.
And as long as you end up settling in cash following the rules of these contracts, everybody
walks away happy, but it can get weird because you can artificially inflate the volumes of
what's being traded.
And what has happened in a number of cases over the years is these large firms have actually
been found to basically push the price in one direction or another by spoofing orders
and spoofing basically means creating a bunch of orders that you have no intention of actually
fulfilling.
And I guess you could best describe it as bullying the market because other traders
that are participating in a market, they're going to be looking at the order books, they're
going to be looking at what the other traders are doing.
And in some cases, if it looks like a whale is coming for you, you might run away, so
to speak, in the market.
And that's kind of how these large firms can push the price of assets on these paper markets
around because they can essentially throw their fiat weight around.
That's a good point.
And speaking of throwing weight around, one of the issues that you talk about in the article
is the tangible commodity of gold and precious metals being an instance where we see this
similar dynamic take place.
How does what you've observed with Bitcoin differ from what you've observed with other
commodities or is it really more similar than different?
As far as I can tell, the similarities are there.
The options in the futures markets seem to operate the same way.
It's just they're still so new and immature that the size of the markets is still relatively
small in comparison to the size of the spot Bitcoin market, which is based upon trading,
hopefully, supposedly the actual asset.
Once again, things can get weird if, say, you're trading all of these paper markets
and they get blown up to the size that you're doing, an order of magnitude more trading
of the asset than actually really exists.
I think that that was basically what happened with the credit default swap market, resulting
in the great financial crisis back in 2008, is that you're essentially building castles
in the air.
There's no foundation for them or the foundation that they're built upon is actually infinitesimally
smaller compared to what you've built.
People are trading back and forth, back and forth, back and forth until eventually somebody
realizes that there's no foundation and then there's a massive panic and the whole scheme
falls apart.
I guess from a historical standpoint, we walk through all of these different examples of
fake Bitcoin and Bitcoin weathered the Fortcoin wars.
We're currently in the IOU problem stage and looking at paper contracts, futures, derivatives,
that is, I would say, more of the forward looking warning of, we've already seen this
happen in other markets.
This is something that we should be keeping our eye on.
Of course, the obvious question is, well, what do we do about it?
We can't stop people from trading and making up unbacked tokens, but we can try to limit
it.
That's where I think the big difference between Bitcoin and other commodities is that one
of the reasons for paper traded commodities to get so big is that it is convenient.
Very few of these traders want to even have to worry about having to physically take delivery
of a tanker of oil, for example.
With Bitcoin, that's not really much of an issue.
You don't really have a good excuse not to take delivery of Bitcoin.
The level of friction required to do that is close to zero once you actually just know
how a Bitcoin wallet works.
I think if we have more pressure on people to be building these markets as being Bitcoin-settled
markets rather than cash-settled markets, that will help.
Also, if we actually could get a spot ETF, that would hopefully take away some of the
demand for the cash-settled paper contracts.
In general, for me, it's just about limiting the magnitude of how big some of these fake
Bitcoin markets can get.
The way that you do that is you give as little Bitcoin as possible for people to base their
fractional reserve schemes on because they generally still need to have some reserves,
especially in the spot crypto exchange casinos.
That's an excellent point.
We're getting ready to open up Q&A if anybody has something they want to ask on this subject,
but you brought up an interesting thought.
This is Twitter Spaces, and we're doing it live.
Do you think that there will ever be stable credit when it comes to Bitcoin-related transactions
as in you could take out a loan denominated in Bitcoin and we would have some stability
in the market?
Well a Bitcoin-denominated loan in terms of needing to pay back something in Bitcoin terms
would probably be pretty tough until Bitcoin becomes a unit of account, but there are already
many different loan products out there.
Now the vast majority of them are rehypothecation schemes, and that's what has been revealed
over the course of this year really is that the rehypothecation doesn't end necessarily
after one step.
It can kind of hop around multiple times, creating more and more leverage to the point
that you've created essentially a highly unstable system, and then you have to figure out where
is the actual money and who owes who what.
That's kind of where we are right now.
But there are what I would consider to be some safer lending options out there.
I think HODL supports it.
I think Unchained supports it.
There's probably a couple others that I'm not aware of, but essentially creating multi-sig
contracts where you're creating a multi-party multi-sig amongst lenders and both the creditors
and the debtors, and essentially locking up those coins and making sure that they don't
get rehypothecated.
I think the value of that has been lost on most people.
It's also a tricky thing to really say that we have a practical solution for because the
nature of these instruments is that rehypothecating assets is more profitable.
It's higher risk, it's higher yield.
The average person is going to, if they're shopping around for loans, they're going to
look for what appears to be the most tantalizing rates, whether that's the yield that they're
earning or the interest that they're paying.
I think most people will just gravitate to whatever looks like the best thing and they
won't even necessarily know that the risk profiles are different.
That's something I don't have a great solution for right now.
I'm not sure if there is one.
There are some perverse incentives at play.
That's an interesting question.
You brought up the debate over a spot ETF and how various participants in the market
are waiting on that.
Are there any risks associated with, say, a spot ETF or a close-end fund that you would
be uncomfortable with or how would that differ from, say, holding Bitcoin with your own keys?
I think the best example is GBTC, which I've been a fan of for my retirement portfolio
for a number of years, but it doesn't track the spot price because, once again, it is
a completely disconnected market.
It's not completely disconnected.
There are, at times, sometimes, for certain people, ways to redeem the underlying asset,
but for all intents and purposes, for most practical investors, it's a disconnected market.
That's why we've seen premiums, I think, over 100% during bull markets when all the retail
folks were trying to buy Bitcoin through their brokerages.
That was the primary financial exposure they could get.
Then, now, we're at this negative 40% discount as a result of a lot of the shenanigans that
have been going on and various entities that were basically trying to arbitrage that premium.
This is tricky.
Very few people, I think, understand the complex nature of these different, quote-unquote,
Bitcoin assets.
The SEC certainly hasn't helped.
I actually had a blog post a few years ago in which I took my retirement account funds
that were in GBTC.
I said, I don't like having to deal with the premium and discount that I don't really have
any understanding of why it's doing what it's doing.
I just want an actual one-to-one Bitcoin ETF.
What happened was there was this Swedish ETN that was launched and my broker added so that
I had access to it.
I essentially sold my GBTC and I bought this Swedish ETN that was an actual one-to-one
backed ETN.
They would adjust their Bitcoin holdings, I think, on a daily basis to make sure that
it was a near perfect match to the exchange rate.
That was all good and well for about six months until the SEC published a notice that basically
said, we believe this ETN is not following some rule.
I don't even remember what.
But immediately when the SEC published that notice, all of the OTC QX market and then
as a result, all of the brokers that were accessing that market essentially blacklisted
it and I was frozen out of the ability to trade it.
I couldn't even sell it.
I think it was almost nine months later when I finally got my broker to hook me up with
an international trading desk where I had to literally pick up the phone and have this
hour-long conversation with someone who had access to the Swedish exchange where this
ETN was natively traded and we were able to transfer my OTC QX market ETN shares over
there and actually do the trade.
It was a really annoying experience that almost resulted in a calamity where almost ended
up selling for a quarter of the actual exchange rate because all of the price tickers had
been frozen for a year and there was this Swedish Kroner to dollar exchange rate issue.
Suffice to say the SEC has made my life harder in a number of different ways over the years
and that was just one of them.
Thank you.
That's an excellent point.
And so if you're a say an everyday Bitcoin investor, what would be the best way to just
bypass all of this and completely exit this fake Bitcoin fugazi and just hold some real
sats?
Well I mean there's no shortage of places where you can buy Bitcoin these days.
I think the most important thing is that you have a well vetted and robust cold storage
solution assuming that you're buying non-trivial quantities of Bitcoin and you need something
a bit more secure than a hot wallet then you just need to make sure you've got that set
up and have your withdrawal address white listed on whatever exchange you're making
your purchases and withdraw as soon as possible.
There's very little need to leave Bitcoin on exchange if you're making a medium to long
term investment.
Excellent.
Alrighty.
And those were the questions that we had and that's all we have time for today.
Thank you everyone for sitting in on this space and feel free to check out Jameson's
article or you can find it at blog.keys.casa and stay safe in these bear market times and
withdraw from exchanges and we'll see you on the other side.
Everyone take care.