Weekly Edition #61
In this edition:
We haven’t written about this recently but Elon Musk bought around a 9.5% stake in Twitter. He was originally going to be on the board but a couple of days after this announcement the company said that he would not end up being a board member. There was a lot of speculation as to why Elon had bought such a large stake. In the US, after someone accumulates a stake larger than 5% of a public company, they need to file a form with the SEC within a couple of days after crossing the 5% threshold. He filed late and filed incorrectly (he later filed the correct form with a different number of shares…). He then conducted some Twitter polls hinting that he might bid to buy the entire company. In order to protect themselves, the Twitter board adopted what is called a poison pill.
There are many different kinds of poison pills, but the basic idea is that it’s a mechanism to prevent someone from making an unsolicited offer for a company. In Twitter’s case the poison pill is that if someone buys 15% of the stock without the boards approval, then other shareholders will have the possibility of buying more stock at half the price. This essentially means that if Musk acquires 15% of the company, other shareholders will buy more shares and dilute his stake. Basically making it impossible for Musk to acquire enough shares to actually buy the company.
Poison pills are a weird concept. It seems odd that a company’s board can essentially dictate what shareholders can and cannot do. In theory it’s the other way around, shareholders appoint the board and are the ultimate owners. However, poison pills have been litigated and have held up in court since many years ago. And they are a great tool to avoid a hostile takeover. Since if a poison pill is adopted and the investor still tries to acquire the company they are the only person that will lose.
One of the purported benefits of cryptocurrencies is their immutability (transactions cannot be easily reversed), and that since it’s all codified there is no ambiguity in interpretation. A smart contract will always execute according to its code, there is no ambiguity. The problem with this logic is that all the code is written by human beings, and we all make mistakes, or simply fail to consider all edge cases that may occur. Therefore, even if a piece of code always does what is written out, there may be unintended consequences in what happens in certain circumstances.
Well in another installment of why crypto is not the future of finance, a stable coin protocol was recently hacked for $182M. Well not hacked per se, more of taken advantage of because what the “hacker” did was outsmart the rules governing the protocol and didn’t really hack anything. He essentially bought Beanstalk governance tokens, which regulate what the crypto protocol can and cannot do. He acquired so many tokens that he had sole control of what could happen with the stable coin. He then created a proposal to send himself a bunch of crypto, and since he had effective control with his purchase of the governance tokens, he voted to let the transaction happen. Therefore, he didn’t hack the protocol, he just outsmarted it and makes $182M in the process. And since crypto is the Wild West there probably won’t be any litigation. And in any case it’s hard to tell if this is illegal since he was playing by the protocols rules.
This leads to another interesting point which is that when you buy crypto you probably have no idea what you’re buying. Sure you may have a high level understanding of how these things work. But unless you are a coder and read the code through and through you won’t really know what can happen. And even if you are, there are still edge cases that you may not think of such as what happened here…
A couple of days after Russia invaded Ukraine, several central banks around the world took drastic measures and limited the Russian Central Bank access to its foreign exchange reserves. They had the power to do this because some of Russia’s reserves were held in USD or Euros. Therefore the Fed and the ECB could essentially freeze their accounts. Russia had been diversifying from mostly holding USD denominated reserves for a while now, but they still had a large chunk in USD and Euros. Now they’re struggling to find where to invest those reserves.
One way a country gains foreign exchange reserves by the export of their products. Russia exports a lot of oil and natural gas which is paid for in USD. The Russian companies which sell this gas then take a portion and buy rubles to pay their local expenses. The central bank facilitates this transaction by selling rubles for dollars or Euros or something else. Central Banks tend to keep plenty foreign exchange reserves in order to stabilize the value of their currency. When Russia was sanctioned and couldn’t get access to their FX reserves they had a hard time defending the value of the ruble. They had to impose capital controls and raise their interest rates in order to stop the panic. More recently they are trying to demand payment for their oil and gas in rubles which would create demand for their currency and hold the value up.
After the sanctions were originally imposed we wrote that this would lead to at least a rethink of how central banks invested their FX reserves. Countries not as friendly to the US will probably decrease their USD reserves. The complicated thing is that there aren’t many other viable options. Most reserves are in USD, Euros, Yen and Swiss Francs. And if you are worried about US sanctions, chances are you wouldn’t feel safe in any of those currencies. Up until recently probably the Swiss Franc was the safest bet, but even they imposed sanctions this time around. An alternative would be to hold them in Renminbi or gold. But the Chinese currency doesn’t have the depth of other markets and they have capital controls. And gold has its own issues, if Russia wanted to sell all their gold they would have a hard time doing so. The volume would be too much for the gold market to handle in the short term. And unless they sold it all to China, the buyer would probably pay in USD or Euros, etc. so they’d be back to square one. In conclusion, the central bank sanctions are tough to get around.
This week’s commentary is filled with a bunch of crypto merely by coincidence. Interesting story about a journalist, which lives in Costa Rica by the way, about his experience trying to travel in El Salvador just by using Bitcoin. Long story short he couldn’t, he ended up paying many things in USD. He had issues as soon as he landed. A couple of issues he encountered:
Cab drivers prefer cash over Bitcoin, in fact most didn’t accept Bitcoin
Double payment at a restaurant because the app took to long to respond so they weren’t sure if the payment had gone through
Sometimes it took a long time for transactions to go through
He tried to get money out from a Bitcoin ATM only to have it say the transaction had gone through but no money came out
It’s always interesting to see how so many people believe Bitcoin will be the future of currency. Even when it’s clear that there is so much more that needs to be done for this to happen. From the simple fact that if I buy Bitcoin because I think its price is going to $1M, then why would I use it to buy a anything. There’s a famous story about a guy that paid like 10,000 Bitcoin for two pizzas back in 2010. Those 10,000 Bitcoins would now be worth something like $400M.
Another algorithmic stable coin that appears another algorithmic stable coin that loses its peg. A stable coin essentially tries to be worth $1 and not deviate from that. There are two ways of doing this. One is to hold assets that back the coin for every coin that is issued. The other way is to have an algorithm that controls supply and demand in order to keep the price pegged at one dollar. We’re not experts as to how this works but essentially there’s a way to create an arbitrage mechanism between two coins. So if the price of the stable coin gets much above or below $1 arbitrageurs can buy and sell and convert it to another token and keep the price at $1. The problem with this approach is that many algorithmic stable coins have faced situations in which the arbitrage mechanism breaks down. Or there’s some sort of doom loop in which the mechanism which should bring the price back in line actually exacerbates the price move and there’s no way out. Like we said before, crypto is the Wild West and investing in a “stable” coin might be dangerous if you don’t know how the coin is supposed to keep its value.
There are issues with the fully backed stable coins like Tether, which we’ve written about many tim a before.
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