The Crypto Traffic Circle

Bitcoin is now on Wall Street and touted by widely respected financial institutions around the world. These new exchange traded funds (ETFs) have been wildly successful as they offer an allocation to history's highest returning asset without the need of understanding how to operate on blockchains and in the Web3 world. The quick success of these ETFs has created a lot of talk about other digital asset opportunities like tokenizing real-world assets (RWAs). In fact, you can already own tokenized RWAs such as U.S. treasuries, commodities like gold, even real estate. The avenues to acquire such assets live outside of the traditional financial rails. Today, your bank and/or investment firm will not assist you in buying these assets, take on any digital asset risk, or even offer an understanding of how it is done. Think about it, if new technology threatens the way you are comfortable doing business, would you push your own clients toward it?

People talk about Bitcoin and other digital assets like the 90s and this burgeoning thing called the internet. Not all internet startups, in fact very few, are still around from the 90s. Most assets you find today in Web3 will be worthless in five years or less. But the ones that do make it long term will be household names like Amazon, Match(.)com, and our favorite search engine the Googs. To invest in these companies in their first decade of public access (i.e. the stock market) you would have made 5000%, 525%, and 570% respectively (give or take). Today, these three names are worth multiples of these returns. The blockchains you have heard about are public by nature and therefore offer early stage investment opportunity for everyone. That does not mean it is suitable for all investors, as there is increased risk with the value you put into these vehicles. It is up to you to decide, as the steward of your own destiny, if the risk is worth it.

"If you are not willing to risk the unusual, you will have to settle for the ordinary." ~ Jim Rohn

The Traffic Circle

I want you to think of blockchain rails as a traffic circle. That thing you are rarely excited to see in front of you and hope to god you don’t get caught in the middle of.

The wildest traffic situation I have ever witnessed was on holiday in Paris with their seven circles of hell — oh, I mean the iconic roundabout circling the Arc de Triomphe. Reimagining this as a blockchain, the edges represent the self custody of cash in your wallet; every step closer to the center is a gravitation towards the vast opportunity the Web3 space offers. When you master the Crypto Traffic Circle, you will understand more about who custodies your value, how many transactions (lane changes) are needed to get where you are going, and the counterparty risk in each lane. Just call me Tom Tom as I navigate your investment vehicles through these digital roadways.

If for some reason you need to liquidate Web3 assets and use the value in the real world, it will take multiple transactions across several institutions with fees and potentially taxes assessed all along the way. I say this to you to point out the need for efficiency when navigating the Crypto Traffic Circle. Cutting across these multiple lanes of traffic, we need a base understanding of blockchain technology and the digital assets that are held within.?

Blockchain

Blockchain technology is a newer form of distributed ledger technology (DLT). DLT has been used for decades by banks and large corporations. If you have ever used an intranet at work, most likely the back end had some kind of DLT to supply one set of data, a single source of truth, that maintains the company’s repository of information that all branches/locations can tap into as needed. This is important for companies spread across the country or globe so everyone is operating on the information pertinent to them. Take your local bank branch; you can stroll in and meet with a banker or work with the ATM to deposit, withdraw, and manage your accounts. That data is not stored and managed onsite. Were you to be traveling and had the need to manage your accounts, you could go into a different branch to do so. This is because of DLT built into the backend of your bank’s digital infrastructure. You have x amount of money at your disposal and you can access it by working with the banking system, in person or via their website, to manage your finances. When you do, the information on their private DLT system changes to reflect your actions for the entire banking corporation. It is private because you only have access to your own account information, not your neighbor’s, best friend’s, or father in-law’s who refuses to admit he is a millionaire (fingers crossed).

The Federal reserve acts in a similar fashion, deploying DLT for banks to settle between one another. Today’s technology of blockchain is very similar, except many have the data available to the public, and it manages the information in specified sizes known as blocks on a time line. Anyone who knows how to access, read, and interpret this data can audit the public blockchain to confirm the validity of its historical transactions. When the blockchain is updated with new blocks of information, they are posted to the end of the existing chain of said blocks, giving it its name. It cannot be altered from its current state as these blocks are now immutable (at least in theory, depending on the chain, how decentralized the management is, and the strength of the encryption protecting the rules that govern it). Bitcoin has become synonymous with blockchain technology as it was the first successful DLT technology to be recognized as a public blockchain. No, Bitcoin is not the first digital asset, it just happens to be the first that solved the problems of the ones that came before it. If you read the Bitcoin white paper, it references several of the earlier technologies that are included in the infrastructure of Bitcoin.

With public blockchains, anyone can record data to be included in the public ledger. To prevent spam, this ledger entry must pay a transaction fee referred to as gas. This gas is paid in the native currency (a cryptocurrency) of that blockchain. Blocks are limited in size on purpose. The "block size wars" that settled around five years ago determined that if Bitcoin blocks are too large in data size then it risks the decentralized nature of the network due to the cost needed to support more data.

The entire Bitcoin blockchain, all 838,000+ blocks of data and counting (tick tock, next block), currently equates to just over 600 gigabytes of data. If you have a mac built in the last three years, your hard drive is probably 750GB, and more likely 1 terabyte. This means that you, on your personal computer, can run a full bitcoin node guaranteeing the validity of every bitcoin transaction since its genesis block in January of 2009. You and I can play banker without that annoying friend, let’s call him Garry, that likes to cheat when he’s the banker in Monopoly. Do you still let Garry be the banker, even though he’s the only one that wants to?

Now that digital data is verifiable from its creation to its most recent location on the blockchain, digitally centric assets can now be scarce. This digital scarcity, introduced to the world with Bitcoin's creation, is verifiable and immutable. And apparently valuable, since to own 100,000,000 Satoshis, or one full bitcoin, costs north of $70,000; making it the most valuable cryptocurrency ever created despite millions of technological iterations that have come after it. Bitcoin was designed to be antifragile and it has survived this long because of it.

Crypto Currencies

The Bitcoin blockchain requires a transaction fee to be paid in Bitcoin. Because Bitcoin is required to post data to its blockchain, where the blocks are limited in size, the amount of crypto needed to record a transaction is variable depending on the network traffic. Supply and demand in its most raw form. Bitcoin also capped its currency’s issuance at 21 million coins, or 21 quadrillion Satoshis (Sats are the smallest piece of a bitcoin, kind of like a penny to a dollar). This simple law of limitation is definable scarcity that humanity has never known. There is no inflation on a Bitcoin standard because there is no way to increase the supply. There is, however, a way to make a Bitcoin more divisible beyond the current Satoshi, like cutting a pizza into eight slices rather than six to make it easier to share with more people.?21,000,000,000,000,000 is a big number, and offers anyone reading this the opportunity to become a Satoshi millionaire and start stacking Sats for a better future.?

It’s not about buying a bitcoin, it’s about protecting your purchasing power across space and time with an asset that is verifiably scarce and distributed in its day to day function. The distributed nature prevents any one party or even group of bad actors from affecting a change that the vast majority of network participants do not agree with. Like the US government printing $1.2 trillion dollars to pay themselves to show up to work tomorrow. Most blow their budget and are out of the game. The US’s ability to print more of the global reserve currency allows them to do what they want, when they want, without personal ramifications. Do not get wrapped up in “unit bias” or trying to buy one full Bitcoin in one transaction. There are far more Satoshis readily available, at an attainable price, with all of the benefits of Bitcoin.

Web3

We have discussed Web3 in the past and what it means to today’s internet connected society. There is more than just the Bitcoin blockchain with many different features available to the public. Many believe these other chains are proving grounds for features to eventually be implemented into Bitcoin, but time will tell. Smart contracts are becoming more commonplace in Bitcoin as time goes on and one can practice navigating these avenues with less valuable assets on other chains in the meantime.

The Crypto Traffic Circle

So why enter the traffic circle at all? In Paris’ seven circles of hell, I still don’t know. For blockchains, the center of the circle offers you, the user, access to smart contracts, which opens up the opportunity to partake in DeFi protocols, NFT ownership, and GameFi ecosystems. You know, join the metaverse, the front end applications of Web3.0 (if you don’t know what I am talking about, please check out the first series of Foolish Finance articles and subscribe as to not miss any more). Understanding the traffic circle structure of blockchains will allow you to navigate these new roads efficiently. Keep in mind that no matter the asset involved in the transaction, you will always need to pay a gas fee in the native cryptocurrency of the chain you are transacting on and potentially incurring taxes. Let’s drive!

The Familiar System

This is the system we are all familiar with. Pure cash holdings in your hand or the equivalent value held in your bank accounts that we tap into as needed through debit/credit cards. These plastic transactions seem instant for us in the real-world but actually take a week, sometimes a month or longer, to fully clear through the traditional financial system. Unlike Cash transactions, which are known as final settlement transactions, which have no additional processes to run. This latter point is the power of self custody assets.

Back to Paris, Rue de Tilsett is a circular street that wraps completely around the traffic circle, removed from the system, and so we will treat it as cash. Holding cash is a form of self custody. You are solely responsible for the safety and security of self custodied assets. Financial institutions, represented by the streets and avenues that connect Rue de Tilsett to the traffic circle, act as a connection to the broader financial system. Banks and investment firms of today offer a third party custody option, safeguarding your assets while offering the financial services that blockchains and their cryptographically secure systems continue to disrupt.

• Holding cash is a form of self custody. You are the only risk to the safety/security of these assets. (All value denominated in $USD terms is affected by inflation)
• Banks and financial institutions offer a third party custody option for assets. Your counterparty risk is these institution you choose and their ability to manage their own finances. They are required to pay for insurance programs (FDIC/SIPC) that cover their customers up to $250k in the event of insolvency.

Let us not forget the regional banking crisis of 2023. Several banks became insolvent due to mismanaged duration risk on their bond holdings. During this institutional shakeout, many learned that their cash value held at banks is not actually held on site or even in the bank's network of branches. If a bank you hold cash value at goes under, you lose those assets, or at least access to those assets, while the "speedy" legal system figures out FDIC/SPIC insurance payouts. How you pay for your mortgage, food, and energy is not of their concern. Good luck if all of your assets are at this one institution. Don’t forget the risk of missing payments or purchases and what this does to your credit and physical health.

Lane 1: Central Exchanges

Your introduction to Web3 infrastructure will be centralized Exchanges. These seemingly buttoned up institutions connect directly with the traditional financial system with KYC (know your customer) requirements and familiar regulations. Central exchanges are a great way to access digital assets, but they are not your custodian. They are a honeypot for bad actors to scam unsuspecting customers, like you and me, out of your valuable assets. They also do not offer any kind of insurance, like FDIC/SIPC, that traditional financial institutions offer even though many newcomers to the digital asset space expect and assume that they do. Use these services as needed to acquire digital assets, but do not store said assets here long term.

The outside lanes of the traffic circle allow you to come and go between traditional and Web3 assets as needed. You will pay fees for every transaction and potentially have tax implications. Until the Web3 space develops more, these exchanges are necessary for transferring your digital value to a usable form in the real world.

• Central exchanges are a 3rd party custody option. You will require two transactions when starting with digital assets in order to exit back to your bank. The first transaction is to liquidate the asset and the second is to transfer the newly acquired $USD to your bank account. The counterparty risk associated with these firms is high as they manage massive levels of value in digital and physical assets at any given time. They also manage all of the personal data of their customers and have proven to be poor at protecting this data. Even if they avoid negative cyber security events, regulators have been sanctioning these institutions sometimes locking up customer funds for months, even years, while they sort out the perceived issues.

Mt. Gox, FTX, Binance... the central exchange options in today’s Crypto universe have left one wanting more. Even Coinbase, the ETF darling custodian and the only publicly traded US Exchange, has been wrapped up in litigation for years despite operating in a transparent form with regulators. The first two exchanges mentioned turned out to be scams leading to theft and the loss of millions of $USD value for their customers. Don't be fooled, the claims by the media that FTX clients are being made whole are nonsense and gaslighting. Look at what those assets are actually worth today, not at the moment of insolvency which crashed the crypto market to lows at the time of news breaking. Don't store funds, physical or digital, at these institutions longer than absolutely necessary.

Lane 2: Web3 Wallets

Another form of self custodial solution; hot wallets, cold wallets, and the various vault solutions available for digital assets. You control these assets like when you hold cash. If you make a mistake and give your cash to some bad actor, never to see them again, no one will reimburse you for your idiocy. (I say this having done this myself in the past. You will never feel dumber than after being scammed out of your value. Save yourself from yourself.) Scams are everywhere. With self custody, it is your duty to not get scammed out of your value.

Just as you can buy a wallet for your cash from an untold number of brands and stores, Web3 wallets are becoming just as widely available for your digital assets. Some of the most common providers include; Metamask, Trust Wallet, Ledger, Phantom, and Trezor. Where they differ is how you interact with them and their perceived security features that you can learn more about in Foolish Finance 1.2.

• Web3 wallets are self custody. The counterparty risk associated with this option is your ability to not get duped and the strength of your personal cyber security protocols. In order to completely exit the system from this stage, at least three transactions are required; sending your assets to a central exchange, liquidation, and then sending to your bank.

The true power of Web3 infrastructure is held within this self custody option. One can act as their own bank with complete self-sovereignty. Acting as your own banker puts all of the onus of financial security on you. Not just making the money and creating value but also securing the value long term. A note of caution, it is not for the faint of heart to go at it alone.

Lane 3: Smart Contracts

The yin and the yang of Web3 infrastructure. This is the promised land, however full of trap doors and malfeasance. A smart contract is an automatically executable digital document that allows whatever the code says to happen the moment you hit “accept,” “confirm,” or “go.” In the Web3 world, CODE IS LAW. If the contract says, “you as the signer agree to transfer all of your assets to the receiving wallet” and you initiate that transaction by accepting these terms, you will lose all of your assets in that wallet and even pay the gas fees to transfer them. If however, you know what is in the smart contract by reading it (given you know how to read the computer language it is written in) or through community confirmation, you can join in the opportunities that the vast Web3 world has to offer.

Smart contracts offer further utility of digital assets on blockchains. From definable ownership of digital art to automated finance, these packages of code empower blockchains to go beyond the mundane.

• Smart contracts are third party custody. The counter party risks can be infinite as in the Web3 world, code is law. Depending on the service you are using for smart contract interaction you may have multiple smart contracts, service providers, even Web2 style infrastructure that you are interacting with and entrusting your digital value to. In the middle of the traffic circle, you are at least four transactions away from completely exiting back to the real world. At times feeling like Clark Griswold, seemingly unable to get where you need to go and continuing round and round.

NFTs: Non-fungible tokens are smart contracts that differ from one another. They are digital representation of anything anyone would like to represent on blockchains, not just art. NFTs had their limelight in 2021 and 2022 as the hype began and grew around digital art. Many got burned at the tail end of this NFT art bull market, paying thousands, some hundreds of thousands, of $USD to hold a digital image of a rather bored looking primate. This speculative bubble is just like any other in financial markets. Be it tulips in the 1600s, South Sea Bubble in the 1700s, Railway Mania in the 1800s, multiple stock market bubbles in the 1900s, Dot-com and US housing bubble in the early 2000s… if people are excited about potential wealth creation, they will take it too far and most will get burned. In the event of the Bored Ape Yacht Club and broader NFT bubble, this is often not the fault of the creators if what they promised to deliver to the owners was kept. I personally know that what the BAYC team promised to deliver has been delivered to anyone holding their NFTs since the day they promised it, at initial mint. When an individual jumps into a bubble, they need to be aware of the risk of the bubble popping and prices returning to proper market levels (supply/demand), however low that may be.

GameFi Platforms: Every gamer out there knows the frustration of online gaming and the classic inability to play with friends on different mediums. XBox users could not play with PC or PlayStation users for most of their life. This was finally mitigated with the advent of Fortnight, the first mainstream cross-platform online multiplayer game, sparking other major developers and platforms to create more interoperability across titles. The assets one develops in a particular game were also lost once the game was replaced by the new version or next big title that your friends migrated to. You could not simply take your earned or purchased skins, sword, magic boots, etc. to the new game. However, in the world of GameFi, assets are NFTs and have been promised to have a cross-platform and interoperable functionality, as long as other developers play with these rules in mind. Gaining assets in the GameFi world means gaining real-world value one can collect in exchange for said assets. Video games have come a long way in story telling and graphic execution, and Web3 is now bringing real-world value to the space like never before.

DeFi: Decentralized finance is a reimagining of the traditional financial rails, built upon the ideations of: decentralization, permissionless, transparency, interoperability, and programmability. This is all done through smart contracts. No KYC or geographic blocks, no wealth or invite requirements; anyone and everyone with an internet connection and device can partake. DeFi offers many common financial services including: lending and borrowing, decentralized exchanges, yield farming (i.e. income producing assets), and stablecoins, shifting one’s risk to the stability of global currencies and traditional assets like gold.

Changing Lanes

Why anyone would find themselves on the inside of Paris’ famous traffic circle is beyond me; however, if you find yourself inside you need to make some lane changes to get where you are ultimately going. Every lane change typically starts with the decision to change lanes, followed by the turn signal, and eventually shifting your car’s position over one lane at a time. On the blockchain, you will need to make many lane changes to partake in the Web3 offerings that most likely inspired you to learn about it. It is similar in that you do one transaction (lane change) at a time, each time going through a process to complete the movement of your assets. Transacting on the blockchain requires a payment of that chain’s base cryptocurrency and the time needed to transact, be it 30 mins to an hour on Bitcoin or mere seconds like on Ethereum or Solana. Network traffic, just like on the road, can affect transaction times and the cost to transact (or amount of real-world value spent on gas needed to get where you are going).

The crypto traffic circle can be used to help you and others understand navigation of the Web3 roads and blockchain based assets in an efficient manner. Knowledge of where your assets lie, the counterparty risk they are beholden to, and how many transactions are needed to get where you are going can be invaluable in a world full of tokenized RWAs. Please share this with anyone you know getting into the digital asset space for a little more understanding of the cutting edge Web3 universe. Tom Tom, out!

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