This week we discuss the US Treasury Department’s sanctions on Tornado Cash and its ramifications on the DeFi ecosystem. It’s still unclear how far the effects of these sanctions could reach, but already the impact on stablecoin issuers is drawing significant attention.
Meanwhile, we recently published our monthly outlook where we take a deeper dive into Ethereum based layer 2 scaling solutions and the recent announcements about zkEVM technology. We think it’s becoming increasingly feasible that L2s could become the application layers hosting the bulk of economic activity for the Ethereum network while the mainnet exists exclusively to store transaction data. For the full report, please visit our research website.
Finally, we’re hosting our next Ask Coinbase Research webinar on August 18 at 10am ET (7am PST). We answer three questions from our institutional clients in 15-20 minutes. Please register to ask your questions here.
Weekly Market Call
View replays of our weekly crypto market analyses from our Americas, APAC and EMEA Coinbase Institutional teams, available here.
The US Treasury Department’s decision to sanction Tornado Cash (an Ethereum based service that mixes digital assets to hide the source of funds) could have meaningful ramifications for DeFi. Any holdings that are majority owned (50% or more) by Tornado Cash are now blocked and must be reported to the Office of Foreign Assets Control (OFAC). OFAC in particular included 45 Ethereum addresses in their Specially Designated Nationals (SDN) list, although some fiat-backed stablecoin issuers were caught in the net as well, i.e. those entities that are beholden to KYC/AML obligations.
The effect on stablecoins could have a broader reach, as the Treasury Department also established that all transactions in the US that involve any Tornado Cash wallets or contracts are prohibited unless exempted by OFAC. The extent of the impact on DeFi from this rule may be much harder to track, as participants in the ecosystem do not necessarily have control or clarity over the source of funds received, depending on the transaction type. It’s still unclear whether the risk is binary or based on the proportion of a given wallet’s exposure. For example decentralized exchange dYdX has started to flag accounts that have immaterial amounts associated with Tornado Cash.
According to Chainalysis, 49.6% of the US$7.6B in ETH that Tornado Cash received since August 2019 came from DeFi protocols, while 17.7% came from sanctioned entities and 10.5% from stolen funds. DeFiLlama reports that the total value locked on Tornado Cash as of August 11 is US$434M.
It’s still unclear how far the effects of these sanctions could stretch, though they have reignited debates about privacy and the risks to infrastructure providers (like Infura) as well as decentralized applications more broadly. There are also both operational and introspective concerns about penalizing a protocol vs a natural person. This could make people reconsider their obligations before sending or transacting assets on DeFi platforms in the future.
Rethinking the inflation narrative?
The lower than expected US CPI print for July has helped put risk markets on a stronger footing, alongside a fall in producer prices - the first decline in more than two years. This seems to be feeding market players’ assumptions that the Fed could take a less aggressive tightening stance in September. The rates curve is currently pricing in a 60bps hike at the September meeting or a ~40% chance they’ll raise rates by another 75bps. Headline inflation came in at 8.5% YoY (vs a Bloomberg median forecast of 8.7%) and down from the 9.1% in June, while core CPI ticked slightly higher to 6.1% but still mostly stable around that level.
Falling energy prices did the heavy lifting, which means that if those costs are contained, broad based inflation can potentially stabilize going forward. The risk is that the base effects from low prints in August and September 2021 means that figures over the next two months may not necessarily come in significantly lower than July’s CPI, which could feed into pressures on the Fed to deliver 75bps at the next FOMC meeting. Indeed, with an unemployment rate at 3.5%, the labor market still looks tight – which can keep domestic demand strong and make it harder to bring inflation down.
Chart: Risk-adjusted performance of BTC vs S&P 500 and Nasdaq
Coinbase Exchange and CES Insights
This week our exchange saw average volume traded. A better than expected CPI print led to a rally across crypto assets as traders priced in a less hawkish Federal Reserve. Once again, ETH has stood out as the most traded asset on the exchange. With the successful Goerli testnet merge behind us, the community looks forward to the final mainnet merge that is likely to come in September (likely dates 15, 16 or 20.) Going into the event, traders have been busy trying to analyze positioning. Some believe ETH has come too far too fast and is due to give some of its gains back. Others firmly believe investors are still largely underweight ETH and will chase it higher after the merge as it becomes a deflationary asset.
Coinbase Execution Services
The CES desk has seen continued buy interest across the board. A number of accounts are swapping into more risky assets as they trade BTC for ETH or AVAX. The more active funds continue to manage risk levels very tightly. Any real move down will see many of these buyers turn to sellers as they look to de-risk.
The BTC chart has improved over the last week. After three straight days of rejecting the EMA70, BTC is set to close above the EMA70 for the first time since April 21, 2022. BTC has had three consecutive closes above the EMA50 which is a good short- to medium-term bullish setup. If BTC can successfully turn the EMA70 into a support, the EMA100 is the next level of resistance (US$26k). The weekly chart is still bearish overall and would need to successfully close above EMA9 and retest the EMA200 at US$26.5k to turn bullish.
View From Around the World
The Monetary Authority of Singapore (MAS) has rescinded its in-principle approval for crypto lender Hodlnaut to obtain a license to provide digital payment token services under the Payment Services Act. This is after Hodlnaut suspended customer withdrawals due to a liquidity crisis and notified the MAS of their intention to withdraw their application. MAS also said that while cryptocurrency investments are “highly hazardous,” meltdowns in the sector have not created financial-stability risks for Singapore. (Bloomberg)
Coinbase is hosting a Protocol Access Program on Polygon - a platform of multiple Ethereum centric scaling solutions – on August 25 at 11am ET. Our Head of Institutional Research, David Duong, and Protocol Specialist, Ben Rodriguez, will speak to Co-founder of Polygon, Sandeep Nailwal, about the future of layer 2 scaling solutions. Please register for this webinar here.
- Date: Thu, August 25, 2022
- Time: 11:00am - 11:30am EDT
- Who: Co-founder of Polygon, Sandeep Nailwal