• FTX is worse than Enron
  • The cost of losing Taiwan
  • Most investors misunderstand bitcoin

Dear Reader,

Welcome to our weekly mailbag edition of The Bleeding Edge. All week, you submitted your questions about the biggest trends in technology. Today, I’ll do my best to answer them.

If you have a question you’d like answered next week, be sure you submit it right here.

FTX is not the blockchain industry

Jeff,

FTX has fallen. What do you think about the blockchain industry in light of this? And should we believe an exchange like Binance?

Fredrik H.

Hi, Fredrik. I’m glad you asked. I’m sure many subscribers are wondering what the impact of the FTX collapse will have on the blockchain industry.

My team and I have been closely tracking the developments and updating subscribers in our digital assets research products, Unchained Profits and Neural Net Profits. And Bleeding Edge readers can catch up on my analysis right here.

But for any readers needing a refresher, here’s the shorter version. FTX—once one of the world’s largest digital asset exchanges—has utterly collapsed.

Through a combination of utter incompetence and outright fraud, billions of dollars’ worth of customer assets have been lost. And it’s looking very unlikely that these clients will ever be made whole again.

The new CEO of FTX—John J. Ray— put it perfectly:

Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.

And we should know that Ray was the man behind the restructuring of Enron. And he’s saying that the FTX debacle is worse.

But as for your question, does this change my view of the blockchain industry? No, it doesn’t.

It’s important that we distinguish between the bad actions of FTX and its executives and the wider industry and asset class. The failure of one is not an indictment of the other. The collapse of Lehman, after all, was not an indictment of all traditional financial services.

FTX reminds me a lot of the Man Financial Global scandal. Client funds were taken and used to bet on sovereign debt. The trades went against Man Financial, it had a liquidity crunch, and it imploded in the same way that FTX did. The scale of the Man Financial mess looks small compared to what FTX has done.

FTX’s CEO, Sam Bankman-Fried (SBF), never really cared about the blockchain industry or what it stood for. In a 2021 interview with Forbes, SBF said he would happily pivot to trading orange juice futures if it meant he could make more money. This is not a mission-driven person.

SBF was focused on building a highly centralized exchange and was actively working with the government to employ stricter regulations, ones that would benefit FTX and hurt the rest of the industry. This is the antithesis of what the blockchain industry stands for.

By contrast, many in the blockchain industry are truly committed to the ideals of building a more open, free, decentralized, and transparent version of the internet. That ideal is still in its infancy, but it’s worth fighting for.

And the FTX debacle could have been entirely avoided if the company had adopted blockchain technology into their operations. A public blockchain—after all—is transparent. The industry would have instantly spotted the nefarious transactions as they would have been recorded and visible on a blockchain.

It was only by centralizing control and obscuring operations that FTX was able to get away with this for as long as they did. This is the exact opposite of what the industry stands for.

Binance has actually come out of all this looking better than before. Its CEO knew something wasn’t right and called out FTX on it. This set the collapse into action, which we now know would have been inevitable.

My biggest concern right now is the government response. We now know that SBF was holding private meetings with Gensler, Chair of the SEC. He was receiving treatment and access that others in the industry were not receiving.

Is there a larger game at play here? Is this the “excuse” that the government will use to impose draconian regulations on the industry so that it can control digital assets and implement its own plans for its CBDC (digital US dollar)?

I believe that the government will implement its digital dollar next year, and after that will issue more regulatory clarity for other digital assets. This will be a good thing for the industry. And I do believe that there is strong enough support to ensure that the government doesn’t go too far in a way that would restrain the ability for companies to innovate, invest, hire, and grow the next generation of internet and financial services technologies.

As for your second question, which exchanges should we trust?

I recently published three options digital asset investors have for safeguarding their assets. Here they are:

  1. Be Selective of Your Exchanges: What’s clear is that some exchanges are trying their best to showcase they’re not engaging in practices like FTX. Exchanges like Kraken, Coinbase, Gemini, and others are coming forward to give additional transparency. Many of these exchanges do hold regular audits. Coinbase does since it’s a publicly traded company.

    If you’re not comfortable taking custody of your own digital assets, look at exchanges like these. It’s also worth looking at some of the insurance policies that exchanges take out in the event a loss of funds happen.

  2. Be Your Own Bank: For those who are willing to take custody of your assets, we strongly suggest a hardware wallet like a Ledger or Trezor. This is the safest way to store your digital assets.

    Of course, while taking custody of your assets is ideal, we understand self-custody is not for everyone. But a quality hardware wallet is relatively inexpensive. And with just some familiarity with transferring digital assets, these wallets can be a great option.

  3. Hire a Custodian:This last option might not be realistic or even necessary for most subscribers. However, for those of us with significant digital asset holdings, we could consider researching institutional custodians.

    Custodians like Coinbase Prime and Fireblocks are regulated and specialize in safeguarding assets for institutional clients. Again, taking this step is likely not realistic or even needed for most investors. But we share it as an option for any subscribers who are interested. 

I hope that answers your question. I’ll have more to say about FTX in the days and weeks ahead.

The Impact of a Taiwan invasion…

Dear Jeff,

Your piece and Taiwan and TSMC was very interesting. Will you recommend getting out of all the stocks with exposure to Taiwan companies, which presumably goes beyond semiconductors?

Perhaps you could provide us with a list of all companies with exposure to Taiwan in our portfolio?

Finally, you comment:

“Importantly, this isn’t the first. TSMC announced plans earlier this year to build a $12 billion plant in Arizona, which is already under construction. The plant is planned to go online by 2024. And it will manufacture 5 nanometer (nm) semiconductors.”

It made me think. If you believe that Taiwan could be invaded (or taken over) sometime between two months from now and two years from now, isn’t the transition of TSM offshore happening too late, especially if they can only start operations in 2024?

After all, they are trying to maintain current demand, while preparing for new demand from new technologies (EV, robots, blockchain, etc). What are your thoughts on this? Thanks.

Gordon E.

Thanks for your question, Gordon. To catch readers up, I have outlined my thoughts on the likelihood of the Chinese government taking control of Taiwan. As I said, I don’t believe it’s a matter of “if”, just “when.” Readers can read the full analysis right here.

And unfortunately, Gordon, it’s not as easy as simply identifying a handful of companies with exposure to Taiwan and TSMC. That’s because the impact of “losing” TSMC would negatively impact the entire world.

TSMC is the world’s largest semiconductor manufacturing company. And semiconductors are the “brains” of all modern electronics. Everything from our smartphones to our cars to our coffeemakers rely on these components. And most of them are fabricated by TSMC.

As I see it, there are two possible scenarios.

  1. China invades—or otherwise takes administrative control of Taiwan as it did with Hong Kong—but allows TSMC and the semiconductor industry to operate normally, more or less.

  1. The Chinese government controls the island and cuts the world off from the manufacturing capabilities of TSMC located on the island. This would be the “nightmare scenario.”

Scenario one makes the most sense. China has already set a precedent with Hong Kong, which was a smooth transition and take over. China patiently waited years to assert stronger and stronger control. It was done in a way that didn’t suddenly impact Hong Kong’s vibrant economy in a negative way.

This would make the most sense with Taiwan. China would benefit from Taiwan’s thriving economy and tech-driven exports. And it can learn from TSM’s expertise in semiconductor manufacturing.

Chinese President Xi Jinping is many things, but he is not reckless. He understands that China’s economy is weak. Its people are suffering under the absurd and ineffective “Zero Covid” policy. And all-out war is the last thing the country needs. We shouldn’t entirely rule out scenario two, but it benefits China less than scenario one.

And Gordon, you’re right. It would have been much smarter for TSMC to have already built new manufacturing plants in the U.S. and Europe in advance of this. 

It would have been appropriate to make those investments years ago. After all, if China did stop all semiconductor related exports in the coming months, the world would come to a halt.

But I can’t help but think that the Chairman of TSMC knows something that we don’t. He is such a prominent figure with ties to the highest levels of governments. If I had to guess, he is well aware of what will unfold, and he knows that scenario one is the path forward.

I believe that the health of TSM will be not only be preserved but encouraged irrespective of the outcome with China. As I shared yesterday, Buffett just took a $4.1 billion position in TSM. It’s safe to say he believes that as well. This was a very rare investment into high-tech by Buffet, who has historically avoided high-tech investments at all costs.

Irrespective of TSM’s efforts to diversify risk with new offshore manufacturing plants, these plans just make sense. The U.S. is TSMC’s largest market in the world in terms of its customers, and there are large economic incentives in the U.S. for new manufacturing plants. 

Not surprisingly, on Wednesday, news broke that Apple plans to source future semiconductors from TSMC’s Arizona fabrication facility as soon as it comes online. Apple is one of TSMC’s largest customers.

While this is not a risk-free situation; I believe that concerns of an outright military conflict along the lines of what we are seeing between Russia and the Ukraine are overplayed. 

And longer term, supply chains for advanced technologies will become more resilient and secure. The decades-long trend of offshoring manufacturing is reversing. Our own economies—and consumers—will be the beneficiaries.

I remain optimistic, but I’m watching any developments like a hawk. If I felt that an all-out invasion of the island was imminent, we would certainly make appropriate changes in our model portfolios.

The true value of bitcoin…

Mr. Brown,

What would you say to people that say “Bitcoin is going under” or “Bitcoin is a scam”?

I continue to hear people on the news, radio, or even people I know personally say these things, and I continue to tell them it isn’t going anywhere (at least the people I know). I am curious to get your take on this topic, because I don’t feel like these naysayers embrace the fact that the underlying technology of Bitcoin is shaping the next version of the web.

Nate W.

Hi, Nate. I’d be happy to offer my thoughts. With the events surrounding FTX, I’m sure the naysayers—as you put it—are out in force. So, it’s worth going back to the very beginning and taking a fresh look at bitcoin.

First, it’s worth noting that bitcoin has been declared “dead” for as long as I can remember. There’s even a website that track’s bitcoin’s obituaries in the press. According to the site, bitcoin has “died” 466 times. Hilarious.

My longtime readers might remember that I first recommended bitcoin back in 2015. It was trading around $240 at the time. Here’s what I wrote back then:

Bitcoin was designed to be a “trustless” network. While that might sound negative, it’s not. “Trustless” merely means that trust is not necessary in Bitcoin transactions because they do not require a third party. A Bitcoin transaction exists solely between the seller and buyer.

[…]

The key is that the Bitcoin network is a safe, secure, and highly functional means to transfer and exchange money irrespective of capital controls.

A lot has changed in the industry since 2015. But that basic explanation of bitcoin’s appeal has not.

The mistake most media pundits—even some investors—make is that they look at bitcoin as if it were a company. They assume that because the price of the asset has declined steeply, the project itself must be close to falling over.

That’s ridiculous. Bitcoin is not a company. There is no CEO, president, or chairman of bitcoin. The correct way to think of bitcoin is as a network. Where most networks are designed to transfer information, the bitcoin blockchain is designed to transfer value.

And when we look at the project in this context, we can see that bitcoin is just fine. The price of the asset has declined sharply. But have a look at the chart below.

What this shows us is daily transactions on the bitcoin blockchain. And what we’ll notice is that the blockchain is still conducting between 250,000 and 300,000 transactions every day.

Transaction volume has come down somewhat from the levels we saw in 2020 and 2021, but it’s still well above the levels we saw from bitcoin’s early years.

That’s what I’d encourage us to keep in mind. The value of the asset itself has declined. But the network is doing just fine. 

In fact, it has become even stronger than before after China banned bitcoin mining. This diversified the bitcoin miners outside of China (good thing) and made for an even more resilient network with even less likelihood that a single party or group of parties could attain majority control over the network. As a reminder, miners are the entities that provide the computing power to run the bitcoin blockchain.

The only way bitcoin “goes under” is if the network participants—all at once—stop contributing to the maintenance of this blockchain. And because of the monetary incentives built into the blockchain, I just don’t view that as a realistic possibility.

The price of bitcoin will be volatile for some time. But the project itself isn’t going away. I hope that answers your question.

And to be clear, bitcoin isn’t a scam. It is the gold standard in the blockchain industry. There is no one person or people that are manipulating the bitcoin blockchain. 

The bitcoin blockchain is software that has pre-programmed monetary policy that everyone can see and understand.

I wish we had the same kind of transparency and policy from the U.S. Federal Reserve and European Central Bank…

That’s all we have time for this week. If you have a question for a future mailbag, you can send it to me right here.

Have a great weekend.

Regards,

Jeff Brown
Editor, The Bleeding Edge