Paper Bitcoin

Paper Bitcoin

I have to admit that the last few days have been very entertaining as we watch the unravelling of the FTX scam and bankruptcy. I've been dabbling in crypto for the past 5 years but haven't been following the news that much. I wasn't even aware of who Sam Bankman Fried (SBF) was or even the scale of FTX.

Being a libertarian, I've been interested in crypto as a way to hold wealth in a independent and decentralized manner. I've never really been interested in trading or any “get rich quick” scheme. My relationship with crypto has been limited to hodling some BTC and ETH on a cold wallet.

I have a few crypto tokens on some exchanges, but the total amount never surpassed $100 USD. If I had more, it was only for a few minutes until the coins were transfered onto my cold wallet.

I never understood people who would leave a significant amount of money on these unregulated, offshore, and immature exchanges. From my point of view, using these exchanges to store funds never seemed aligned with the crypto philosophy. Crypto should be about trustless and decentralized systems. The anxiety should come from losing your keys, or sending your funds to a mistyped address – not getting hacked or scammed.

Anyways, going back to the FTX saga, at first I was watching the whole story like when you drive by a car crash on the highway and you can't help but slow down and look at the mess. I felt very unconcerned by the whole thing. That's until I started understanding the concept of “paper bitcoin”. I was shocked.

Everytime I had bought Bitcoin, I had immediately transfered it to my cold wallet. I know my wallet address and I can see the transaction on any blockchain explorer. This seemed like “crypto 101” to me.

Then it hit me – all these people have been buying crypto on exchanges and the only proof they relied on is their account balance. Basically an HTML page where your balance is simply text. Nothing more. You have no way of verifying that you actually own tokens. Your funds are limited to an entry in a database. (Just like at any financial institution.)

This opens the door for one of the greatest scam one could dream of: you open up a crypto exchange and you sell “paper bitcoin” to people. They send you USD, you put Bitcoin on their balance, but it's all fugazi

What do you do with all your deposits? You buy a penthouse in the Bahamas, you live the dream life, and you hope there is a never a bankrun. If you're lucky, you can live that lifestyle for 5-15 years.

Let's stop daydreaming and let's go back to paper bitcoins. The question that is burning in my mind is how many bitcoins were sold to people? We know there is a limited supply of 21 million, but what if there are claims out there for 50 million bitcoins? What if a large chunk of all bitcoins are only bits in a database? I have no idea how big that issue could be, but I know it's out there and it's bothering me.

Investors who have invested in precious metals are well aware of this type of issue. Especially nowadays with ETFs, you can buy gold or silver easily from any broker. The last I want is to advertise Blackrock, but they do have some pretty sizeable ETFs for precious metals such as $IAU (iShares Gold Trust). There is around 25 billion dollar invested in that fund, which advertises itself as a good “exposure to the day-to-day movement of the price of gold bullion”. That doesn't mean that if you invest 100k$ into that fund someone will go out and buy 100k$ of physical gold.

$IAU is not even the largest gold ETF – there is also the SPDR $GLD which weighs in at 50 billion dollars in assets under management. Again, that fund's primary value proposition is that it “reflect[s] the performance of the price of gold bullion, less the Trust's expenses”. It does say it's backed by physical assets, but to what extent? 100%? Probably not.

I'm not saying there is something wrong per se with the $IAU or $GLD ETFs – however, I wonder how many people buy those ETFs thinking it's analog to buying physical gold.

The good news for gold is that it's a market valued at more than 11 trillion dollars. That means that it would take many times over the assets under management for these ETFs to make a sizeable dent in the overall gold market.

I fear that the same may not be true for crypto…

P.S. not your keys, not your crypto