Bloomberg's Matt Levine on Hex
Here is an economic system, or a system anyway:
- I make up a crypto token called MattCoin. I can issue an unlimited amount of MattCoins, since I made them up.
- I sell them to people for money.
- You can use MattCoins to make term deposits, with me: You can give me back your MattCoins and I will keep them for some specified time period (say, a year), and at the end of the period I will hand them back to you with interest.
- The interest is paid in MattCoins.
- The interest rate is high, say, 38% per year.
- This is the only thing you can do with the MattCoins. They’re not useful for payments, they don’t run smart contracts on a blockchain, all you can do is trade them on crypto exchanges and deposit them for a 38% yield paid in kind.
So you pay me $100 for 100 MattCoins, you deposit them with me for a year, and at the end of the year I give you back 138 MattCoins.
At the end of the year, how much would you expect your 138 MattCoins to be worth? I think the main options are
[1]:
- $138. You put in $100 for 100 MattCoins, meaning that they are worth $1 each, and in a year you get back 138 MattCoins. If they are still worth $1 each, then 138 MattCoins are worth $138.
- $100. You put in $100 for some MattCoins, absolutely no economic activity happened, and in a year you get back 138 MattCoins. This is like a stock split: You had 100 shares of a pot worth $100, now you have 138 shares of a pot worth $100, each share is worth less but the pot hasn’t changed.
- $0. You put in $100 for some MattCoins, absolutely no economic activity happened or will ever happen, in a year you get back 138 MattCoins, but I keep the $100 and you don’t get to exchange your 138 MattCoins for real money again. There is not actually a pot with $100 in it; I just took the $100! You put in $100 and got back a pile of magic beans that are not redeemable for anything. The pile grew bigger over the year, but it remains worthless.
- More than $138. You put in $100 for 100 MattCoins, those MattCoins offered a 38% yield, other people see that 38% yield and said “I want some of that,” they buy some MattCoins, the price of MattCoin rises, still other people see the rising price and say “ooh I want some of that,” the price rises further, it’s a virtuous cycle, eventually each MattCoin is worth like $10,000 and your 138 MattCoins make you a millionaire.
I think that Answer 3 is the standard answer that traditional financial analysis would give you: You bought an electronic token with no cash flows ever, so it’s worth zero. I am drawn to this traditional analysis, but it has not really worked all that well for understanding crypto.
I think that Answer 4
is the standard answer that crypto would give you. This is a
completely accepted mechanism of crypto finance: You have some token, the main thing that the token does is generate more tokens, you call those additional tokens “yield,” people are attracted to the yield, they buy the token and its price goes up. The “yield” does not come from
any economic activity in the real world; it just comes from printing more tokens. “Ponzinomics,”
people sometimes
say. Loosely speaking, this is the thought process behind crypto “Ponzicoins” like
OlympusDAO and
Wonderland. Loosely speaking, it is the thought process behind many algorithmic stablecoins like
TerraUSD. Loosely speaking, it is the thought process that Sam Bankman-Fried once
described to me on Odd Lots: “You start with a company that builds a box and in practice this box, they probably dress it up to look like a life-changing, you know, world-altering protocol that's gonna replace all the big banks in 38 days or whatever. Maybe for now actually ignore what it does or pretend it does literally nothing. It's just a box.”
Anyway here’s a US Securities and Exchange Commission
enforcement action against a crypto project called Hex
[2] and its founder, a guy named Richard Schueler who apparently goes by Richard Heart:
There is a lot going on in
the complaint, including a very fun paragraph detailing Heart’s spending:
But mostly I love Hex’s economic model. Here it is:
Notice how you earn your interest on Hex: You send it to a dead address so no one can ever use it again. This is not what
banks do to pay interest: Banks take deposits and use them to fund lending to support real-world economic activity. It is not what, say, Ethereum does to pay staking rewards: Ethereum stakers validate transactions and thus arguably add to the economic value of the Ethereum network. Hex does
absolutely nothing, but it just prints some extra tokens (which cost it nothing!) to pay “yield.” This is inflationary, but the staking is arguably deflationary (you can’t sell the tokens that you’ve sent to the dead address), so if everything works out just right the value of Hex tokens goes up and your 38% in-kind yield is great.
This was in 2019, back when a lot of people found this economic model plausible, so it all did work out for a while. From the SEC complaint:
And then it didn’t; Hex
peaked in 2021 at about $0.49, and trades at about $0.006 today, down almost 99% from the peak.
I want to mention this case for two reasons. One is that it is absolutely a time capsule of crypto in 2019: Hex’s economic model was allegedly just “buy our token and we will give you more of our token and that’s how you will make money,” and in 2019 enough crypto investors were like “sure that makes sense” that Heart was able to raise
a billion dollars. There is something magnificent about raising so much money with such a tissue-thin idea.
The other is that the SEC is suing Heart for
securities fraud, arguing that Hex tokens were
securities, under the traditional US securities-law analysis that we have
discussed a
lot around
here, which says that a security is “an investment of money in a common enterprise with profits to come solely from the efforts of others.” And so the SEC cites evidence that the profits of Hex were to come from the efforts of Heart:
But look at that economic model! The profits that Hex promised didn’t come from anyone building anything; they came from (1) printing more Hex and (2) people buying it. This was not an investment in some promised ecosystem that was being built by a dedicated team of technologists to revolutionize computing or whatever; this was … an investment in nothing? This was so transparent a Ponzi, in the SEC’s own telling, that I’m not even sure it’s a security.
