Top Stories of the Week - 3/17

This week in the newsletter, we discuss Ethereum’s Shanghai upgrade, the announcement of an Arbitrum token airdrop, and provide updates on the banking crisis and bitcoin’s out performance. Subscribe here and receive Galaxy's Weekly Top Stories, and more, directly to your inbox.

Banking System Continues to Shudder in Wake of Runs

After last weekend’s failure of SVB and takeover of Signature Bank, some tension eases and but more questions emerge. Fears of bank weakness expanded overseas, with Credit Suisse’s biggest shareholder saying they would not invest more money into the lender, which sent its sending shares tumbling. On Thursday, though, the Swiss central bank agreed to loan Credit Suisse $54bn in a bid to increase confidence in the concern, and Reuters reported that Credit Suisse executives told employees that tapping the Swiss central bank’s lending facility does not trigger a “viability event.” the holding company’s bonds continue to trade at significant dicsounts, suggesting markets believe the bank remains materially distressed.

Stateside, the New York Department of Financial Services said Tuesday that the closure of Signature Bank “had nothing to do with crypto,” and instead said there was “a significant crisis of confidence in the bank’s leadership.” We wrote on Monday that Signature Bank director Barney Frank thought it had been closed due to regulators wanting to send an “anti-crypto message.” On Wednesday, Reuters reported that “any buyer of Signature must agree to give up all the crypto business at the bank,” based on information from two sources who are “familiar with the matter.” On Thursday, though, an FDIC told Blockworks refuting that claim, saying that “the FDIC would not require the divestment of crypto activities” as a condition for acquiring the bank.

Bloomberg reported that banks borrowed a combined $164.8bn from two separate federal backstop facilities during the 7 days ending on Wednesday, March 15, a record high and more than the biggest week in the 2008-2009 financial crisis (which was $110bn during the week of October 29, 2008).

11 banks deposited $30bn into First Republic, which itself had appeared to be teetering over the last week, stemming the bleeding for that relatively large regional bank. Many banks were downgraded by ratings agencies this week. For more on the backstory of the banking crisis, read our note from Monday.

Bitcoin was broadly higher throughout the week, hitting its highest levels since June 2022 on the back of the banking crisis. At the time of writing, BTCUSD is trading near $27,000.

Our take

Things moved quickly this week, which started with trading halts of almost every regional bank stock and an address from U.S. President Joe Biden. The level of discount window activity shows just how potentially widespread impairments may be across the broader banking system, although as the week wore on, it appeared that official actions like the Federal Reserve’s new facility (the “Bank Term Funding Program” or BTFP) were beginning to bring more stability back to the marketplace.

As we wrote on Monday, a major source of the strain felt by banks is the Federal Reserve’s rate hiking regime, and the crisis has put the FOMC’s upcoming announcement on rate policy (next Wednesday March 22) under a microscope. Expectations are all over the map, but at the time of writing the market is pricing a 19bps hike on March 22, which is essentially the “dovish hike” of 25bps.

In many ways, this is a seminal moment for Bitcoin. Satoshi Nakamoto launched Bitcoin on Jan. 3, 2009 near the height of the Great Financial Crisis and inscribed the words “Chancellor on brink of second bailout for banks.” Bitcoin is many things, but it crucially offers a genuine alternative to the traditional banking system, and Satoshi intended it that way. A similar moment emerged in Spring 2020, when COVID led central banks to dramatically increase the money supply and governments to send stimulus checks just at the moment when Bitcoin was halving its issuance. That juxtaposition preceded and even helped cause Bitcoin’s last bull run. This time, it’s less Bitcoin’s monetary policy that is shining and more its decentralized, transparent, uncensorable, and fully reserved nature. Said another way, as a fractionally reserved banking system teeters on the brink, Bitcoin’s resilience, predictability, and relative safety stands in stark relief. -AT

Ethereum Devs to Activate Shanghai Upgrade April 12

Following a somewhat successful Goerli testnet upgrade, Ethereum core developers have officially scheduled Ethereum’s next mainnet upgrade for April 12. The upgrade, dubbed Shanghai and Capella, or Shapella in short, will activate staked ETH withdrawals on Ethereum. It will allow validator node operators to realize rewards they have accumulated through Beacon Chain issuance and enable validators to fully exit from the network by unstaking their principal deposits of 32 ETH. Notably, Lido, the largest Ethereum staking pool controlling over one third of staked ETH on Ethereum, will not enable redemptions of their liquid staking token, stETH, for ETH at Shanghai. The development team behind the Lido protocol tweeted on Tuesday that the upgrades to their contract for enabling staked ETH withdrawals were still undergoing security audits. “The current expectation is for mainnet withdrawals to be live around mid-May,” the Lido team said. Coinbase, which is the second largest staking entity on Ethereum commanding roughly 12% of total ETH staked, has announced that their withdrawal functionality will be ready for the activation of Shanghai in April. Rocketpool, which is the third largest liquid staking protocol on Ethereum, has also announced their readiness for Shanghai, along with a few other notable improvements to their protocol, which will together be activated in tandem with Ethereum's wider network upgrade.

Our take

Ethereum core developers are shipping staked ETH withdrawals remarkably fast following the monumental Merge upgrade. Since Ethereum’s transition to proof-of-stake back in September 2022, the pace of protocol development has not slowed. To ship the Shanghai upgrade, developers made difficult decisions to push back other promising code changes and focus almost exclusively on the implementation of staked ETH withdrawals and despite the narrow focus of Shanghai, development efforts for Cancun, the upgrade following Shanghai, have continued unabated in parallel to preparations for staked ETH withdrawals. Developers have also not had to divert any attention or resources away from planning for Shanghai or Cancun to prioritize pressing fixes or updates to the Merge upgrade, which was the riskiest upgrade ever implemented in Ethereum’s history. The Merge was also Ethereum’s most delayed upgrade, which is why many Ethereum stakeholders had been skeptical about the ability of developers to ship withdrawal functionality post-Merge in a timely manner. But in a rare turn of events, it appears Ethereum developers are prioritizing upgrade speed over size and scope and actually succeeding in shipping code changes faster in the process. Shanghai being the first upgrade post-Merge, it remains to be seen to what extent other forthcoming upgrades will also follow the same straightforward pattern of development.

Shanghai and the activation of staked ETH withdrawals represents a closure to Ethereum’s Merge upgrade and the network’s transition to a proof-of-stake (PoS) consensus mechanism. Without the ability for validators to unstake, a core functionality of the Beacon Chain, that is Ethereum’s consensus layer, has gone untested on mainnet for over two years. Assumptions about how the Ethereum monetary policy dynamically responds to large unstaking events has never been challenged against real-world events and market fluctuations. Allowing validators to finally opt-in to full withdrawals is a major step for Ethereum that is akin to the network taking off the training wheels of its PoS consensus mechanism. To this end, it will be important to watch how the network handles a large backlog of partial and full withdrawal requests that have accumulated over the past 2 years at the activation of Shanghai in April.

The fact that Lido, Ethereum’s largest staking provider, will not be enabling staked ETH withdrawals at Shanghai does not greatly change expectations of unstaking activity or sell pressure at the time of the upgrade because the majority of unstaking activity is still likely to be initiated by independent validator node operators, not liquid staking entities. Independent validator node operators unlike stakers that have deposited ETH to Lido are the ones that do not have access to liquidity and have a higher potential of rotating out their staked ETH to a liquid staking provider for greater liquidity, ease of operations, and potentially to earn more rewards through the rehypothecation of staked assets. To read more about the potential impacts of staked ETH withdrawals on the price of ETH, read this Galaxy research report.

Though expectations around unstaking activity remain largely unchanged, the optics around Lido’s announcement may fuel greater support for Lido’s competitors who are ready for the Shanghai upgrade like Coinbase and Rocketpool. At Shanghai, these liquid staking tokens of Coinbase and Rocketpool that do support withdrawals may trade at a greater premium to Lido’s liquid staking token stETH which will remain encumbered until mid-May. Because Lido is the largest staking provider on Ethereum, there is some amount of understanding around delayed withdrawals as the Lido team more so than other staking teams must take extra precautions around code security. However, the line between care and complacency can very quickly become blurred as evidenced and influenced time and again by sentiments from the Ethereum community about Ethereum core protocol development. -CK

Arbitrum (Finally) Set to Launch ARB token

Arbitrum shares details behind its ARB token set to launch next week. According to the Arbitrum Foundation, eligible users can claim their airdrop on March 23 (snapshot for eligibility taken on February 6). Airdrop criteria included bridging assets to Arbitrum, interacting with smart contracts, and transacting on Nova – Arbitrum's dedicated chain for social and gaming applications. Additionally, transaction frequency, transaction type, and transacted amount are also factors that go into determining the award amounts. Arbitrum users will be able to check their eligibility for the airdrop and claim tokens by visiting gov.arbitrum.foundation.

12.75% of the total supply will be made available for the airdrop. The rest of the supply is concentrated among insiders and the DAOs treasury. Investors will receive 17.53%, employees 26.94%, and the DAO treasury will hold 42.78% of the token supply. Despite roughly 56% of the 10bn ARB total supply being controlled by the Arbitrum community and DAO treasury, 46% of the token supply is held by insiders.

After the airdrop, token holders can participate in voting on key decisions governing the Arbitrum network; token recipients who wish to not participate in governance are encouraged to delegate their voting power to another user/entity. The Arbitrum Foundation emphasized its commitment to decentralization, stating, “Arbitrum DAO will have the power to control key decisions at the core protocol level, from how the chain's technology is upgraded to how the revenue from the chain can be used to support the ecosystem.”

Now, the largest L2 Optimistic Rollup will be governed by two bodies; the Security Council and the Arbitrum DAO. The Security Council is a 12-member council of entities elected by members of the Arbitrum DAO. The DAO will include Arbitrum users and Ethereum DAOs selected by the foundation. Additionally, Arbitrum’s DAO will have the right to delegate, modify and remove the Secuity Council’s voting power.

Our take

Arbitrum’s heightened focus on decentralizing their governance framework is a monumental event for the Arbitrum ecosystem. Not only will the DAO have decision making power for future protocol upgrades, but also hold the responsibility of protecting the license for Arbitrum’s codebase. Further, developers that wish to build L2 scaling solutions with Arbitrum’s codebase are required to seek approval from the DAO. However, the Arbitrum Foundation clarified that developers do not need permission to build applications on top of Arbitrum. Although Arbitrum is opening the door for developers to use their codebase, the DAO will enforce Arbitrum’s new DAO Constitution, limiting development exclusively for Ethereum applications. Arbitrum’s continued commitment to scaling Ethereum highlights the DAOs critical role in maintaining the protocols vision from this point forward.

Arbitrum’s token airdrop will inevitably bring attention back to the Optimistic Rollup scaling wars and place pressure on Optimism, the second largest Optimistic Rollup. Read our report on Optimism & Arbitrum, part 1 of our Glass Half Full series. Arbitrum leads Optimism in TVL with $2.8bn - 2.5x greater than Optimism’s TVL ($1.1bn). Despite some recent network activity being fueled by airdrop expectations, Arbitrum also has an edge in developer activity compared to Optimism. According to Electric Capital’s Developer Report, as of 12/15/22, Optimism had 183 total developers (+75 or +73% YoY) of which 67 were full-time developers, while Arbitrum had 215 total developers (+59 or +38% YoY) of which 80 were full-time. The developer talent and commitment within Arbitrum’s ecosystem will be a key driving force motivating users to continue using their Optimistic Rollup.

Compared to Optimism and it's OP token, Arbitrum is a step ahead from working on fraud proofs, which introduces the potential that the ARB token can have more functionality than just governance though decentralizing the validator set. Arbitrum is inevitably paving the way to decentralizing their validator set, however, the foundation has yet to give clarity on this subject. Monitoring the ARB tokens usage in governance will give some color on what to expect regarding future token use cases for ARB. - GP

Other news

• Fidelity launches bitcoin & ether trading for all its 37m retail account olders

• Euler Finance offers $1mn reward for information about the attacker behind $200mn exploit

• 21Shares shutters six crypto exchange traded products due to low demand.

• Bankruptcy judge presiding over Voyager case denies bid from the U.S. government to pause court proceedings.

• Salesforce taps into NFTs through a new suite of new Web3 products.

• SEC Chairman Gary Gensler restates his opinion that proof-of-stake tokens could meet the defintion of securities under the Howey Test.

• Uniswap V3 goes live on BNB chain.

• UK government adds crypto declaration to tax forms.