Minting Cryptocurrencies and Creating Finance Apps

In 2017, Yazan Barghuthi left a career consulting to financial institutions to mint cryptocurrencies and create finance solutions with blockchain technology.

My education was in chemical engineering and I started my professional career as a programmer. I quickly switched to finance and worked six years at Deloitte and Oliver Wyman, consulting to large financial institutions. But still being into tech from my programming days, I always wanted to go back. So I did data science for a bit, and that’s when I started learning about cryptocurrencies and blockchain technology.

Web 1.0 (read only) happened when I was a kid, and at 17 I was still too young to get in on Web 2.0 (participative social). In 2016, I didn’t want to miss getting in on Web 3.0/web3 (read, write, execute). This story is about how my partners and I minted cryptocurrencies and created decentralized finance solutions with blockchain technology.

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Yazan provides background for those not up to speed on cryptocurrencies and blockchains.

Bitcoin was invented in 2008 by person or persons unknown, going by the pseudonym Satoshi Nakamoto. Changes in Bitcoin ownership are recorded in lines of code on a “blockchain.” The blockchain is maintained in a peer-to-peer computer network made up of users’ machines; there is no central authority or clearing bank. Data on the blockchain is unerasable and the blockchain’s encryption system allows only the Bitcoin’s owner to transfer possession of the Bitcoin.

Once the only cryptocurrency, Bitcoin now accounts for only around 40% of the volatile market capitalization of all crypto currencies, right now totaling about $1 trillion. Ethereum is the next largest currency at about a 20% share and the next largest crypto currency has only a 6% share. Hundreds of additional cryptocurrencies aggregate to the remaining third of market capitalization.

Bitcoin and other cryptocurrency “tokens” exist on their blockchains, but blockchain technology, and its essential feature as a permanent immutable ledger of transactions replicated across multiple computers, has other uses. A simple record-keeping example would be storing all the information there is to know about a car over its life: manufacturing details, parts list, titling and registration, repairs, accidents, recalls, parking tickets, and scraping. More complex, a “smart contract” embedded in a blockchain might interrogate a financial database on the Internet, look up an asset price, and distribute cryptocurrency according to some formula.

Ethereum’s blockchain technology was built to be more conducive to writing smart contracts than Bitcoin’s and Ethereum has become the default environment blockchain programmers use, even to create new cryptocurrencies.

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Is it a Security?

In 2016, cryptocurrency projects were popping up left and right, but their legal status as a security, commodity, or something else was in doubt. Suddenly a lot of programmers were trying to understand securities law. Or at least the programmers who didn’t subscribe to the idea that code was a law unto itself, not subject to financial regulations, tax authorities, or 900 years of common law. Some programmers were a little full of themselves and the power of code.

Most programmers, who don’t fall into the “code is law” camp, but into the more sensible “law is law” camp, learned about the 1946 SEC versus W. J. Howey Co. case and the resulting “Howey Test.” The Howey Company sold Florida citrus groves to investors and leased them back. Lease payments depended on the crop’s profitability at market. The Howey court created a four-part test to determine whether something is a security: (1) an investment of money (2) in a common enterprise (3) with the expectation of profit (4) to be derived from the efforts of others. The Howey Company’s scheme with lease payments dependent on profitability passes this test and the company had illegally issued securities.

Meanwhile, most blockchain projects follow what I call “the Disney dollars analogy” and their tokens also pass the Howey yest and are securities. Say Robert Iger sells Disney dollars for 50 cents and uses the proceeds to build his next Disneyland. When Disneyland opens, Disney dollar holders will be able to use those coupons at full face-value. But the person buying the Disney dollars might not want to go to Disneyland. He just believes that when the new Disneyland opens, the coupons will be worth a dollar.

If the Disney dollar buyer doesn’t intend to use the Disney dollars himself, but instead intends to sell them to someone who wants to go to Disneyland, his profit is “derived from the efforts of others,” Roger Iger and Disneyland “cast members.” Disney dollars pass the Howey test and are securities. Similarly, if a cryptocurrency is tradable before the blockchain project it finances is complete, it’s probably a security, at least under US law.

We hear about bad actors in the crypto space and obviously there are a lot of them, but there are a lot of good actors too. A lot of cryptocurrency creators added quizzes to the start of their token sale to ensure that people knew what they were doing and had the intent to use the product their token was associated with themselves. People self-regulated to sometimes a nonsensical degree because crypto was such an uncertain space at the time.

The Crypto Valley

My co-founders and I had backgrounds in financial compliance. I at Deloitte and Oliver Wyman, my co-founder at Pricewaterhouse Coopers, and one of our advisors as former chief operating officer of Soros Fund and partner at Pricewaterhouse Coopers. We wanted legal and regulatory clarity and were unsatisfied with the uncertainty surrounding initial token offerings in the US and the necessary steps to avoid becoming security issuers. As we thought about the problem, the solution became obvious. Ethereum had conducted a token sale. We should find out how and where they did it. It turns out it was in a small Swiss-German speaking canton in Switzerland called Zug, which was becoming known as “Crypto Valley.”

My German-Jordanian co-founder flew to Zug and found out that while crypto regulation there wasn’t totally settled, the canton intended to issue fulsome regulations and provide clarity. The canton had attracted a lot of crypto investment, so we thought coming regulation might be permissive.

We registered our company, Jibrel, in Crypto Valley, became a licensed financial intermediary, and created test versions of our cryptocurrency. We waited for clarity from our lawyers and ultimately, from FINMA, the Swiss Financial Market Supervisory Authority. They were quite responsive and would answer our what-if questions about how to avoid having our token classified as a security. Eventually we got what’s known as a no objection letter. Our initial batch of tokens was sold, but programmatically locked to prevent their transfer before our project was built. There is less chance of cryptocurrency being classified as a security if you don’t issue the tokens until after Disneyland is built.

Know Your Customer

The usual way of issuing tokens is to create a smart contract that receives someone’s Ethereum and sends back your token automatically. So you can imagine, there’s no control over who you are selling your token to and the buyers have complete anonymity. But we wanted to issue tokens and provide blockchain solutions that interacted with the real world of regulated entities, laws, and taxes. We wanted our blockchain solutions to be accepted and used by legitimate businesses.

We performed the due diligence necessary to meet know-your-customer (KYC) hurdles. We examined people’s passports. We did tests of liveness where the buyer had to record a statement on their video camera. We had them provide proof of address and complete a Swiss source-of-funds form.

We hired companies that checked for money laundering, politically exposed persons, and sanctions from the US Treasury Office of Foreign Assets Control. My co-founder became a licensed anti-money laundering officer so we had someone in the senior team who was well versed.

One additional check deserves mention. We had a company look at a potential token buyer’s blockchain, to see if the Ethereum he was using to buy our token had ever been owned by a bad actor. So we weren’t just checking the potential token buyer, but everyone his Ethereum token had ever been associated with. The blockchain provides this information in a way that is immutable and undeniable. I ask people, what’s easier to regulate, email or snail mail? Netflix or pirated DVDs? When you move to the digital format, it’s easier to regulate at scale. Imagine the manpower required to examine every letter delivered in the US, but the manpower required, especially with natural language processing tools, to examine every email, much more information dense, is a fraction of the effort.

We met some interesting people doing our due diligence, reflective of the 2017 crypto bull market. There was a 17-year-old Scandinavian who wanted to buy a quarter-of-a-million dollars’ worth of our token. This was obviously a red flag. It turns out he had been a warehouse worker and hurt his knee in a workplace injury. The government compensated him $4,500 which he put into Ethereum’s initial token offering. He was sitting on $12-$13 million dollars of Ethereum. We waited until he turned 18 to engage him further.

Another suspicious application came from a stay-at-home housewife in Korea who also wanted to invest a large amount in our token. Her proof of address, bank statements, and our know-your-customer drill all checked out. When we investigated her further, it turned out she had a son who used to play eSports. He won a competition where they awarded him $10,000 in Ethereum, when Ethereum was $7. Ethereum at this point was a thousand dollars and this woman had $1.5 million. A lot of what we ran into was stranger than fiction.

We rejected something like 55% of applications that reached KYC and we voided something like $6-$7 million worth of transactions when we didn’t issue them tokens.

Opening a Bank Account

Once we were done with our customer onboarding, we wanted to liquidate some Ethereum people had paid us and get operating funds in a bank so that we could start building blockchain products and wallets and explorers and other tools for our community and ecosystem. But no bank would speak with us. The second we said, “We created a cryptocurrency,” they hung up on us.

When we set up in Switzerland, the main ambition was to tokenize real currencies. We wanted to create dollar tokens, Euro tokens, and Korean won tokens. It’s not very difficult. It’s a simple case of maintaining a bank balance equal to the amount represented by tokens. Every token is a liability with a corresponding asset in the bank, so liabilities and assets must match one to one.

It was our belief that if we were going to use smart contracts to build instruments like collateralized bond obligations and mortgage-backed securities, we needed to tokenize real currencies. People pay their mortgages in dollars, not Ethereum or Bitcoin. The first step to allowing this technology to interact with the real world was to deal in real currencies.

But we needed bank accounts to do this and it seemed impossible. This became a big frustration. Our whole mandate, the name Jibrel, comes from the Hebrew, Aramaic, and Arabic words for Gabriel, because he was the archangel who intermediated between heaven and earth. Our mandate was to connect the heavens, the crypto economy, with the earth, the traditional economy. And here we were, unable to open a bank account!

We told the bankers, “Come to our offices and check our KYC compliance. If our KYC is insufficient for these people to open bank accounts with you, then don’t open a bank account for us. But at least come and see our procedures and documentation.”

And that piqued the interest of a few banks, especially given that we came from finance and regulated backgrounds. Once they checked our procedures and records, we were able to open bank accounts. Back then, there were a few banks that understood that blockchain technology was inevitable and there would be rewards for early adopters. Those banks have grown tremendously and some of their customers are very big players in this space, like the exchanges Kraken and Circle.

Blockchain Products

We built really complicated, cool products, but they didn’t have immediate uses at the time or market fit. We started thinking, “Okay, everyone seems to want to buy and sell tokens. Let’s provide people the ability to put equity in token format.” So we built a platform that allowed people to tokenize their own company and then sell those tokens, representing equity interests in the company, online. But this was in 2017 and early 2018 during the first big cryptocurrency runup. People were interested in moonshots and replicating Bitcoin’s 2017 1,200% rise. They weren’t interested in using crypto to invest in real bricks-and-mortar businesses with audited financials.

We set up a new entity in Abu Dhabi and issued a smart sukuk on Ethereum. Sukuks are capital-raising instruments that adhere to Islamic law, including the prohibition against charging interest. The issuance required dirham and dollar tokens so we were able to use our stable tokens. We had the cooperation of Al Hilal Bank and the local financial regulator, Abu Dhabi Global Markets.

We translated the bond’s payment and maturity dates into Ethereum block numbers, because a block on Ethereum is created every 15 seconds. How many blocks will elapse in the next six months? Okay, we’re going to code these payments. They’ll go from the bank’s account to the bond holder’s account, directly on chain without anyone having to administer it.

But the further we got tokenizing financial assets, the more we realized it was the equivalent of digitizing books when the Internet was invented. It’s a good use case, but it’s not the most exciting thing you can do with the technology. The most exciting things you can do with the Internet are native to the Internet. You can argue that Twitter is an abstraction of a town hall or a message board, but that’s not true. What Twitter does, constraining people to 140 or 280 characters, is native to the Internet.

We realized how much overhead is required to do things transparently and securely in the real world. Meanwhile, you can build more interesting things sticking to the Blockchain decentralized world rather than creating a hybrid. We’re seeing that today and that’s probably the main trend that’s going to emerge going forward. Because we were getting a bit disheartened bashing our heads against problems that didn’t get solved, or creating solutions that didn’t get adopted, we turned our attention to Tranche.Finance.

We created a decentralized finance tool that separated variable cryptocurrency interest into a fixed-rate tranche and an inverse-floating-rate tranche. At its peak, there was something like $16-$20 million on the platform and it was a top 50 Decentralized Finance (DeFi) protocol. It is fluid and decentralized. If Amazon web servers and our website went down, the Tranche smart contracts will continue to live on Ethereum where you can interact with them directly.

While Tranche.Finance still takes a chunk of my attention, I spend most of my time on other blockchain projects. Developers work on several things at once, bounce from jurisdiction to jurisdiction, try as many use cases as possible, and seek receptive regulatory environments. Once you build something on the blockchain and deploy it, it lives forever and doesn’t require anyone to manage it. Smart contract production is like movie production. A director picks his cast, gets a producer and whatnot, finds financing, and then they make a movie. The movie generates value until the end of time. The director may go on to make another movie with the same cast and crew or with another team.

Blockchain’s Future

When the legendary investor Stanley Druckenmiller learned that when Bitcoin declined from $17,000 to $3,000, 86% of those who owned it at $17,000 never sold, he called Bitcoin “something with a finite supply” where “86% of the owners are religious zealots.” Warren Buffet called Bitcoin seashells, which I find interesting because at one point in human history, we used seashells as currency.

At origin, Bitcoin fired a shot at the traditional financial system and its fiat money. The first block on the Bitcoin chain includes a reference to a 3 January 2009 headline in The Times, “Chancellor on brink of second bailout for banks” referring to Alistair Darling, the UK’s Chancellor of the Exchequer, and the Global Financial Crisis.

There was an ethos at Bitcoin’s start of hard money, money that isn’t in the control of others and can’t be debased. By design, there can only be 21 million Bitcoins. Fewer than 2 million are left to be mined, and they won’t all be mined until 2140. That means that over the next 117 years, the supply of Bitcoin will increase 10%. Meanwhile, US dollar M2 money supply increased 38% in the last three years.

There are blockchain programmers who think that they and the blockchain are going to kill banks and the traditional financial system. I tell them, “The banks survived electricity. They’ll survive you and the blockchain.” Blockchain technologies are going to augment our current world. Those who figure out where cryptocurrencies and smart contracts belong in the existing world will be rewarded for that solution.

This is an exciting time in crypto because we are seeing centralized entities fail. We’re being reminded that these things should have been decentralized from the start. I suspect we’ll see the emergence of more decentralized technologies, because we are learning that scams and scandals are not a function of technology, be it tokens, tulips, penny stocks, or the garbage that’s listed on the London Stock Exchange’s Alternative Investment Market. The behavior of participants is determined by the regulatory environment they’re operating in. But nothing is more open to regulation than blockchain technology with its transparency, auditability, and immutability.

For example, Ethereum is pretty good about anti-money laundering, even if it’s not good at know-your-customer. Ethereum block creators don’t approve transactions that have interacted with addresses flagged by the US Treasury or Department of Homeland Security. Even at the Uniswap decentralized crypto exchange, there’s a push to comply with whatever standards the government puts out. So we’re seeing a lot more self-regulation at decentralized technologies. Because these technologies can’t limit themselves to users from any one country, they must take a wider self-regulatory approach whereas centralized exchanges like FTX and Binance can shop around the world for regulation and commit regulatory arbitrage by playing regulators against one another.

While the ethos “move fast and break things” was suitable for Silicon Valley, we’re quickly learning that it may be unwise to embody it when operating in a highly regulated field like financial services. Companies approaching this space as they would software development are in for a bad time.

Alameda Research, the investment arm of the now defunct FTX, was an early investor in CoinMENA, an exchange I founded in the Middle East. Shortly after orally agreeing to terms, they sent their million-dollar investment via USDC, prior to even reviewing the draft agreement. As an entity regulated directly by the Bahraini Central Bank, we had to work especially hard to ensure all our dealings with them were fully compliant.

When the Internet was emerging, the US was the absolute global powerhouse. We got a single worldwide Internet, mostly, because of US hegemony. Blockchain technology can make capital as interconnected as information, but how that is accomplished in a multipolar world is to be seen. Maybe the East plays on Binance Smart Chain and the West plays on Ethereum. There are geopolitical considerations with this technology. Because it’s the Internet of money, it’s quite important to a lot of people.

Yazan Barghuthi is the co-founder of Jibrel Network, an open source web3 development company based in Canton of Zug, Switzerland. He is also co-founder of CoinMENA, a leading crypto exchange in the Middle East providing direct and regulated access to digital assets.

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Copyright © 2023 Yazan Barghuthi. All rights reserved. Used here by permission. Short excerpts may be republished if Stories.Finance is credited or linked.