This week in the newsletter we write about a prominent SEC loss in federal court, Sony attempting and failing to censor transactions on its own L2 and what it means for the future of corporate blockchain usage, and a proposal to alter Solana's monetary policy.

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SEC Gets Smacked Down by Federal Court

Federal appeals court orders SEC to "explain" itself in major win for crypto. After getting the right to file a rare interlocutory appeal against the SDNY's ruling on its Motion to Dismiss last week, this week Coinbase won an important partial victory against the SEC at the Third Circuit Court of Appeals. Coinbase had petitioned the Third Circuit Court of Appeals for a writ of mandamus to force the Securities & Exchange Commission to conduct formal rulemaking on key crypto-related issues.

In July 2022, Coinbase filed a petition with the SEC asking it to engage in a formal rulemaking process to create new rules to clarify whether and how digital assets would be considered securities under existing laws. After the SEC's subsequent inaction, Coinbase sued the SEC in federal court to force the agency to act in April 2023. When the SEC denied its petition in December 2023, Coinbase filed a challenge with the Third Circuit Court of Appeals arguing that the SEC's denial was insufficiently argued.

In an order published Monday, the Third Circuit Court of Appeals declined to force the SEC to conduct rulemaking, as Coinbase had requested, but instead remanded the petition back to the SEC and ordered that the SEC provide a fuller explanation of its reasoning for denying Coinbase's petition.

While Coinbase's victory was only partial, the appellate court was harsh in its criticism of the SEC's approach to Coinbase's request. Writing for the majority, Judge Thomas Ambro said that the SEC's denial was "arbitrary and capricious" for being "insufficiently reasoned." Concurring with the majority opinion, Judge Stephanos Bibas wrote that "the SEC repeatedly sues crypto companies for not complying with the law, yet it will not tell them how to comply" and noted, "that caginess creates a serious constitutional problem; due process guarantees fair notice."

OUR TAKE:

While Coinbase's victory here is partial, and it may ultimately be mooted if new SEC leadership takes a wholly different tack on these issues as we have written is likely, it nonetheless represents the biggest rebuke yet of the SEC's overall approach to the digital assets industry at the highest judicial level yet (appellate). Indeed, the suggestion by the Court that there could be constitutional issues at play is particularly significant. While the judges on the appellate panel disagreed whether Coinbase was actually denied due process, or the extent to which it was, they nonetheless expressed significant displeasure with the SEC's approach and the thoroughness of the agency's responses both to Coinbase and to the Court. This Court's criticism of the SEC's approach is the most industry-aligned assessment at such a high level of the judicial branch yet.

Although the Court's assessment is reassuring and welcomed by the crypto industry, it ultimately may not matter much. Reuters reported Wednesday that Republican-appointed Commissioners Hester Peirce and Mark Uyeda are "initiating the process that would ultimately lead to guidance or rules clarifying when the agency considers a cryptocurrency to be a security, and reviewing some crypto enforcement cases pending in the courts." This reporting is very much in line with our predictions following President-elect Trump's victory in November. We wrote in our Nov. 10, 2024 report "Entering a Digital Golden Era" that we expected the "number of crypto enforcements will pause, some lawsuits will be paused or withdrawn, no action letters on specific topics or to specific projects could be issued, and the doors will open for industry and regulators to discuss sensible paths forward" once new leadership takes over at the SEC. That could happen as soon as Jan. 21, 2025, when either Hester Peirce or Mark Uyeda will be made acting chair (whereas we expect nominee Paul Atkins won't be confirmed until April). In any case, if the new SEC leadership does rethink and reverse the approach of the last 4 years, Coinbase's petition to the Third Circuit Court of Appeals will effectively be mooted. It's possible that the SEC's response to the Third Circuit order might be to say something along the lines of "We no longer agree with the arguments previously made in this case, and instead we intend to rethink our position." Similarly, if the new SEC withdraws its case against Coinbase, it's possible that Coinbase's interlocutory appeal in that case may also become unnecessary.

But even though it was a partial victory, and even though it may become moot, the Third Circuit Court of Appeals order forcing the SEC to further explain its reasoning for denying Coinbase's rulemaking appeal is perhaps the most prominent and important rebukes of the SEC's handling of digital assets yet. The order is vindicating for the crypto industry, which has long complained that the SEC is demanding compliance with existing securities laws without providing the tools or process to do so. - Alex Thorn

Sony Launches Soneium Blockchain to Controversy

Sony's public blockchain launch met with community backlash. Launched on Tuesday by Sony Block Solutions Labs (a JV between Sony Group and Startale Labs), Soneium is an Ethereum L2 developed using Optimism's OP Stack. Sony first announced the Soneium blockchain in August 2024 as part of a larger web3 initiative to leverage the Group's IP (incl. brands from Sony Pictures, Music, and PlayStation) across the metaverse. Sony's web3 offerings also incorporate S.BLOX, a crypto exchange (formerly 'WhaleFin'; acquired by Sony last year), and SNFT, an NFT-based fan marketing platform on Soneium. According to the announcement blog, the project aims to empower creators, protect content rights, and create fair profit-sharing mechanisms.

Shortly after the mainnet launch, two memecoins (including AIBO - a coin based on robotic dogs designed by Sony) were blacklisted and restricted from transfers due to violation of Sony's IP rights, according to a Soneium spokesperson. This action was met with significant backlash from community members for "effectively rugging users" and "censorship" by the blockchain's operators. The Soneium team responded that they are committed to protecting creators' IPs and rights onchain while maintaining the spirit of decentralization, highlighting their blacklisting policy in their official docs over IP and Contracts Protection (the docs have since been updated to include new details about a grace period for potential blacklisting decisions).

Soneium director Sota Watanabe then clarified that no funds were frozen and that the blacklist only restricts public RPC interactions with the flagged contracts (and is fully reversible). Interestingly, L2Beat researcher @donnoh_eth demonstrated how to successfully bypass the Soneium sequencer's restrictions to buy AIBO by using the ForceInclusion function - a safety measure on most OP Stack chains that enables L2 users to directly submit transactions to the L1 to bypass sequencer censorship. This entire incident raises questions over the level of control that enterprises should have to protect IP or to control the use of the chain generally while maintaining a public blockchain network.

OUR TAKE:

For a blockchain project that clearly states its core mission is to empower creators by "protecting content rights and creating fair profit-sharing mechanism", Soneium's crackdown on unauthorized use of its IP still seemed to catch many users by surprise. When it comes to open-source permissionless networks, proprietary tech/IP/patents do not have the same protections for creators as they do in the web2 world, so corporations understandably will seek some level of control over activities on their blockchains. Yet, crypto natives hold fast to values of decentralization and censorship resistance, so the blacklisting actions may appear as an attack and a bad precedent for other enterprise blockchains. However, several reasons why user concerns may be overblown:

Rollups are constructed in a variety of ways and on many of the top rollups today (incl. those built using the OP Stack and Arbitrum tech stack), sequencers can throttle but not censor. Users have a variety of safety exit mechanisms in case of L2 operator failure or misbehavior (e.g., the ForceInclude function, submitting fraud proofs, or the ability to self-propose in case of proposer failure). Users just need to be aware of how rules are enforced (L2Beat is a phenomenal resource for L2 risk factors) and a variety of frontend solutions are available for non-tech savvy users to access these solutions (e.g., WakeUp on Arbitrum). Soneium's target audience is creators/fans, not crypto natives. This implies new use cases for a group of users that may value IP protection over censorship resistance. Ideologies between different user groups may not always align and that's okay. For DeFi purists, other blockchains with stronger censorship-resistance properties are available.

In our view, the Soneium team handled the situation extremely well: they did not try to hide the blacklisting ability which was available in the docs, they communicated openly about the situation, and they added a grace period for potential blacklisting decisions in the future.

The incident raises questions about the underlying infra chosen to build Soneium. Sony easily could have made Soneium a closed, KYC'd system with no escape hatches. However, as noted above, L2s uniquely benefit from the censorship-resistant properties of Ethereum. Soneium can always adjust system parameters if the blacklisting policy fails to deter further violations. Other blockchain frameworks or L1s may provide varying levels of admin controls to meet the needs of enterprises, though censorship can occur at all levels of the crypto tech stack (e.g., app, wallet, exchange, asset, etc.).

In any case, optics around the IP blacklisting policy shouldn't overshadow Sony's assertive entry into web3. One of the largest entertainment/media/tech corporations is looking to drive new innovative experiences with the potential to onboard billions of users. This could be a pivotal moment that sparks a new wave of enterprise adoption. - Charles Yu

Solana Governance Proposal to Change Issuance Schedule

Solana validators propose a staking economics change as $2bn token unlock approaches. A proposal to modify Solana's validator economics was posted on GitHub early Thursday by Multicoin Capital. The proposal would effectively reduce new issuance and therefore the rewards paid to validators. This marks the first significant attempt to change the chain's tokenomics, aiming to lower Solana's inflation rate and introduce a dynamic mechanism tied to an ideal staking rate. The proposal comes ahead of a planned unlock of 11.2 million SOL ($2.4 billion) emanating from the FTX estate.

Currently, Solana's inflation rate follows a fixed schedule: starting at 8% annually after the network's launch in February 2021, decreasing 15% year-over-year until it stabilizes at 1.5%. Inflation, now at ~5%, redistributes value from non-staking holders to stakers and validators, rewarding them for securing the network. The initial high inflation rate reflected early network risks and incentivized liquidity and staking participation, while the proposed reduction is a sign that the stakeholders think the ecosystem is maturing.

Multicoin Capital's proposal suggests adopting an inflation model similar to Fantom's, which adjusts dynamically based on a target staking rate. Under this system, inflation decreases when staking exceeds targets, reducing the "risk-free" rate and encouraging token use. Conversely, inflation rises when staking falls short of the target, boosting participation and network security.

Governance would determine the target staking rate and a velocity parameter to control how quickly inflation adjusts. The proposed target is 50%, bounded between 33% (to prevent Sybil attacks) and 67% (to promote productive usage). The velocity parameter would govern the inflation response to deviations from the target.

This proposal comes at a pivotal moment for Solana. The ecosystem is still dealing with the aftermath of FTX's collapse, and the upcoming estate unlock has revived concerns from that turbulent period. While Solana has rebounded from its >90% drawdown and hasn't suffered a downtime incident since February 2024, transaction failures remain high. Adjusted tokenomics could align better with the network's growing maturity, but, notably, a major validator and token holder is behind the push to lower inflation.

The proposed changes would benefit validators with robust MEV (maximal extractable value) infrastructure, as MEV would constitute a greater share of validator income, potentially increasing validator concentration. However, decentralization has explicitly never been Solana's number one priority. This shift would rebalance some long-term value accrual from those securing network state to those optimizing block economics.

OUR TAKE:

We are of two minds when it comes to this proposal.

On the optimistic side, this proposal represents a thoughtful evolution of Solana's economics. Unlike Bitcoin's static monetary policy, Solana's dynamic inflation model could reflect its role as a fast, decentralized global state machine. In that regard, having the economics of Solana be reflexive with its usage is reasonable and takes many of the lessons learned from central banks managing interest rates. While Bitcoin's ethos is incompatible with changing monetary policy, and rightly so, not everything needs to be (or can be) like Bitcoin. Programmatic monetary policy may be a comfortable middle ground to promote Solana's goals while avoiding arbitrary monetary policy decisions.

However, critics may view it as an attempt by crypto funds or other large holders to protect their investments from inflation and the FTX supply unlock. The upcoming release of ~11.2 million SOL is a significant supply overhang, and reducing inflation could mitigate its impact on token prices. While the proposal critiques Solana's current inflation schedule as arbitrary, it sets the upper limit at the existing schedule without addressing conditions that might warrant higher inflation in the future (e.g., validator failures or slashing events).

Ultimately, while the proposal seeks to enhance network security and capital efficiency, it also aims to reduce price pressure- a dual goal that aligns with the interests of token holders both large and small. The debate will give a fascinating view into the overall ecosystem's thinking on the balance between holders, providers, and users, especially when large stakers and validators weigh in. - Thaddeus Pinakiewicz

Charts of the Week

The top 10 Ethereum rollups by total value secured (not to be confused with the commonly used total value locked in DeFi), combined for their second-highest revenue month in December since the introduction of EIP-4844 and blobs in March 2024's Dencun upgrade. Throughout the month these rollups combined for $21.4 million in total revenue. This is ~33% lower than the highest post-Dencun monthly revenue of $30.8 million in April 2024 and is 406% higher than the lowest post-Dencun monthly revenue of $4.2 million in September 2024. For the entire year of 2024, these rollups combined for $291.7 million of total revenue. Base (30%), Arbitrum (15%), and Linea (13%) captured 59% of the total revenue earned by these rollups over the year. Based received $89 million in revenue, compared to Arbitrum's $44.2 million and Linea's $39.2 million.

The onchain costs (calldata batch, blob, Type-3 transaction, and ZKP costs) for rollups decreased dramatically after the implementation of Dencun in March 2024. In total, these rollups spent $118.2 million in onchain costs throughout 2024; $18.2 million of which came between April and December 2024 and $100 million of which came in the three months between January and March 2024 before Dencun went live.

In total, these rollups brought home $173 million in income after onchain costs. Note, running a rollup can also require additional, offchain costs that are not picked up in the onchain data. Base, Linea, and Arbitrum were the top 3 rollups by income generated after onchain costs in this observation for 2024. Base generated $76.5 million in income, compared to Linea's $26.2 million, and Arbitrum's $21.9 million.

Other News

• Tether completes USDT0 with interop protocol LayerZero, relocates to El Salvador

• Coinbase launches Bitcoin-backed onchain loans via DeFi protocol Morpho

• MoonPay buys crypto payment company Helio

• One of Italy's largest banks buys $1M worth of Bitcoin

• Trump's Treasury pick Scott Bessent says he sees 'no reason' for a US CBDC

• Nasdaq files 19b-4 form for Canary Litecoin ETF

• Trump receptive to include US-based coins in 'America-first' crypto reserve

• Rep. Tom Emmer appointed as vice chair of the Digital Assets Subcommittee

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