There has been a lot written about the crypto winter but I want to call out two perspectives I thought had something interesting to say.
One is the ever reliable, entertaining and informative Matt Levine in his Bloomberg Money Stuff column. The nominal focus is the immediate impact on Voyager Digital Ltd but his broader point is that, while crypto started as a response to the 2008 financial crisis and the associated problems with the conventional banking system, one of the more tangible achievements of the DeFi financial system system that has been built on crypto foundations has been to recreate the interconnectedness, leverage and opacity that crypto was meant to replace.
He starts with the theory …
“A Bitcoin is a Bitcoin, not the debt of some bank, so there is no buildup of leverage in the system as investors hunt for safe assets. Crypto avoids the opacity of traditional banks: Crypto transactions occur on an open transparent blockchain; there are no hidden obligations that can bring the system down. Crypto is decentralized and open; “code is law”; mistakes lead to failures, not bailouts. “The basic philosophical difference between the traditional financial system and the cryptocurrency system is that traditional finance is about the extension of credit, and crypto is not,” I wrote earlier this month.Matt Levine, “Money Stuff” Bloomberg 24 June 2022
… while in practice …
But the current crypto winter shows that this is amazingly untrue in practice. There is a ton of leverage and interconnection, and who owes what to whom is surprisingly opaque, and when it causes problems it is addressed by negotiated bailouts from large crypto players. Crypto has recreated the opaque, highly leveraged, bailout-prone traditional financial system of 2008.Matt Levine, “Money Stuff” Bloomberg 24 June 2022
.. and concludes
I don’t know what to make of that. Mostly I just want to say: What an accomplishment! Rebuilding the pre-2008 financial system is a weird achievement, but certainly a difficult one, and they went and did it. One other possible conclusion is that that system was somehow … “good” might not be the word, but “natural”? Like, something in the nature of finance, or in the nature of humans, tends toward embedding opaque leverage in financial systems? Crypto was a reaction against that tendency, but as time went on, that tendency crept into crypto too.”Matt Levine, “Money Stuff” Bloomberg 24 June 2022
… the optimistic perspective
I don’t want this to be a pile in on crypto so let me conclude on a more optimistic note courtesy of Gillian Tett at the Financial Times. Gillian, like Matt, notes that leverage and complexity are always problematic
“The companies imploding are those that feature one or all of the following traits: high leverage, opposition to regulation, excessively complex innovations and heavy spending on expansion”Gillian Tett, “Crypto enthusiasts are betting the house on creative destruction” Financial Times 23 June 2022
Gillian however argues that this can be viewed as a healthy dose of creative destruction that is getting rid of the rubbish and allowing better versions to secure their place in the future. She concedes that this may just be “desperate spin” on the part of the DeFi and crypto industry but I do believe she makes a good point.
The individual players obviously do not like it, but every industry benefits from creative destruction and I think there is a pretty strong argument that part of the problem the conventional financial system faces is that it has been shielded from the full force of this process.
I have to confess that it is still not obvious to me what exactly crypto and DeFi will contribute to the future of finance but history shows that companies themselves often stumble on solutions that seem obvious in hindsight but were not what they set out to create. The often quoted story of rise of the personal computer is a case in point (who knew that we all needed one). All we can say at this point is that the current crypto winter is at least increasing the odds that the industry might yet deliver something useful and maybe even revolutionary.
Summing up, scepticism is a pretty sound foundation for viewing most innovations in finance but there is room for a little optimism as well.
Tony – From the Outside