Crypto & Web3.0
10 Truths About Crypto From ex-Goldman Sachs
Crypto is repeating the path of the traditional financial system before the 2008 global crisis – but that doesn’t mean its collapse is imminent.
11 interesting insights from an article by Matt Levine, Bloomberg columnist and former Goldman Sachs analyst.
1. Our lives consist of records in databases, and therefore require a lot of trust in their custodians
Seriously: our money, the stocks in our brokerage account, and indeed the ownership of the apartment in which we live, are merely records in databases stored somewhere.
Once individuals in human society had to rely on physically asserting their rights (“my bag of gold is in my basement, and if you come to take it away, I will come out to meet you with a club”), but now this function has been largely delegated to those who manage the relevant databases – the government, the banks, and so on.
This is much more convenient, but instead we are forced to trust all these institutions.
2. Crypto was originally built on the idea of a lack of trust…
The bitcoin revolution, invented by an unknown genius under the pseudonym Satoshi Nakamoto in 2008, was to eliminate the need for trust. When sending a bank payment to a stranger, we have little choice but to trust an intermediary in the form of a bank (which both parties to the transaction must trust).
3. …but eventually the crypto industry came full circle and returned to the idea of trust.
Of course, true hardcore crypto-enthusiasts still recite the mantra “not your keys, not your coins” and trust no one. But as cryptocurrencies become more deeply embedded in the lives of the general populace, more and more people are treating the whole industry as an extension of the financial system they’re used to.
“Oh, some decent looking guys are offering a crypto deposit at 18%? It’s probably as safe as my bank, only a little more profitable” – that’s what more than a million and a half customers who entrusted their savings to the crypto-lending company Celsius, which loudly went bankrupt in June 2022 (the value of the “deposits” it accepted exceeded $12 billion) thought approximately.
4. In fact, the crypto industry is now engaged in an accelerated reinvention of all the financial mechanisms that led to the global financial meltdown of 2008
This is very ironic, because cryptocurrency appeared in 2008 as a response to disappointment of technological intelligentsia in traditional banking system, which was not as reliable as everyone thought (remember all those pyramids of supposedly “super-reliable” mortgages in the USA?). That is why bitcoin is fundamentally built on the idea that “real” money should have nothing to do with debt – and, among other things, therefore have more stability.
But as soon as the money flowed into blockchain (and the total capitalization of cryptocurrencies exceeded $3 trillion in 2021), all these beautiful ideals were in fact forgotten – all the same former investment bankers came into crypto, who began to create similar structures as in 2008 with multiple re-pledging of assets and huge credit shoulders.
It is not surprising that in 2022, everything finally came to a systemic crisis on the crypto market and the collapse of its total capitalization to $1 trillion: the high-profile stories of consecutive projects (Terra/Luna, Celsius, Three Arrows Capital, Voyager, and so on) show a spontaneous system of complex debt interdependencies between large players.
5. Despite some similarity of events in the crypto-world with the financial crisis of 2008, the crypto-war, which began in 2022, did not spread to the traditional financial system
In 2008, the global financial system came close to a possible collapse. The reason was that the assets considered by almost all market participants to be super-reliable (the mortgage debt with the highest credit rating) suddenly depreciated sharply – and this caused a series of bankruptcies of the largest banks.
A parallel can be drawn here with the collapse of the so-called TerraUSD stabelcoins (traded under the ticker symbol UST), whose capitalization reached $18 billion at its peak and which were considered by many crypto-enthusiasts to be the most stable cryptocurrency. However, in May 2022, TerraUSD tokens depreciated 98% in just a few days, triggering a chain of bankruptcies of other major crypto players (including hedge fund Three Arrows Capital and the Voyager trading platform).
At the same time, the unfolding large-scale crisis in crypto had almost no effect on traditional financial institutions. The reason for this is that large institutional investors are still wary of investing in cryptoassets – respectively, they have not yet had time to build up a large share of such investments on their balance sheets.
But that’s slowly changing, with more and more large foreign investment banks announcing plans to provide infrastructure for crypto investments – so it’s no surprise that financial regulators around the world are becoming more concerned and willing to tighten regulation of the blockchain industry.
6. Attempts to censor crypto may be more successful than crypto-enthusiasts expected
Bitcoin was born in the wake of the crypto movement – the idea that crypto algorithms could provide greater protection for individual rights from government interference than the traditional financial system. However, over the years, the cryptocurrency ecosystem has still not become a full-fledged “thing in itself”: to use the accumulated crypto-wealth, it will still almost always require its conversion in one form or another into traditional financial assets.
It is at this point that government attempts to impose tight controls on blockchain finances may prove most successful. As an example, Matt Levine cites the high-profile story of Elijah Lichtenstein and Heather Morgan, who stole several billion dollars worth of bitcoins from the Bitfinex exchange in a hacking attack in 2016, but were never able to successfully “launder” them and use the wealth that fell upon them. They were eventually arrested by the FBI in early 2022, and most of the stolen crypto was simply confiscated.
7. Stablecoins are a bridge to the traditional financial system, but not all of them are equally reliable
Stablecoins have already surpassed $140 billion in aggregate capitalization, and for many people, they are the first step to diving into crypto.
Matt Levine divides these kinds of staplecoins into “secured with traditional financial assets” (USDT, USDC, BUSD), “good algorithmic” (super-secured with other cryptocurrency – like DAI) and “bad algorithmic” (essentially unsecured with anything – see TerraUSD tokens that went to zero).
Matt’s prediction that sooner or later the holders of secured steblecoins will start to be paid interest yields automatically is curious. After all, the most popular stabelcoins originated back in the era of near-zero interest rates, when lack of yield on current accounts was the norm. And now, after the U.S. Federal Reserve’s aggressive hike in the discount rate to 4% per annum, the free use by issuers of such staplecoins (Tether, Circle, Binance) of the funds entrusted to them by token holders may already begin to raise questions.
8. Different cryptocurrencies represent different values: bitcoin is built on the idea of privacy, while Ethereum is its exact opposite
Although bitcoin’s transaction base is fully public and open, one of the cornerstone ideas for bitcoin-maximalists is the value of anonymity and privacy. The creator of bitcoin himself, under the pseudonym Satoshi Nakamoto (whose identity, by the way, was never revealed in the end) wrote that every transfer of this cryptocurrency should ideally take place to a freshly created wallet address – so that no one could easily link disparate transactions to a single owner.
That said, the Ethereum blockchain philosophy, according to Matt Levine, is in a sense at the other end of the privacy spectrum: it is more like an open-source programming community, where, on the contrary, personal reputation is valued first and foremost. It is in etherium that the possibility of buying a personal ENS domain is implemented, which allows, among other things, to publicly link your cryptocurrency wallet to your name.
This idea was further developed in Vitalik Buterin’s Soulbound Tokens concept, designed to store a set of cryptographically verified life achievements (educational diplomas, professional successes or failures, etc.).
9. The idea that bitcoin protects against inflation has failed
Many crypto fans have promoted the idea that bitcoin is a financial asset superior to traditional assets (stocks, bonds) for two reasons:
- First, the total number of bitcoins is severely limited from above (they will never be mined more than 21 million, with most of them already mined by now) – which means that unlimited bitcoin issuance is impossible (unlike traditional currencies), and it should offer excellent protection against inflation.
- Secondly, bitcoin’s price is not fundamentally tied to traditional markets – hence, its addition to an investment portfolio must reduce its risk (for example, bitcoin that is not correlated with stocks can also grow on the declines of traditional markets).
Both of these theses proved disproved in practice in 2022. Despite a record jump in inflation in the U.S., which rose from 1.4% per year in early 2021 to the current 8.2% per year, bitcoin has fallen in value by nearly 30% in those 22 months. At the same time, bitcoin did not show any discord with stocks: it responded to the U.S. market’s nearly 20% drop from early 2022 to late October by slumping nearly 60% over the same period.
10. In the crypto world, “Ponzi scheme” is not always a scam, sometimes it is the official business model
But the crypto industry is not just bitcoin! In 2021, the concept of web3 became very popular: it is based on the idea that users of almost any Internet project can simultaneously be investors in it, getting increasing in the price of tokens for a variety of actions.
But this model has big risks: it is often impossible to say for sure whether the number of users of a protocol is growing because it gives them a valuable product, or just because everybody rushes to buy tokens in the hope to get rich? In a sense, writes Matt Levine, “every web3 project is also a pyramid scheme. After all, according to the “greater fool theory,” tokens will only appreciate as long as the influx of new users who want to buy them grows. And the customer base of any product cannot increase forever…
The pyramid principle is even more evident in DeFi projects aimed at so-called “yield farming,” where tokens are repeatedly redeposited on special income crypto-deposits to maximize the interest earned.
One of the most prominent cryptopyramids was the Olympus DAO project, which at one point offered returns as high as 7,000% per annum. No one particularly denied that such interest could be solely the result of a speculative pyramid scheme, but it was claimed that if everyone continued to invest in the project at the same time, it would somehow make everyone rich at the same time… As a result, the Olympus tokens, of course, depreciated by 99%.
Conclusion.just because crypto has no easily understood fundamental connection to the real world does not mean that it cannot eventually take over the world.
After all, writes Matt Levine, the traditional financial system has by now also reached a certain level of absolute abstraction – where it is often no longer at all clear how it is connected to the real world. Every day traders make multibillion-dollar trades in complex derivatives that end up not resulting in any physical delivery in the real world; and the shares of some companies like GameStop have long since become hopelessly disconnected in price from any reasonably justifiable fundamentals.
But maybe the unobservable link to real-world assets isn’t crypto’s main intractable problem. After all, blockchain is great for asset trading in video games. And if video games (broadly construed to include virtual reality and Zuckerberg’s meta universe) eventually become an integral part of our lives, then maybe cryptocurrency as a phenomenon will become even more valuable to our society?