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Sunday, November 20, 2022

The Only Crypto Story You Need, by Matt Levine – Bloomberg

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Connecting decision makers to a dynamic network of information, people and ideas, Bloomberg quickly and accurately delivers business and financial information, news and insight around the world
Americas+1 212 318 2000
EMEA+44 20 7330 7500
Asia Pacific+65 6212 1000
This had an appeal, and crypto became very valuable, and people looked to put their money to work in crypto—and they trusted people. Over and over again, they trusted Quadriga and Terra and Voyager and Celsius and dozens of other projects that failed or ran off with their money or got hacked. They just fell over themselves to trust people.
Why did they do this? Well, there’s a common thread in these kinds of things. The people who are easiest to pull in are often the ones who think they’re the most independent-minded and cynical. “Either the bank is lying or Celsius is lying,” Celsius told people, flattering their unjustified belief that they knew the real score.
But there’s something else, too. The people who trusted Celsius weren’t tripped up only by their belief that they were outsmarting the system, though there was that. They also…they thought Celsius was a bank? It looked sort of like a bank. It did things, with crypto, that were banklike. They were familiar with how banks work. They understood that banks are safe, that if you put money in a bank you can get it back. They looked at Celsius and thought, “Well, this is a big thing, it has a nice website, it’s available to Americans. Surely if it was a problem someone would’ve done something about it.”65
There’s something a bit alarming about this. Crypto is in a way about rejecting the institutions of society, about being trustless and censorship-resistant. But it quietly free-rides on people’s deep reservoir of trust in those institutions. People are so used to trusting banks that, when Celsius told them not to trust banks, they said, “Ah, yes, OK,” then trusted Celsius to work like a bank, to be regulated like a bank. They didn’t worry about Celsius’s opacity and leverage. They didn’t do their own due diligence on its loans and audit its DeFi positions and demand irrefutable proof of its soundness. It promised to pay them back, and that was good enough for them.
But there’s something hopeful about it, too. Trust in institutions is so strong and resilient that all of crypto’s bluster can’t stamp it out. “Not your keys, not your coins, put your trust only in verifiable code,” crypto evangelists yelled, and people heard them and said, “Yes, that is nice, but I’m busy, I’m going to trust these nice strangers with my Bitcoin.”
Crypto, in its origins, was about abandoning the system of social trust that’s been built up over centuries and replacing it with cryptographic proof. And then it got going and rebuilt systems of trust all over again. What a nice vote of confidence in the idea of trust.
There’s a related story about money. One way to think of money is that it’s a system of social credit. Society has mechanisms—capitalism, politics, etc.—to allocate resources, with a rough heuristic of: “The more good stuff you do for society, the more good stuff you get for yourself.” Money is a rough way of keeping track of that. If you do good stuff for other people, they give you money, which you can use to buy good stuff for yourself.
Another way to think about money is that it’s some sort of external objective fact. If you have money, it’s your money, and society has nothing to say about whether you can keep it or what you can do with it.
Crypto starts from the second view: Your Bitcoin are yours immutably; they’re controlled only by your private key, and no government or bank can take them away from you. But the history of crypto since Satoshi has undermined this view. If you got your Bitcoin illegitimately, the government can trace them and stop you from spending them. There are still gatekeepers—crypto exchanges and fiat off-ramps and banks—that decide what you can do with your money. Crypto might be immutable and “censorship-resistant,” but its interactions with the real world are not.
Not just that. Crypto isn’t even immutable, not really. In 2016 an important smart contract on the Ethereum blockchain called the DAO got hacked. (DAO is now a generic term, but this was the DAO, the first of its name.) There was a flaw in the contract that allowed a hacker to drain a lot of money from it, and he did. Ethereum was a new technology, so the hack was a big deal.
“The descriptions didn’t matter; only the code did.” June 17, 2016
This hack was controversial; there was controversy about whether it was even a “hack.” Some people said: “Look, if the code of the smart contract allowed the hacker to do this, then it was allowed. There’s no external standard of validity, just the code, and if it happened in the code, it’s fine. If we reverse this transaction, we will destroy the essence of the blockchain, which is the irreversibility of transactions.”
Other people said: “No, that’s nuts. This was a big hack, and lots of people lost money.” It was clear enough—to humans, anyway—that this was not how people intended the smart contract to work, even if it was in fact how it worked. Sometimes the code is wrong.
The Ethereum network decided to roll back the blockchain and reverse the hack. That’s hard to do. You couldn’t just amass a bunch of computer power yourself and hack the Ethereum blockchain and reverse transactions. But if everyone in Ethereum agrees to do it, they can.66 Cryptocurrency isn’t money that’s totally immune to censorship, that’s atomic and individual and immutable. It’s money that’s controlled by consensus, much like dollars are. It’s a different form of consensus—proof-of-work mining, proof-of-stake validation, decentralized communities, DAOs, Discord chats—but the thing that gives you the money and makes the money valuable is that consensus.
Here’s another, more speculative story.
The most valuable thing in human life, this story begins, is connection. Being with your friends, making friends, feeling esteemed by your peers: These are the things that give life meaning.
“Sure, sure, sure, whatever,” you say, because this feels fuzzy and fake. But look how rich Mark Zuckerberg is! In 1999, if you’d said, “A giant contributor to US gross domestic product is the friends we made along the way,” that wouldn’t have made any sense. Now, Facebook is worth almost half a trillion dollars—though, to be fair, it’s changed its name to Meta Platforms Inc. to mark its pivot away from friendships.
And to mark its pivot to the metaverse. I don’t know what the metaverse is. But I gather that it means something like: Our lives, our social lives, our intellectual lives, our professional lives, our aesthetic lives, the things that we do all day that give our lives meaning, will take place increasingly on interconnected computers. Our reality will be intermediated increasingly by computers and the internet.
Human social life moving to the internet has economic value, it turns out, though if you explain the mechanism, it seems remarkably trivial. “If people talk to their friends about vacuums, and you show them an ad about vacuums, they’ll probably buy a vacuum.” “If we intermediate between people’s friendships, we can serve ads.”
A key lesson of crypto is: A bunch of people can get together online and make their community have economic value, and then capture that value for themselves. If you explain the mechanism for that, it sounds even worse. “Well, see, there’s this token of membership in the community, and it’s up 400% this week. Also the tokens are JPEGs of monkeys.”
But look, pretty soon, what are we going to sell to each other? Online communities are valuable. There’s money to be made.
There are lots of online communities, though. One is Bored Ape Yacht Club, a self-selected club where you become a member by buying an expensive membership token. The value of that community is, I guess, you feel cool and exclusive? Maybe you befriend a celebrity or a venture capitalist, bonding over your apes.
Or there’s social networking. Facebook is valuable; make a Neo-Facebook; give people a token; let them keep the value for themselves. “Advertisers can get your data only if they pay you in tokens,” you tell them, or “You can earn tokens for posting, which you can then use to pay other people for posting.” Why not?
Or gaming. “If you buy a laser in this game, it’s an NFT, and it’s yours to keep forever. Maybe you can use it in another game.” Why not? These are standard claims about web3 that leave me mostly cold. I don’t want to be in the advertising-data-selling or computer-game-arms-dealing businesses.
But other online communities are DeFi? Like, in some crude sense, what decentralized finance is is a big community of people who get together to pretend to trade financial assets—or, rather, who trade financial assets in a sort of virtual world. They’ve built derivatives exchanges and secured lending protocols and new ways to do market-making, but instead of trading stocks or bonds they trade tokens that they made up. And those tokens are valuable, in part because they’re linked to other online communities (you can use DeFi to buy Ether that you then use to buy NFTs to become a Bored Ape owner), but also in part because DeFi is itself an online community, or cluster of communities, and the tokens it trades are points in that community. If you build a cool trading platform or execute a cool trade, you’ll earn tokens, which you can spend on other cool trading platforms or trades. Talented financial traders are willing to work on projects to get those tokens. If you had some of those tokens, you could hire those traders.
A problem, and an advantage, of crypto is that it financializes everything. “What if reading your favorite book made you an investor in its stock.” Feh, it’s a story that only a venture capitalist could love. On the other hand, it’s a story that venture capitalists love. A minimalist case for crypto is:
“It’s an efficient way to get venture capitalists to put money into software projects.”
Or it’s a Ponzi. The web3 vision of having the customers of every project also be its investors works well in times of speculative excess, but it’s disastrous in a crash. “All our customers have a stake in our success” is great when token prices go up, but it also means that all your customers become poorer when token prices go down, which makes it hard to attract customers.
But we’ve only really seen the boom. The problem with making every product also a Ponzi is that you can’t be sure if your customers are there for the product or the Ponzi. When it collapses, you can. If they’re still there–if they still use your product without getting rich off the token–then that means your product is promising. If not, well, you ran a Ponzi.
The great speculative frenzy of crypto and web3 over the past few years drew a lot of money and attention and talent into the crypto world. A great deal of that money and attention and talent went strictly to optimizing the speculative frenzy, to tweaking the tokenomics and leveraging the bets so people could make as much money as possible without actually building anything. Some of it probably went into building, though.
Now the speculative frenzy has, if not disappeared, at least cooled. Now if you’re trying to raise money for a web3 project, it should probably do something, besides issuing a token that goes up. If it creates value for people, if the product is something people want, then the tokens will take care of themselves. Crypto people have a lot to prove on that front. One reason the 2022 crisis in crypto didn’t spark a contagion is that crypto has so few connections to things that matter to people. They play games and gamble on the blockchain, but they don’t have mortgages there.
Perhaps this is all a self-referential sinkhole for smart finance people, but honestly it would be weird if that’s all it ever turned out to be. If so many smart finance people have moved into the crypto financial system, if they find it so much more enjoyable and functional and productive than the traditional financial system, surely they’ll eventually figure out how to make it, you know, useful.
Here’s another way to tell this story. There’s the real world, and people do stuff in the real world. They grow food and build houses.
Over many centuries a financial system grew up, as an adjunct to the real world. That financial system enabled people to do more stuff in the real world. They could build railroads or semiconductor factories or electric cars, because they could raise money from strangers to fund their activities. They could buy bigger houses, because they could borrow money from banks. They could also trade out-of-the-money call options on GameStop, because that’s fun and you can make memes about it, but that’s an accidental feature of a financial system that mostly does serious stuff in the real world.
By 2008, or 2022, that system looked pretty abstract. When you think about modern finance, you often think about things like those GameStop options, or the system of payment for order flow that enables their trading, or synthetic collateralized debt obligations referencing other CDOs referencing pools of mortgage-backed securities. There’s a house there somewhere, under the CDO-squareds. All the sophisticated modern finance can be traced back, step by step, to the real world. Sure, it’s a lot of steps now. But the important point is that sophisticated modern finance was built up, step by step, from the real world. The real world came first, then finance, then the more complicated epiphenomena of finance.
Crypto, meanwhile, has built a financial system from first principles, pure and pleasing on its own, unsullied by contact with the real world. (I exaggerate: The basic function of sending money using crypto, Satoshi’s original goal, is fairly practical. But, otherwise.) That’s interesting as an object of aesthetic contemplation, and I’ve enjoyed contemplating it, and I hope you have, too. And it’s attracted a lot of finance people who also enjoy contemplating it, and getting rich. And their task is to build back down, step by step, to connect the elegant financial system of crypto to the real world. You’ve built a derivatives exchange, cool, cool. But can a real company use it to hedge a real risk facing its real factory? You’ve built a decentralized lending platform, awesome. But can a young family use it to buy a house?
And the answer is, you know, maybe, give it time. The crypto system has attracted a lot of smart people who want to solve these problems, in part because they’re intellectually interesting problems and in part because solving them will make these people rich.
But another part of the answer might be that the real world—growing food, building houses—is a smaller part of economic life than it used to be, and that manipulating symbolic objects in online databases is a bigger part. Modern life is lived in databases. And crypto is about a new way of keeping databases (on the blockchain).
If you build a financial system that has trouble with houses but is particularly suited to financing video games—one that lets you keep your character on the blockchain, and borrow money from a decentralized platform to buy a cool hat for her, or whatever, I don’t know—then that system might be increasingly valuable as video games become an increasingly important part of life. If you build a financial system whose main appeal is its database, it will be well-suited to a world lived in databases. If the world is increasingly software and advertising and online social networking and, good Lord, the metaverse, then the crypto financial system doesn’t have to build all the way back down to the real world to be valuable. The world can come to crypto.
Editor: Pat Regnier
Development: Peru Dayani, James Singleton
Production: Emily Engelman, Steph Davidson, Thomas Houston, Michael Frazer, Justin McLean, Bernadette Walker
Designers: Albert Hicks IV, Alexander Shoukas
Photo editors: Aeriel Brown, Donna Cohen, Ryan Duffin, Dietmar Liz-Lepiorz, Leonor Mamanna
Audio: Mark Leydorf
Copy editors: William Elstrom, Nicholas Mullan, Minette Valeriano
Editorial assistance: Jim Aley, stacy-marie ishmael, Olga Kharif, Margaret Sutherlin, Folder Studio
Photos: Alamy (21), AP Images (1), Bloomberg (5), Classic Stock (1), Everett Collection (1), Getty Images (64), Juliana Tan (1), Library of Congress (1), Nasa (1), Netflix/Everett Collection (1), Reuters (2), Shutterstock (4), Trunk Archive (1), YouTube (1). Videos: Getty Images (3)


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