Cryptocurrency is having a bad year. The dream of a revolutionary, decentralised currency has morphed into something of a nightmare, pockmarked by bankruptcies, scams and tanking coin value.
But beyond the intricacies of ‘stonks’ and dogecoin, the broader story of crypto is one that should be of interest to everybody, even if the word ‘blockchain’ makes your brain shut down. Crypto was meant to break all the rules of traditional financial markets and launch new currencies not controlled by the banking institutions that crashed the global economy and then made sure the public paid for it. Instead, it’s a space that has become synonymous with some of the worst excesses of Wall Street – but in a new format. Why?
Novara Media spoke to Stephen Diehl, software engineer and author of ‘Popping the Crypto Bubble’, to make sense of how radical ideas have curdled into a recreation of 1920s greed – and why little has changed since speculation manias of the 1700s.
Novara Media: What were cryptocurrencies meant to be?
Stephen Diehl: Depending on who you ask, this has many answers. Broadly speaking, Bitcoin started off as an attempt to be a digital currency that didn’t require a trusted intermediary, like a payment processor. It doesn’t do that very well. The problem with Bitcoin is that the economics of it are designed in a very poor way. It makes for a very poor currency because it goes up and down. A single tweet can cause the price to go up or down by 20% in a day.
What have cryptocurrencies become?
As a currency, it’s basically a failure. As a result of that, it’s now treated as a speculative asset, so like a stock or a bond. The price of a speculative asset can go up and down. That’s largely what [cryptocurrencies] are today. But it’s a stock where, unlike an actual business, which does an activity in the world that generates profit […] there’s actually no underlying hard assets or a company behind it.
So it’s just sort of like a floating asset, with its value purely derived from how much people say it’s worth?
Correct. It’s like a get rich quick scheme, where you’re betting on the number of other people in the get rich quick scheme.
What was the initial philosophy underpinning cryptocurrencies?
The original designers of Bitcoin sincerely believed that financial institutions were not to be trusted. There’s truth in that, as we saw in the global financial crisis, which is the time period that [crypto] came up. There’s definitely a libertarian streak inside of crypto that believes that institutions, be they government, be they financial, are inherently flawed and need to be replaced with software. And that’s the essence of the decentralisation narrative.
Broadly speaking, it resonates a lot with American style rightwing libertarianism, that largely has a distrust in things like central banks, the Federal Reserve, that sees the minimisation of the state to be one of their political imaginaries. That’s probably the predominant philosophy in at least one subset of crypto.
Is that philosophy still present?
It’s not the predominant philosophy anymore. These days, crypto is largely dominated by traditional Wall Street types. They are, by definition, the establishment. They are speculators and hedge fund managers; they don’t care so much about the libertarian narrative. [But] there’s [still] a lot of different schools of thought.
Someone like Sam Bankman-Fried – former CEO of FTX, the second largest cryptocurrency exchange in the world which announced its bankruptcy two weeks ago – came from Wall Street. He was also motivated to enter crypto by a supposedly radical philosophy called ‘effective altruism’.
How did that play out? It seems like crypto is full of these ambitious ideologies that don’t actually reflect what’s actually happening.
Exactly right. Crypto people are really good at telling grand stories that take the extreme complexities of the world and reduce them down to simple answers. Sam happened to latch onto this particular narrative called ‘effective altruism’, which you can think of as this synthesis of utilitarianism, moral philosophy and long termism – the belief that we should value the happiness of future beings who don’t exist.
Sam particularly believed in this form where he felt the most ethical thing he could do was to make a lot of money in any way possible, and then divert that money toward causes he deemed in the interest of future civilisation. There’s a lot of assumptions baked into that model. And look at how it turned out.
When did crypto start mimicking the Wall Street world it was supposed to pose an alternative to?
I put this around the 2016 era. That’s when we saw the naive libertarian ideation of the original founders sublimate into a lot more traditional finance types. And that’s when the Ethereum network [a global software platform] came into existence, and people learned they could do crowd sales of financial assets that look a lot like equity on the network. That launched a speculative mania called the ICO bubble, which ran for three or four years. And that’s really when these ideas about overthrowing the state and creating hard money, independent of central banks, gave way to ‘how can I make a lot of money really fast on these get rich quick schemes that I can offer to the public?’
Can you explain the Ethereum network to the n00bs among us?
Imagine like you’re starting a company, and you create shares in the company. So the same kind of joint stock companies we’ve had for 1,000 years. The shares in the company exist on an Excel sheet. They are a way of slicing up the productive activity of the company, and selling the future value of some of the labour that you will do in the future to shareholders who invest capital today.
What crypto allows people to do is create these virtual shares in a company that was on the blockchain, and sell them as if they were shares in an actual company, except there’s actually no claim on anything. People started trading them exactly like they trade stocks, except without any regulation, no controls, no disclosures, no investor protections. It became the wild west of investing.
Who were the first kinds of people to migrate from Wall Street to speculating on crypto?
Banks are not generally involved with this, because banks are quite regulated entities. They’re not actually legally allowed to hold class on the balance sheet. However, private institutions – think [instead] family offices, high net worth individuals, hedge funds – were the first players in that space.
Why is crypto building institutions that mirror Wall Street, like exchanges and trading firms. Is it because of the people now involved, or was this inevitable from crypto’s flawed beginnings?
It’s a bit of both. I would argue that the Wall Street people came in because of the failure of [crypto] as a currency. What hedge funds are looking for is returns in the market. Over the last ten years of zero interest rates, there’s been increasingly few places that you could find yield in the market. So they have to increasingly buy riskier assets.
What appeals to the hedge funds about crypto is that everything that’s been illegal in markets for 100 years is legal in crypto markets. Things like market manipulation, wash trading, painting the tape, front running, insider trading that people can use to make a lot of money are now suddenly legal again. Hedge funds are not generally very scrupulous in how they make money. They saw an opportunity and they went for it.
As far as why it’s recreating the same institutions – well, that’s what they know. That’s how they make money. And if you’re an institutional investor, you need the same kind of infrastructure if you’re going to onboard your [limited partner] money into these funds.
So they’re basically recreating the unregulated financial markets of the 1920s?
Yeah, there’s a lot of parallels between the crypto market today and the speculative excess that happened leading up to the Great Depression. Uncannily similar parallels.
There’s a reason that right after the 1929 market crash, we put in a framework called the Securities Act of 1933 and the Securities Exchange Act 239 to clean up the mess. What happens when you ignore all securities regulation that’s meant to protect investors from these various things that these hedge funds are doing is that you see the same catastrophes unfold that happened in the 1920s. People have become enamoured with basically going back to like [20th] century financial systems, along with all the catastrophes that came with them.
Is there a wider fallout when this unregulated crypto space experiences major crashes, like that of FTX?
FTX was the second largest player in the entire space globally. It would be the equivalent of a Citibank or a JP Morgan collapsing. It’s enormous relative to that space. But it imploded in 48 hours, two weeks ago, and the broader market didn’t even care. It’s so self-contained, because of existing banking regulations, that it’s basically like a mini version of the global financial crisis happening in a bottle, completely isolated from the rest of the world. There are a few pension funds that were exposed to this, and there’ll be a few hedge funds that will go bankrupt. But broadly speaking, the FTSE 500 didn’t even react to the crypto explosion.
Are these small-self contained bubbles of speculation and bust going to be more frequent in the future?
In some sense, these things have always existed. There have been speculative manias ever since the 1700s. In Britain, probably the most famous one is a bubble from 1720, in which people started speculating on the South Sea Company, which is like the East India Company. They were allegedly trading in the South Sea, in the new Americas, but they didn’t actually do any trade. People were buying shares in this company that didn’t actually do anything.
The South Sea Company was the cryptocurrency of the 1720s. And nothing has changed since then. Things have always been in markets. And if you look in the dark corners of the financial system, you’re always going to find these speculative manias Every generation has to learn the same lessons over and over again. It’s a bleak indictment of humanity. But it’s also something that has a lot of historical precedent.
Is the promise of crypto dead? Was it even alive in the first place?
I think your readers should look at how it’s going. Within the last two weeks, the second largest player just blew up. It was a scandal that rocked the entire financial world. All of the narratives that crypto purports seem to be discredited at this point. And what crypto really is just a vehicle for pure naked speculation, detached from anything in the real economy.
We already have a word for that: a casino. That’s what crypto is. So in some sense, the only thing it’s succeeded at doing is not creating a new financial system. It’s just created a new digital form of gambling.
It’s a strange phenomenon to watch a technology built on revolutionary ideals morph into the very apotheosis of the corruption on Wall Street that it was born out of. It’s the equivalent of watching radical Marxists suddenly all become hedge fund managers.