Taylor: What we can learn from the great crypto meltdown of 2022

In May, trouble in the world of crypto finance began when fake money called Terra turned out to be worthless. Three Arrows Capital, a large cryptocurrency hedge fund, declared insolvency the next month after reporting a $500 million loss on Terra.

Celsius Network, a crypto brokerage, went bankrupt in July, reporting 20-to-1 leverage on its assets. Also that month, Voyager Digital, another crypto brokerage, went under, reporting a delinquent $650 million loan to Three Arrows Capital.

And in October, FTX — the second-largest crypto brokerage, run by former industry darling Sam Bankman-Fried — declared bankruptcy after bailing out Voyager Digital, and FTX appears to have “borrowed” — and lost — customer funds on its way to insolvency. As of late November, Genesis Global Capital LLC has halted withdrawals, which is typically a precursor to bankruptcy.

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One major centralized exchange, called Binance, has not gone under.

I’m sure everything’s fine over at Binance. Don’t worry.

In the meantime, I have some updated thoughts on crypto.

The paradox of crypto

Two indelible features of cryptocurrency — the entire point of crypto, I believe — is the lack of governmental and regulatory limits.

This is why it’s so exciting. Crypto is not like fiat money that can be destroyed by unscrupulous governments inflating away value. It’s unconstrained by the machinations of the Federal Reserve or the boring risk limits of the Securities and Exchange Commission. Best of all, at least for a while, it seemed to offer a way to accumulate wealth outside the grasping, greedy hands of the Internal Revenue Service.

For people subject to foreign currency controls, like Chinese citizens, crypto offered a clever way to liberate wealth from the Communist Party’s claws.

But here is the paradox, now brutally exposed. When the point of the thing is to avoid governments and skirt regulation, who can you turn to for help when you need to root out bad actors, such as hackers, thieves, scam artists, opaque offshore institutions and exchanges that lack reasonable risk limits?

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Crypto’s central feature — not its bug — is a trustless and lawless environment that’s driven by decentralized and unyielding computer code rather than the meddling inefficiencies of the laws of fallible man and inefficient government. But how do I get my money back when my investment is suddenly gone?

And if crypto in the future is centralized and regulated, doesn’t that wreck the whole objective? You might as well own stupid fiat money, like dollars. In late 2022, this central paradox has not been solved.

If exchanges keep going out of business and locking you out of redemptions, you’ll want to get your fake money off the exchange and into a wallet you control. But you can’t then use that fake money for anything. If you ever want to use your crypto, it’s convenient if your fake money is on an exchange, rather than locked in “cold storage” on a hard drive. This is the current conundrum and paradox still to be solved: Will crypto be useful as a medium of exchange for anything in the future.

The speculative fiction future

For the past few weeks, I have been reading Neal Stephenson’s “Cryptonomicon,” a 1999 speculative-fiction novel involving a startup’s attempt to create digital currency untrackable by governments. It’s good, although I’m only halfway through the book. In my defense and as a warning, it’s 1,000 pages long.

Stephenson’s novel predated Satoshi Nakamoto’s 2008 white paper spelling out the creation of bitcoin through the trustless code-based method known as the blockchain. Stephenson builds a plausible fictional history of cryptography that underlies this trustless future currency.

It is no small thing to solve the technological problems posed in “Cryptonomicon.” The blockchain technology envisioned by Satoshi solved a lot of it. Even though cryptocurrencies may be stuck in a rut at year-end 2022, we may soon live in a blockchain-enabled world. Certainly, tens of billions of dollars in venture capital have bet annually on this future for the past few years.

The test of blockchain’s future is not whether it’s exciting when cryptocurrency values go up. The real test of its usefulness starts now, when the coins go down in value. If blockchain adoption as a useful technology survives this, then I will believe in its staying power.

Relearning centuries of finance in a decade

For crypto skeptics like me, who come from the finance world, the most fascinating part of crypto in 2022 has been the painful relearning of lessons that we learned long ago.

People can be hyped into a frenzy of buying something they do not understand, as long as they believe it will go up in value for some reason, or because other people will buy it, or for no reason at all; think the 1720 South Sea bubble and the 1999 dot-com bubble. Interest rate hikes act like a brick wall to halt inflation and speculation; think the 1982 Volcker-induced recession. Highly-rated, stable, “riskless” assets can, with enough hidden leverage and intermediary risk, lose value very quickly.

And it’s not about how much debt my counterpart has. It’s about how much debt my counterpart’s counterpart has. Think 2008 AAA-rated mortgage CDOs. In times of panic, a central bank is really useful in order to save the system, such as during the 1907 JP Morgan-led bank rescue and the 2008 mortgage crisis.

Recognizing crypto is a cult

When a prophet has called for the day of revelation on a specific date, and then that date passes, do the true believers lose faith? No. They double down on a future revelation and strengthen their commitment to their dear leader’s new pronouncements.

This resembles the apparent failures of communism. To true-believers, “true communism” has never been tried. Similarly, true believers insist that we need to double down on a purer form for true crypto to emerge and reach its fullest potential.

Likewise, true cryptocurrency requires full decentralization on the blockchain. Failed central exchanges like Celsius, Voyager, FTX and Genesis were compromises and perversions of the true hardcore dream of decentralized crypto.

On true believer Reddit threads, this message takes the form of urging participants to get their crypto out of centralized exchanges and into cold storage, which is roughly speaking like putting your fake money on a memory stick, where it will be safe.

And useless. But never mind that.

The promised land of crypto resides in its decentralization, as founder Nakamoto intended.

Also, there’s a lot of talk about how apostate Bankman-Fried, founder of FTX, was getting close to regulators, SEC Chairman Gary Gensler in particular, when centralization and regulation are crypto’s enemies.

The best thing about crypto

Perhaps I am a bit of a jerk for finding pleasure in the financial collapse of a system that is so far based on pump-and-dump schemes and fake money.

But at least such schadenfreude won’t last long or be directed toward too many.

My favorite thing about cryptocurrencies, which is worth noting at this moment, is the lack of financial contagion. No banks have gone under. The stock market is ignoring the cryptocurrency implosion. Nobody is getting bailed out, unless it is by other crypto lunatics.

This is great news for the rest of us.

Michael Taylor is a columnist for the San Antonio Express-News, author of “The Financial Rules for New College Graduates” and host of the podcast “No Hill for a Climber.”

[email protected] | twitter.com/michael_taylor


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