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How cryptocurrencies are the Amazon of money – DL News
- The social value promised by DeFi lies in the end of the financial intermediary.
- Don’t fall for the hype of financial innovation.
Wolfgang Münchau is a columnist for DL News. He is co-founder and director of Eurointelligence and writes a column on European affairs for the New statesman. The opinions are his.
When I was a young financial journalist in the mid-1980s, I met the late Ivan Boesky, an investor who called himself a modern arbitrageur.
He deceived me.
The old arbitrage was the exploitation of price differences between exchanges. If sterling bills were cheaper in medieval Paris than in Bruges, an investment banker would buy them in Paris and resell them in Bruges.
This would lead to an equalization of prices. Even though everyone is in it for the money, there is social value in this transaction. It increased the efficiency of the markets.
But that’s not what Boesky did. He made the implausible claim that he would arbitrage information – merger arbitrage as he called it.
It sounded intriguing to us, but it turned out to be a euphemism for insider trading.
A few months after our meeting he was arrested. What seemed like a financial innovation to me turned out to be old-fashioned fraud.
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He served time in prison, was barred from financial markets for life, became a government informant and stayed out of the spotlight until his death last month.
Michael Douglas’ Gordon Gekko character in the 1987 film “Wall Street” – the “greed is good” part – was based on Boesky.
What the Boesky experience taught me is that financial innovation doesn’t actually exist.
“When someone claims to have created an innovation, it is usually more likely that they have found a way to hide the risks.”
That might seem like a bold statement. But think about it.
Finance is the intermediation between borrowers and lenders, savers and investors.
You can structure credit in several ways. Or cover the risk.
But when someone claims to have created an innovation, it is usually more likely that they have found a way to hide the risks. Case in point: US subprime mortgages in the 2000s, which hid bad credit conditions in vast pools of investment grade products.
Fundamental observation
So how does this apply to cryptocurrencies or, more precisely, decentralized finance?
Let’s start with the tendency of many to confuse the properties of DeFi tools – tokens, blockchain networks, smart contracts – with the industry itself.
The social value promised by DeFi lies in the end of the financial intermediary. This is a big deal, and one that would justify some of the large investment flows into the cryptocurrency sector.
What Amazon initially did for books and then everything else is what cryptocurrencies can do for finance.
The potential of cryptocurrencies
In finance, it is possible to estimate the current costs of the rent-seeking intermediary in terms of the margin between market interest rates and lending rates, or credit card interest rates.
In other words, the spread you see between central bank capital and the rate your bank charges you on deposits, or charges you on debt, is enormously large.
This is the savings potential that cryptocurrencies can offer.
It can eliminate some of the hassle involved with a mortgage application and can match borrowers and lenders in ways that are not possible with the mostly static institutions of modern finance.
But beware of claims that go beyond this. In statistics there is a famous method called “bootstrap”, a sampling technique that superficially appears to create data from nothing.
You can bootstrap data, but not money, just as a central bank cannot expand the money supply beyond certain thresholds for long periods without creating inflation.
Bubbles can persist for surprisingly long times, even decades. Some people will make a killing while it lasts. If it’s not sustainable, it will end.
The natural barrier for DeFi is that ownership of real assets is regulated by national laws. A court order is required to claim the assets of the defaulting debtor.
Unsecured lending, which is the business of banks, is difficult in a purely crypto universe.
Wholesale financial markets already operate with high levels of efficiency and low margins.
The main promise for DeFi from an economic perspective would be the parts of financial markets that suffer the most friction in the form of high transaction costs and barriers to entry.
This would be a social value, but would still require cryptocurrency-friendly regulation.
Social value
This scenario is different from what I have talked about in previous articles about cryptocurrencies as a potential replacement for fiat money. This does not require the collusion of the authorities.
The social value here is the freedom to transact without state control. What the two have in common is the elimination of rent-seeking middlemen.
For DeFi, the intermediary argument matters most. But I struggle to see a world of decentralized finance that operates outside of large-scale legal systems.
In a fiat monetary system, a distinction is made between internal and external money. Domestic money is money created by banks, for example through loans.
External money exists outside the financial system, like gold. Crypto money can be classified as external money from the perspective of the non-crypto world.
In this definition, cryptocurrency is a bubble that bursts or is fueled by fiat money that allows cryptocurrency investors to liquidate their positions.
But don’t give in to the hype of financial innovation. There are many Boeskys out there in the crypto universe.
I think Amazon is the best way to think about DeFi. Amazon has brutally eliminated the middlemen.
But just as Amazon didn’t reinvent the book, cryptocurrencies won’t reinvent finance.