Cryptocurrency is the Segway of finance
A cool toy that's ultimately not very useful
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Sam Bankman-Fried is under arrest and facing a broad range of federal charges.
That makes, I think, for a good time to reflect on the larger trajectory of cryptocurrency, which isn’t really a new technology anymore. Crypto defenders used to point out that the early internet seemed trivial but pretty swiftly grew into a juggernaut that’s upended many aspects of our lives. And that’s certainly true. But I also think it’s worth pointing out that the mid-90s version of the internet — which was mainly people killing time in trivial ways that a normal person was totally free to ignore — was genuinely useful to the people who were using it.
The 1997 version of the internet wasn’t necessarily more useful than other random distractions like board games, novels, HBO, or fantasy baseball, but it was additive to the available stock of amusements available. I liked to argue with God-knows-who about politics on Prodigy message boards and pretend that, like Demosthenes and Locke from Ender’s Game, I could someday influence world affairs by posting influential essays online. Growth of the internet over the last quarter-century has been striking, but an awful lot of it has been a pretty straightforward iteration on things that were already present, just powered by much faster and more mobile connections.
Crypto, by contrast, is best known for the fact that (some) people like to trade it speculatively. This led to the creation of some companies that specialize in facilitating crypto speculation — and one of the best-known of those businesses turned out to be stealing money from its clients, while its main rival is facing possible criminal prosecution for violating money-laundering rules.
Crypto true believers argue that exchanges like FTX don’t reflect the real vision, and that the whole point was to create a way of conducting digital transactions that doesn’t require a trusted intermediary.
And that’s true. But the fact that the most successful crypto businesses were, in fact, trading exchanges suggests a fundamental weakness here, which is that while crypto is technologically impressive, it doesn’t actually seem very useful in practice. Solving hard engineering problems is often financially lucrative and socially valuable. But there’s no guarantee that this will be the case. The pyramids of ancient Egypt are famously impressive engineering marvels, but they don’t do anything particularly useful. They’re just cool.
The mystery of ownership
I was watching Home Alone recently, and when Joe Pesci speculates about what kind of goodies are likely in the McAllister home, he mentions “marketable securities.” At least two other 90s cinematic classics — Die Hard and Heat — feature criminals who are planning to steal “bearer bonds.”
Today, of course, the idea that you could steal stocks or bonds is absurd. These aren’t physical objects that you can take from someone’s house, they’re entries on a spreadsheet somewhere.
On some level, it’s interesting that the Wet Bandits were planning to steal objects from inside the house, not the house itself. Even though it would be just as easy to change the locks and claim the house, it’s obvious that nobody actually does this. Houses are worth a lot more than electronics, but having physical possession of a home isn’t what it means to own it — owning a home means you have the title to the house. And even though the whole American title system is a huge mess on many levels (hence the title insurance industry), it works well enough that nobody steals houses.
Ownership, generally, is a legal abstraction.
I spoke recently to an attorney who works in Ohio for oil and gas companies. There was a lot of oil exploration in Ohio a hundred years ago, which led to a lot of buying and selling of mineral rights to various parcels of Ohio land. This was followed by a decades-long span of very little drilling activity in the area. Now, thanks to hydraulic fracturing, there is renewed interest. But because the mineral rights were oftentimes separated from the land generations ago, oil and gas companies face the problem of figuring out who currently owns the rights and negotiating deals with them. These are frequently people who don’t live in Ohio and may not even be aware that they inherited seemingly worthless mineral rights. There are two interesting facts about this situation.
One is that even though the rights owners probably wouldn’t notice if the current landowners just re-sold the rights to oil and gas companies, they still can’t do it. The other is that because this whole situation is inconvenient for oil and gas companies, they are trying to convince the state legislature to re-write the rules and make long-unused mineral rights refer to landowners.
Their argument is that it would generate jobs and economic activity, and be a net wealth transfer from out-of-state rights holders to current Ohioans. I have no idea whether the state legislature will listen to the oil companies, but they might. The question of who does and doesn’t own the mineral rights is a question of rules. There are pieces of paper documenting the sale of mineral rights and other pieces of paper specifying patterns of inheritance and also the possibility that the state legislature will promulgate new pieces of paper that override the old pieces of paper. And to be clear, this isn’t like “communists might take over” — this is a right-wing, pro-business proposal!
Trusted intermediaries are very useful
The big point I want to make about all of this is that it’s often pretty useful to have a trusted intermediary be the custodian of your property rather than leave it up to the vagaries of possession.
We see very clear movement over time away from stuff like bearer bonds and paper stock certificates in favor of “Ameritrade says I own such-and-such.” This is because making it harder for your stuff to be lost or stolen is very valuable. Alex Tabarrok, a very smart economist who I often agree with, was explaining recently that crypto is useful because it lets him make very rapid financial transactions at weird hours of the night. Adam Ozimek replied that with normal banks, you get the much more valuable commodity of peace of mind.
Crypto boosters replied that you shouldn’t trust the banks, they’re bad, etc. But the genius of the American banking system is you don’t need to trust the banks.
An example: When I first moved to D.C., I needed to establish an account with a local bank, so I did what any self-respecting American would do and opened an account with the bank that had a branch closest to my house without doing even the most cursory amount of research. Was the bank well-managed? Was it run by people with integrity? Did the regulators in charge of the bank have any idea what they were doing? I didn’t think about these questions even slightly. The answer turned out to be that the bank was not well-managed, and that the people running it were in fact criminals who were laundering money for jihadist terrorists and fascists. This was exposed by law enforcement, not by safety and soundness regulators — but of course the legal penalties for all the crimes turned out to greatly imperil the safety and soundness of the bank.
And when I learned this news, I … did nothing, because the FDIC guaranteed the continued smooth operation of everyone’s accounts while the banking was hastily merged with another bank I’d never heard of (PNC out of Pittsburgh). I think most Riggs Bank clients never thought anything of it.
Another time, someone successfully stole my identity and emptied all the money out of my account at PNC.
This was a pain in the ass that involved me getting a bunch of papers together to prove that I was actually me, but the fact is I lost $0 in this process. Not because PNC is a bunch of nice people, but because those are the rules.
Because banks have to make you whole in the event of fraud, they invest in trying to stop it. My bank once decided it was suspicious that within a 24-hour period I bought tickets to see “Punisher: War Zone,” a hot dog at a 7/11 in the Copenhagen Airport, and a sweater in Berlin without having purchased any plane tickets. I admit this was odd, but I had my reasons, and it was cleared up with a quick call from the bank’s fraud department.
Crypto’s basic model starts from the idea that electronic transactions are convenient relative to paying for everything with little pieces of precious metals, that the current reliance on trusted intermediaries is a necessary evil, and that developing a means to conduct electronic transactions without a trusted intermediary is a big win. But this just isn’t true. For the bulk of the world’s economic activity, the trusted intermediary system is a much better way to do things. Not just for technical reasons related to blockchain energy consumption, but because alternative approaches leave you dangerously vulnerable to criminals. This means in turn that the primary bona fide use of an alternate system is for committing crimes. The bad thing about bearer bonds (which don’t exist anymore) was that they were good targets for thieves; the good thing about them was that they were useful tools for tax evasion and money laundering.
Stores of value that are convenient for the commission of crimes are themselves vulnerable to being stolen, because unless you’re stealing a sandwich and eating it right away, you sort of have to commit follow-up financial crimes to make the theft worthwhile.
This doesn’t mean crypto is all bad
Scott Alexander has a good post sarcastically titled “Why I'm Less Than Infinitely Hostile To Cryptocurrency” that illustrates a few cases in which cryptocurrency is genuinely useful.
What I do think is important to say about his examples, though, is that some of the top use cases that a normal person would be sympathetic to still involve committing crimes. It’s just that most Americans think that the currency controls in places like Venezuela are bad. Alexander talks about using crypto to funnel money to sympathetic people in Russia who need funds to escape the country — the case there isn’t “here’s an example of a non-criminal use of crypto,” it’s “helping this guy break the relevant rules is good.” And I’m generally very sympathetic to that. When I went to Argentina, I participated in some black market currency exchanges. I wouldn’t say my motives were entirely high-minded; the point was to get myself a better exchange rate than what was available on the legal market.
But I really did feel okay about it. Argentina is a land of notorious macroeconomic policy mismanagement, and while I think there’s a case on the merits for countries imposing controls on capital inflows, trying to restrict moving money out of a country is basically always just governments trying to cover their own bad policies.
The other use cases, as Alexander surveys, are that while I’m singing the praises of participating in a solid banking system, not everyone is lucky enough to live in a country with a good banking system. Even we Americans are laboring under a system for making payments and clearing transactions that’s slow and laborious compared to some countries in Europe and Asia. And much of the world is in much worse shape than the United States. I criticized the idea that crypto is an improvement over the trusted intermediary method, but crypto is in important ways an improvement over keeping a bunch of $20 paper bills rolled up in your sock or trying to move your savings across international borders by trading all your possessions for small, easily smuggled diamonds.
Things that have many of the properties of physical cash or bearer bonds but that are also digital have some very real uses.
The good news isn’t that good
I’m not sure if many Americans know this, but a very large share of physical American currency circulates abroad as a response to both weak banking systems and people’s desire to do crimes. We’re talking hundreds of billions of dollars worth of pieces of paper — it’s not crazy to think that people would be interested in some alternative to all those rolls of cash.
The problem with crypto here is that even though this foreign circulation constitutes a huge share of the value of physical currency, it has embedded utility here in the United States. You can take cash to an American bank and deposit it there. Once it’s there in the bank, you can use it to pay taxes. And critically, even if you actually can’t open an American bank account and put your dollars into it, I can do that. Since I and hundreds of millions of other Americans could put American currency into our American bank accounts, we are generally willing to give you things of value in exchange for your paper American currency. Even people who are many stages removed from the actual U.S. financial system treat U.S. dollars as valuable, in part as a solution to a coordination problem, but in part because there are all these Americans and American banks that give the pieces of paper embedded value.
Similarly, you can use diamonds as a method of smuggling wealth across borders, but the reason this works is that there are people who will pay a lot of money for diamond jewelry.
Crypto can be used to work around laws or bank system failures, but only if the tokens maintain some value. But what use case props that value up? Just working around laws and bank system failures? That’s not nothing. But it’s also not a lot, since almost by definition, all the demand for this is going to be in relatively poor and dysfunctional countries. Venezuelans are using crypto as a safe harbor because their economy is collapsing. People in Vietnam use a lot of crypto and Vietnam is getting richer, but I don’t think Vietnam is going to get rich with a crypto-powered financial system. Either they’re going to get their banking act together and prosper, or they’re going to hit limits to the economic potential of a country that lacks proper banking.
There’s also the “digital gold” scenario where some people think that stockpiling some crypto assets is a good way to hedge against tyranny or future state collapse. I don’t think this really makes very much sense, but holding physical gold as a hedge against state collapse doesn’t make much sense either, and some people have been doing it for generations. Crypto is much more up-to-date and easier to store than gold, so I’m actually pretty bullish on Bitcoin partially displacing gold as a paranoiac’s hedge over time. This makes it a potentially lucrative long-term investment (the “market cap” of gold is high), but still nothing like a transformative technology.
A good analogy might be the Segway, which was heavily hyped when it was first invented and is genuinely pretty nifty, but serves only very marginal niches as an actual means of transportation. It turns out that not every technical feat is all that useful, while the social technology of abstract property rights and the rule of law is very valuable.
The Segway, originally intended as transportation, now mainly serves the niche 'analogy' market.
Matt,
What is more difficult to understand is why what you say here isn't obvious to everyone. And it gets back to "what is money?" Of course, money is what everyone agrees it is. But who is everyone?
More than the rule of law and property rights, it is a 25 trillion dollar economy, the most powerful military in the world, and relative political stability for 250 years that makes most people agree on the value of dollars. Otherwise, I might be sending you a box of tulips to pay for my Slow Boring subscription.