I first seriously heard about cryptocurrency while I was working on Wall Street.
This was in 2013. I was trading Argentine credit. One of my local brokers in Buenos Aires wanted to know if I had knew anything about bitcoin. Argentina, at the time, had been locked out of capital markets for over a decade. The peso, ostensibly pegged to the US dollar, traded at a discount on the ground, leaving locals hungry for other stores of value. Capital controls meant that getting money offshore often involved suitcases and ferries to Uruguay. The country was on the brink of another default.
The promise of bitcoin, in this context, was a store of value that would not be captive to the ineptitude or harm of a single, central authority.
As I dug further into bitcoin, more promises of an alternative, improved financial system presented themselves. The European debt crisis, and specifically the asset seizures in Cyprus, highlighted the significance of a digital store of value that could be owned directly – that could not be compromised by an external actor.
Here was an asset that did not demand an intermediary. Sitting on a trading desk at the time, the removal of rent-seeking middlemen from the system was particularly compelling. This technology could allow counterparties to interact directly, without having to disclose the details of their transactions or identities to third parties.
This was also an asset that was programmable. As a derivatives trader, I spent a lot of time thinking about counterparty exposure, collateral and capital requirements. Could smart contracts provide an automatically enforceable means of accounting for this sort of systemic risk?
It had not taken me long to grow disillusioned with the old financial system. Insider trading went on at scale. Reckless risk-taking was often rewarded. Market manipulation, under the guise of many different names, remained rampant.
Cryptocurrency promised an alternative to this system.
For many, 2017 will be the year that they first seriously heard about bitcoin. As I consider the state of cryptocurrency today, however, I don’t see many fulfilled promises.
Instead, we have constructed around crypto a warped version of the legacy financial system, with all the familiar players: issuers, broker dealers, exchanges and custodians. Along with these players come the legacy problems of centralized control, intermediation, systemic risk, market malpractice and – importantly – short-term greed.
We may think that we are down the crypto rabbit hole, but really we are through the Wall Street looking glass.
Cryptocurrency tends to be marketed as “trustless.” A truer way of thinking about it is that can replace the necessity of trusting a single, central authority with the ability to trust a network of decentralized actors.
Many of the tokens that have emerged in the last year, however, have been issued by small teams of entrepreneurs, who must be trusted to get the project off the ground. Thanks to the cryptocurrency community’s emphasis on open source development, later-stage work often proceeds in a more decentralized manner.
Nonetheless, investors and consumers need to reconcile the dissonance between the sales pitch of decentralization and the reality of how these projects are often run in their early days.
The paradox of centralized cryptocurrency creation is perhaps nowhere so clearly on display as in Venezuela. The Venezuelan president, Nicolas Maduro, announced a few weeks ago his intent to issue a cryptocurrency, presumably in order to evade sanctions. This is unlikely to work, but it also misses the point. A promise of bitcoin is to act as a store of value that would not be captive to a central authority.
A new Venezuelan cryptocurrency, if issued by Maduro, is just as likely to be mismanaged as the bolivar.
Other assets also make this point. Tether is an example of a centrally-mismanaged token. It claims to be a fully-collateralized, dollar-backed asset. The fact that it is not redeemable, coupled with the opaque and problematic accounting practices of its issuers, however, makes it as questionable as any of Wall Street’s financial creations, if not more so.
Decentralization is a transformative concept in finance and technology. But if the source of value for these products still relies on a central issuer, then how different are they from the financial products that Wall Street has been devising for decades?
Cryptocurrency is also talked about as a disintermediating technology. The peer-to-peer nature of blockchain-based assets is perhaps their most interesting feature.
The reality of how these assets are generally being transacted and custodied, however, is highly intermediated.
The professionalization of the issuance process is onef example of cryptocurrency markets replicating the legacy system. The services provided by investment banks in equity capital markets are now getting packaged and sold to teams of entrepreneurs looking to do token sales.
These services include running diligence on investors, book-building, addressing compliance concerns and handling the legal process. On the one hand, this marks an important initiative in maturing the market. On the other, it is recreating Wall Street’s system around this new asset class.
The platforms that facilitate the buying and selling of cryptocurrencies and tokens also fit this category. The development of over-the-counter trading desks in cryptocurrency feels particularly ironic for me, given I first really understood bitcoin’s value proposition while sitting on a trading desk myself. These desks and exchanges undoubtedly play critical roles in providing liquidity to the market, but in many ways they are replicating what we knew from the old system.
For this reason, decentralized exchange is one of the most compelling areas of research in the space. Rather than rebuild the legacy exchanges, decentralized exchange seeks to enable a new way of transacting that is truer to the value proposition of the technology.
Wallets, like exchanges, have been significant in driving adoption of, speculation on, and use of cryptocurrency. Interaction with private keys remains a real user experience challenge. While many do choose to self-custody their cryptocurrencies, and the very option to do so is one of the important features of this asset class, we have yet to see a product enable secure and reasonable private key custody without reliance on third parties.
In place of this, the industry has again created mirror images of the legacy system: professional custody services using everything from safe deposit boxes to Swiss bank vaults.
These mirror images of Wall Street have a distorted quality. Not only do they imprecisely (or immaturely) resemble the old financial infrastructure on which they are based, but they also bend and corrupt the original intent of the product. Cryptocurrency has created more intermediaries than it has displaced.
The intent was to give people direct control of their funds, free from seizure from banks and governments. Instead, people are handing over that control to a new class of actors–who are frequently even less accountable than their old school counterparts.
The question of institutional accountability speaks directly to another promise of cryptocurrency. With its capacity for programmability, crypto can enforce financial contracts. This could solve issues of collateral management and guarantee compliance with capital requirements. The 2008 financial crisis was exacerbated, in part, by a lack of clarity about exposures among counterparties. Auditability and enforceability inherent to crypto should help mitigate, or at least reveal, this kind of systemic risk.
However, the third parties that have been created around cryptocurrency equally exposed to each other as banks, exchanges, and custodians were in 2008.
Commingling of funds within wallets and exchanges, opaque accounting, cross-exchange exposure and unclear margin requirements are a few of the sources of institutional risk in the market. The relative lack of standards in cryptocurrency means that these risks are poorly studied and understood. Disclosures on the subject have yet to be widely demanded by customers and are far from commonplace.
The nascent infrastructure growing up around cryptocurrency reflects the institutions of Wall Street. It’s little wonder that the same risks persist.
The parallels between the old and the new are not limited to issuers, infrastructure and institutions. The parallels also permeate the integrity of the players in the system.
Market manipulation, insider trading, shilling, spoofing, pumping-and-dumping and conflicts of interest abound in cryptocurrency markets. This comes as no surprise to anyone who has sat on a Wall Street trading desk, especially considering the relative immaturity of crypto markets.
When I was a trader, I found myself acutely aware that Wall Street might be the hub of it all, but somewhere – on the other end of all the Bloomberg screens, and broker-dealers, and custodians, and clearing houses, and asset managers and mutual funds – were individuals and their retirement money or their college savings.
The same is becoming true of cryptocurrency as retail consumers buy in.
Initiatives and standards are starting to emerge within the industry. Like so much else in crypto markets, these initiatives largely reflect lessons learned by Wall Street. Disclosures by journalists, pundits, and fund managers are starting to become commonplace. Messari, an open source EDGAR-like database, is offering transparency to investors on newly-issued tokens. The Brooklyn Project, launched by Consensys, focuses on consumer protection and setting standards for tokens, encouraging self-regulation by issuers.
Even Coinbase’s probe into employee insider trading demonstrates that it is taking its role in the market – and setting standards for it – seriously.
As Wall Street learned for itself, accountability is an important market practice. These are important developments not just for consumer protection, but also for the growth and longevity of the market as a whole.
If the hype in 2016 was all about replacing Wall Street’s infrastructure with blockchain technology, then 2017 was all about replicating Wall Street’s infrastructure around crypto.
This has led us astray of many of the original promises of cryptocurrency: promises about the roles of issuers, of intermediaries, and of institutions. The level of integrity in the market, unfortunately, also reflects that of the old system, exacerbated by general market immaturity and a lack of agreed-upon standards.
“Long term greedy” is a notion that crypto would do well to borrow from Wall Street. The idea is that certain behaviors, while they may benefit you less in the short term, will pay off in the long run.
These behaviors include having a steady hand in volatile markets, something cryptocurrency investors are well familiar with. More importantly, though, these behaviors also entail respecting other market participants.
I think 2018 will see cryptocurrency markets continue to grow up and self-regulate. 2018 will teach us that being long term greedy is about more than holding – it’s also about maintaining integrity.
Finally, 2018 may return us to some of the original intent of cryptocurrency as the market awakens to remember that the real value lies not through the looking glass, but in the original promises of decentralization and disintermediation.