When it hits the fan, crypto edition — Bitvo

A bull market in stocks!

But crypto still has some cleanup to do.

Some in fintwit have been giddy about the latest SEC actions. And various commentators are announcing that crypto is dead. Again.

But they seem to have forgotten the history of TradFi.

It wasn’t all that long ago that we were facing another financial catastrophe. It’s the fourth or fifth in the last 25 years if memory serves.

We will find out what will happen in crypto soon enough. But it’s good to take a step back and get a big-picture view of unfolding events.

Regulatory attention isn’t fun, but it’s not necessarily bearish.

The history of markets and transformative social and economic events give us a vision of what might be in play.

And crypto has an important contribution to make in a world that is aggressively pushing to centralize everything.

But first, a little history.

From giddy to needing a sedative

In markets, there are giddy times followed potentially by medication time . Every market goes through up and down cycles.

Booms create opportunities and eventually drive animal spirits. New products, services, and ideas proliferate.

Some are good. Others suck.

And unfortunately, there are also frauds and scams.

This is not unique to any one market. This happens in every market.

And regulation is supposed to encourage people, entrepreneurs, and others to be transparent and truthful. So we have rules, laws, and regulations to provide participants with guidance, incentives, and disincentives.

One of the challenges that crypto faces is a belief that it is so new, that none of these rules apply. But it would appear that some in crypto didn’t bother to look at financial history which is littered with examples of what not to do.

Sure, blockchain and several elements of it are new and distinct. There are a ton of unique concepts and configurations that are now possible.

But leverage, saying one thing and doing another, and overt challenges to authority are old.

The history of finance is filled with examples of failed financial ideas, projects, and concepts.

And all of them are written down somewhere.

Knowing what didn’t work before is valuable

I am reminded of one of the founders of Brex when he came to Vancouver in 2019. During the session, he attributed some of their early success to one decision he and his partner made when they pivoted from VR back to their wheelhouse, which was fintech.

He said that before they founded their fintech, they didn’t want to know why others succeeded. They wanted to know why others had failed.

So they went out to the YC fintech alums to get the answer.

And what he discovered was that most of these founders knew exactly why they failed.

When they showed up at a bank to develop a key partnership, they were missing a crucial resource. And without that resource they made an impression about how serious they were.

The missing resource was a guy in a suit with a background in compliance.

So he said that their first hire was a suit with a deep background in financial compliance.

But his core point, and the one that matters, is that by learning from the mistakes that others had made before, he kicked off what was, at the time, a very successful business.

Now, looking back at the history of TradFi, there are plenty of lowlights providing warnings of what to avoid.

And some insight into the origins of the regulations that followed.

The history of finance has lots of skeletons

One event was the South Sea Bubble in England, an event filled with scams and chaos. Charles Mackay immortalized the event in his classic Extraordinary Delusions and the Madness of Crowds. The outcome of the South Sea event was the Bubble Act in 1720. The act effectively prevented the creation of joint stock companies until the Bank Charter Act of 1844.

Around the same time as the South Sea Bubble, there was John Law and the Mississippi Company Bubble. Law combined paper money, a bank, precious metals, and stock of the Mississippi Company into what became a French financial mushroom cloud.

Banking failures and market panics have been a mainstay of economic and financial life for more than 400 years. In the US alone, major financial calamities occurred in 1819, 1937, 1873, 1907, and 1929.

And you don’t have to look back all that far from today to see numerous examples of other financial debacles.

In 1987 we had a crash related to portfolio insurance, an algorithmic trading system with a major design flaw.

In 1998, Long Term Capital (LTCM), brought the financial markets to its knees. Here a group of geniuses made highly leveraged bets across a series of supposedly uncorrelated illiquid assets. Which was a successful play until the spreads blew out in the wrong direction.

But wait, there’s more!

From dot-bomb to the GFC

The dot com bubble successfully incinerated lots of money, reputations and investment accounts. Its aftermath was followed by the uncovering of all kinds of nefarious activities during that boom.

Then there was Enron.

If you follow the natural gas market, you might remember Amaranth and its domination of that market. Brian Hunter bet the farm on a hurricane season that never came, giving John Arnold, the player on the other side of the trade, legend status. Amaranth was wiped out while taking down the entire sector with it.

What about old Bernie Madoff? He managed to avoid regulatory scrutiny for years, despite numerous whistleblowers, before being unveiled as a fraud.

And the Great Financial Crisis, still fresh, was a cesspool of problems from liar loans to leverage, to rehypothecation of assets, to paid-for ratings on structured products and a lack of reserves for CDS (Credit Default Swap) sellers, and so much more.

Post-GFC, many billions in fines have been handed out to an endless slew of banks and financial institutions.

So crypto’s experience is by no means unique in this respect.

Crypto’s challenges are not unprecedented

Remember 2021? All horns, hats, and whistles, right?

What followed in 2022 was a series of calamities.

Sure, interest rates were a catalyst. But so was leverage, too much centralization, overpromising and under delivering, and lousy business models.

But this isn’t new.

The ICO bubble and blowup is a bit like the old South Sea experience.

Terra Luna? Crypto’s Mississippi Company.

Celsius? Well, not exactly Bernie Madoff since they were actually doing the trades, but Barings Bank might be a good example. Remember Barings? Probably not. They’re gone, evaporated by a trader in the firm .

3AC? Well, that one sounds a lot like Amaranth, just with a different product — a familiar story of too much concentration and leverage in a market with some market cap limitations.

Alameda? Incompetence isn’t something new in the trading and investing space. There are so many examples of this, including Societe General’s Jerome Kerviel , Japan’s Sumitomo Copper, and many many more.

When people do stupid stuff, it should be expected to get the attention of regulators. And if you look back at 2021 and 2022, there were lots of examples of stupid. But not out of the ordinary in the history of finance.

Now is this the end of crypto?

Well, in spite of a long history of debacles in TradFi, it’s still around. So the regulatory scrutiny we’re seeing in crypto is more of a growing pains problem rather than outright bearish.

And getting this mess cleaned up now is important because there are some pressing challenges ahead.

Decentralization is the threat

Crypto narratives have made numerous claims about all kinds of outcomes. Some of these are a hard sell, like crypto will replace TradFi. Maybe it will. Maybe it won’t. The claim of a hedge, in many ways, makes an argument that is hard to quantify unless you think the whole system is going to fail. That’s gold’s official role. So that could be a big one.

But the core theme of crypto, blockchain, and the various other elements that are going to make a big difference is decentralization. And the more you look around, the more you realize how powerful this simple idea is.

In fact, it might just be a credible threat to certain entities.

On Kim Iversen’s Show, Catherine Austin Fitts argued that the financial system, TradFi, requires a reset. According to Fitts, at this point it’s inevitable. However, what that reset should be is open for debate.

The highly centralized reset being pushed by a consortium of NGOs is one potential version. In this version, one may be seduced into trading permissionless, peer-to-peer, decentralized, and inalienable human rights for bugs, 15-minute cities, and social credit scores.

@Punk6529 wrote a great thread on Twitter coming from another angle. He argued that blockchain tech and its powerful tracking and decentralized record-keeping would be ideal for tracking government spending.

Now, this is a powerful idea. And given the trillions of moolah governments have manufactured over the last three years, you can see how this might give certain officials some consternation.

Because as we look around, we are seeing some efforts to centralize.

One organization wants to control all healthcare across the globe. Another wants to control food production and what you can eat. Still, another wants to control your movement. Another wants to control money, flows and tracking, and so on.

Decentralized, peer-to-peer, permissionless interactions of free people represent a threat to those wanting to concentrate power in a centralized way.

And that means getting crypto cleaned up and ready to rumble.

Because there is a transformation going on, and we want to have some viable tools and a seat at the table when the time comes to determine the future of humanity.

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Bitvo is a crypto trading platform regulated with FINTRAC as a Money Services Business and as a restricted dealer with the Canadian Securities Administrators.

Originally published at https://bitvo.com on June 16, 2023.