Speaker 1: This is Bloomberg Crypto, a daily Bloomberg I Heard podcast,
Speaker 1: and I'm Stacy Marie Ishmael, Managing editor of Crypto for
Speaker 1: Bloomberg News. Let me cut to the chase. Matt Levine,
Speaker 1: my colleague on the Bloomberg Opinion side of the house,
Speaker 1: is perhaps the greatest finance blogger ever to do it,
Speaker 1: and in what is both a flex and a service,
Speaker 1: He's just written tens of thousands of words on the
Speaker 1: subject of crypto for a special issue of Bloomberg Business Week.
Speaker 1: Matt's gone deep into the blockchain to break down its origins,
Speaker 1: it's possible, futures, and the current state of a technology
Speaker 1: that's showing up everywhere in industries ranging from finance to
Speaker 1: shipping too, of course video games. And we're going to
Speaker 1: be bringing his exploration to you in audio form thanks
Speaker 1: to the talents of Bloomberg editor and professional voice actor
Speaker 1: Mark Ledoff. You'll get weekly chapters of the special Crypto
Speaker 1: issue of Bloomberg Business Week. Welcome to the fifth chapter
Speaker 1: of the special audio edition of the Bloomberg Business Week
Speaker 1: Crypto issue, written by Matt Levine and narrated by Mark Ledoff.
Speaker 1: Mr Chapter needs to catch up you can find previous
Speaker 1: episodes right here in the Bloomberg Crypto Podcast feed Part three.
Speaker 1: The crypto financial system. Let's step back a bit and
Speaker 1: abstract from what we've discussed so far. Crypto is one
Speaker 1: a set of tokens which are worth fluctuating amounts of money.
Speaker 1: We can say that these tokens are financial assets, like
Speaker 1: stocks and bonds. Two. A novel set of way is
Speaker 1: to create new tokens and distribute them and try to
Speaker 1: make them worth money. Three a novel way of holding
Speaker 1: financial assets. Instead of the databases that people use to
Speaker 1: hold stocks and bonds, you can own your own crypto
Speaker 1: on the blockchain. Four A novel way to write contracts
Speaker 1: and computer programs computer programs that are contracts and contracts
Speaker 1: that are computer programs. If you read only that description,
Speaker 1: you might object, Yes, fine, but what is crypto for?
Speaker 1: What do these tokens do? Why are they worth money?
Speaker 1: Nothing in that description answers those objections. I suppose the
Speaker 1: last one does in a sense. Crypto tokens are for
Speaker 1: building smart contracts, for trading crypto tokens. But it's not
Speaker 1: a very good answer because it's entirely self referential. Yes, fine,
Speaker 1: but why are you trading the tokens in the first place,
Speaker 1: and you might have another complaint. Classically, a financial asset
Speaker 1: means a contractual claim on the cash flows of some
Speaker 1: person or entity. A share of stock represents a claim
Speaker 1: on the profits of a company. A bond represents a
Speaker 1: claim on repayment from a company or government, etcetera. My
Speaker 1: financial asset represents a liability or equity issuance of somebody else.
Speaker 1: Each financial asset has both an owner and an obliger.
Speaker 1: Some crypto, I would argue, looks a lot like that.
Speaker 1: It's an equity claim on the value of some cryptoe business.
Speaker 1: But a lot of crypto is consciously not like that.
Speaker 1: Bitcoin is digital gold. It's specifically not a financial asset.
Speaker 1: Owning a bitcoin doesn't represent a claim on anyone else.
Speaker 1: A bitcoin exists as an independent thing that you can own,
Speaker 1: not a contractual relationship between parties, like stock or a bond.
Speaker 1: In the text, I use financial asset in the extremely
Speaker 1: loose sense of like a thing with a fluctuating price
Speaker 1: that you can see on your computer screen, and that
Speaker 1: hedge funds can trade. But cryptocurrencies aren't technically financial assets,
Speaker 1: or not always anyway, But for now I want to
Speaker 1: set such objections to the side. If you're a certain
Speaker 1: sort of financial person, a financial engineer, an arbitragere, a
Speaker 1: market structure enthusiast, a builder of high frequency trading systems,
Speaker 1: this abstract set of facts is incredibly, incredibly beautiful. You
Speaker 1: wake up one day and there's just a whole other
Speaker 1: financial system. It's full of smart people building interesting things,
Speaker 1: and it's full of idiots making terrible mistakes. People have
Speaker 1: built brilliant new ways to make financial bets that you
Speaker 1: can use, and they've built insane new ways to make
Speaker 1: financial bets that you can exploit. How can you not
Speaker 1: want to join in? It's so interesting, so intellectually appealing,
Speaker 1: such a blank canvas for all of your aesthetic views
Speaker 1: about how markets should work. Also, so many idiots are
Speaker 1: getting rich. Why shouldn't you? There are other appealing properties
Speaker 1: when you compare this system to traditional finance. The cryptosystem
Speaker 1: is philosophically one of permissionless innovation. The workings of the
Speaker 1: major blockchains are public and open source. If you want
Speaker 1: to build a derivatives exchange, or margin lending protocol or
Speaker 1: whatever in ethereum, you just do it. You don't need
Speaker 1: to set up a meeting with vitallic Bouteran to get
Speaker 1: his approval. You don't need to negotiate access and fees
Speaker 1: with the Ethereum Corp. There is no Ethereum Corp. Anyone
Speaker 1: can try anything and see if it works. If you're
Speaker 1: a smart young person coming from traditional finance, this feels liberating.
Speaker 1: If you're used to spending months negotiating credit agreements with
Speaker 1: prime brokers and setting up direct access to trade on
Speaker 1: a stock exchange, the idea that you can just do
Speaker 1: stuff in crypto with no preliminaries is amazing. Obviously, it's
Speaker 1: a bit alarming as well. Some of those long, slow
Speaker 1: processes in traditional finance are there to prevent money laundering
Speaker 1: or fraud or ill considered risk taking, but empirically a
Speaker 1: lot of them aren't really preventing any of those things,
Speaker 1: and aren't doing so in an optimal way. A lot
Speaker 1: of them are just how it's always been done. Nothing
Speaker 1: in crypto is how it's always been done. It's all
Speaker 1: too new, and so people invented a financial system for crypto.
Speaker 1: It runs alongside the traditional financial system, though they touch
Speaker 1: at many points. In some ways, it looks a lot
Speaker 1: like a copy of the traditional financial system. In other ways,
Speaker 1: it looks totally different. In some ways, it's a streamlined
Speaker 1: and modernized and innovative evolution of the traditional system. In
Speaker 1: other ways, it's a chaotic and stupid devolution of the
Speaker 1: traditional system, a version of traditional finance traad FI, as
Speaker 1: crypto people call it, that unlearned important historic lessons about
Speaker 1: fraud and leverage and risk and regulation. It's so fun.
Speaker 1: Let's talk about it. A your keys, your coins, your
Speaker 1: hard drive in a garbage one holding crypto. Maybe the
Speaker 1: first thing to say about the crypto financial system is
Speaker 1: that the traditional financial system is deeply intermediated, and the
Speaker 1: crypto system is not. If you have money, your bank
Speaker 1: tracks your money for you. If you have stock, your
Speaker 1: broker tracks your stock for you, et cetera. One dumb,
Speaker 1: simple thing that this means, if you have money in
Speaker 1: the bank, your bank has to give it to you.
Speaker 1: If you forget the pin code for your A T
Speaker 1: M card, or if you forget the password for your
Speaker 1: online banking, you'll have a hard time taking out money,
Speaker 1: and that will be inconvenient for you. But the bank
Speaker 1: owes you the money. They can't just be like, ah ha,
Speaker 1: got you the money. Is ours. Now there's some process
Speaker 1: by which you can go into the bank and prove
Speaker 1: that you are who you say you are, and they're like, fine,
Speaker 1: will reset your password. It's test one, two, three, four,
Speaker 1: don't forget this time. Crypto doesn't necessarily work like that.
Speaker 1: Owning bitcoin means one having a public bitcoin address with
Speaker 1: some bitcoin in it, and to possessing the private key
Speaker 1: to that address. If you have the public address private
Speaker 1: key pair, then you own the bitcoin. You can transfer
Speaker 1: them to someone else on the blockchain. If you don't
Speaker 1: have that pair, then you can't. If you lose your
Speaker 1: private key or lose track of your public address, there's
Speaker 1: no one to recover your password for you or give
Speaker 1: you back your bitcoin. They're just gone. There are ways to,
Speaker 1: you know, not lose your keys. Mainly, people use software wallets,
Speaker 1: which generate and keep track of their addresses and private
Speaker 1: keys and allow them to sign transactions and send and
Speaker 1: receive crypto online. The wallets maybe desktop or phone apps,
Speaker 1: or extensions on a browser. Most modern wallets require you
Speaker 1: to keep track not of private keys, but rather a
Speaker 1: seed phase of typically twelve random looking words maybe army,
Speaker 1: truth speak, average and so on. The phrase can be
Speaker 1: used as a seed to generate lots of public private
Speaker 1: key pairs, so the wallet can create lots of different
Speaker 1: addresses that can all be recovered from a single seed phrase.
Speaker 1: People often speak of wallets holding crypto, but really what
Speaker 1: they have are these keys for various addresses. The crypto
Speaker 1: is only ever on the blockchain. Then you write the
Speaker 1: seed phrase down on a piece of paper, which is
Speaker 1: easier to write than a long random number. But this
Speaker 1: is a developing technology, and there's a long history of
Speaker 1: people losing forgetting or throwing away their private keys or
Speaker 1: seed phrases. A guy in Wales named James Howell's periodically
Speaker 1: pops up in the news because he threw away a
Speaker 1: hard drive with the private key for eight thousand bitcoin.
Speaker 1: He's pretty sure he knows the garbage dump that has
Speaker 1: his hard drive, and for years he's been waging a
Speaker 1: campaign to dig up the dump and sift through the garbage.
Speaker 1: If he finds the hard drive, and if it still works,
Speaker 1: then he'll have bitcoin worth about a hundred and fifty
Speaker 1: million dollars which he can use to pay all the
Speaker 1: garbage diggers. In one sense, it would be much much
Speaker 1: better to have a financial system in which the bank
Speaker 1: could reset his password and give him back the eight
Speaker 1: thousand bitcoin instead of digging up a garbage dump. In
Speaker 1: another sense, this is an extremely funny financial system, and
Speaker 1: there's a charm to that two not holding crypto. If
Speaker 1: you're a portfolio manager at an institutional investor and you
Speaker 1: want to buy a bitcoin, and you go to your
Speaker 1: compliance and operations people and say, I want to buy
Speaker 1: a bitcoin, and I will write our private keys down
Speaker 1: on a post it that I will keep next to
Speaker 1: my computer, they will say no. If you propose better
Speaker 1: security measures, they might still say no, this stuff is
Speaker 1: too new, too scary. If you say, Mega Bank Custody
Speaker 1: Services will hold our bitcoin for us, and we'll just
Speaker 1: have a book entry on their ledger saying we have bitcoin,
Speaker 1: then compliance might be a bit more comfortable. But that
Speaker 1: requires a bank to offer that service. But what if
Speaker 1: you go to your compliance and say, I'm just going
Speaker 1: to enter into a bet with a hedge fund on
Speaker 1: the price of bitcoin. For every dollar the bitcoin goes up,
Speaker 1: the hedge fund will pay us five dollars. For every
Speaker 1: dollar that it goes down, we'll pay them five dollars.
Speaker 1: Then you don't have to own crypto at all all
Speaker 1: you have is an over the counter derivative with a
Speaker 1: hedge fund. Compliance knows what that is. That's an understandable thing.
Speaker 1: There are no weird custody issues there because there's nothing
Speaker 1: to keep custody of. There are no weird coins to
Speaker 1: worry about, just a contract with a hedge fund to
Speaker 1: pay you money. You can write contracts on the price
Speaker 1: of corn, on interest rates, and on hurricane damage. So
Speaker 1: why not bitcoin. You do due diligence on the hedge fund,
Speaker 1: You get comfortable with the credit and collateral terms, and
Speaker 1: then you sign the contract and then economically you own
Speaker 1: some bitcoin. Your investment is up when bitcoin goes up
Speaker 1: and down when bitcoin goes down, without the worries of
Speaker 1: really owning bitcoin, no keys to lose. And so in
Speaker 1: traditional finance there's a big business offering those instruments. CME
Speaker 1: Group Inc. Offers Bitcoin futures, which are basically the bet
Speaker 1: that I outlined above. You pay me five dollars for
Speaker 1: every dollar the bitcoin goes up, and I pay you
Speaker 1: five dollars for every dollar it goes down. It's a trusted, centralized,
Speaker 1: traditional finance way to bet on the price movements of bitcoin. Still,
Speaker 1: not everyone can buy futures, which require a lot of
Speaker 1: money and aren't offered by some retail brokerages. In the
Speaker 1: US financial system, pretty much the easiest thing to invest
Speaker 1: in is stocks, so wrapping bitcoin in a stock would
Speaker 1: increase its appeal. The easiest way to do this would
Speaker 1: be a cash bitcoin exchange traded fund, a pot of
Speaker 1: money that trades like a stock on a stock exchange
Speaker 1: and invests the money in bitcoin. People keep trying to
Speaker 1: do this, but the US Securities and Exchange Commission remained
Speaker 1: skeptical and hasn't approved cash bitcoin ETFs, though they exist
Speaker 1: in some other countries. The US has however, approved bitcoin
Speaker 1: futures e t f s, which invest in bitcoin through
Speaker 1: futures contracts. Two layers of abstraction. A bitcoin wrapped in
Speaker 1: a futures contract, wrapped in a stock, and delivered to
Speaker 1: your brokerage account b C five one fiat on ramps. Okay,
Speaker 1: I said, one way to own a bitcoin is to
Speaker 1: write your private key on a post it note. But
Speaker 1: where did you get that bitcoin? In the early days
Speaker 1: of bitcoin, a reasonably plausible answer would be I mind it.
Speaker 1: Every bitcoin ever created has come from mining, and early
Speaker 1: bitcoin was in part a hobbyist mining operation. In modern crypto,
Speaker 1: you're not going to get very far just by mining
Speaker 1: crypt to on your home computer. The main way people
Speaker 1: in most of the world get into crypto is that
Speaker 1: they exchange dollars or euros, pounds, you on, etcetera. What
Speaker 1: crypto people call fiat for crypto and how they do
Speaker 1: that is a tricky question. One simple way is for
Speaker 1: you to find someone with crypto and say, hey, can
Speaker 1: I buy some of your crypto? They say sure, and
Speaker 1: you arrange a deal. In researching this article, I set
Speaker 1: up an ethereum wallet and texted a friend to ask
Speaker 1: if he had any Ether I could buy. He replied sure,
Speaker 1: and I said send me twenty dollars worth and gave
Speaker 1: him my public address. He sent me twenty dollars of ether,
Speaker 1: and then he texted me to say done. Then mom
Speaker 1: me twenty dollars. I did, and our transaction was complete.
Speaker 1: He sent me the ether before I sent him the dollars,
Speaker 1: so he took some credit risk, and in fact I
Speaker 1: was away from my phone when he sent it, so
Speaker 1: he ended up taking my credit risk for several hours.
Speaker 1: When I did get his text, I briefly considered that
Speaker 1: it would be very funny if as part of my
Speaker 1: research for this article, I stole twenty dollars of either
Speaker 1: from him, but that seemed mean. Just so you know,
Speaker 1: Bloomberg's Code of Journalistic Ethics forbids journalists who write about crypto,
Speaker 1: including me, from owning more than a nominal amount of
Speaker 1: crypto for research purposes. This rule itself is arguably biasing.
Speaker 1: It forbids crypto enthusiasts from writing about crypto, but never mind.
Speaker 1: In researching this article, I bought twenty dollars of ether
Speaker 1: from a friend by Venmo and a hundred dollars of
Speaker 1: ether from coin Base. This also led to coin Base
Speaker 1: giving me like five dollars of free bitcoin as a
Speaker 1: new account bonus. In seeking permission to do this, I
Speaker 1: told my boss is that one I planned to lose
Speaker 1: all my money, but two, if I accidentally made any profit,
Speaker 1: I would donate it. I did spend like eight dollars
Speaker 1: of ether on the Matthew Levine dot et h domain.
Speaker 1: I'm not coin to lie. This was fun to do
Speaker 1: and fun to write about. It felt sillier and more
Speaker 1: exciting than my automatic monthly Vanguard investments, but it's not
Speaker 1: a good way to run a financial system. Incidentally, the
Speaker 1: day after I did that trade, I met with the
Speaker 1: team behind a decentralized finance protocol and was like, well,
Speaker 1: how would you quickly turn dollars into ether in New York?
Speaker 1: And they had no great answers and we're like, we're
Speaker 1: working on it, and I was like, well, I texted
Speaker 1: a friend for ether and then then mode him the money,
Speaker 1: and they were like, yeah, that's probably what we would do.
Speaker 1: In general, if you get a text asking you to
Speaker 1: send crypto to a string of letters and numbers, you
Speaker 1: should throw your phone into the ocean instead. The main
Speaker 1: way that normal people by crypto is through crypto exchanges,
Speaker 1: specifically centralized crypto exchanges. Crypto exchanges are companies coin based.
Speaker 1: Gemini Finance, f t X, Kraken and bitfin X are
Speaker 1: some big ones that accept regular money for crypto. You
Speaker 1: wire an exchange a hundred dollars and it gives you
Speaker 1: one hundred dollars worth of bitcoin, perhaps minus a fee.
Speaker 1: In the olden days, the stereotype was that a lot
Speaker 1: of crypto exchanges were run by criminals or incompetent teenagers
Speaker 1: or incompetent teenage criminals. The standard crypto exchange transaction was
Speaker 1: one you exchange your dollars for bitcoin to buy heroin,
Speaker 1: and then to the exchange got hacked and lost your
Speaker 1: bitcoin before you could even buy the heroin. Modern crypto
Speaker 1: exchanges are less like that. For one thing, they're more
Speaker 1: careful and technically adept, so they're less likely to lose
Speaker 1: your bitcoin. For another thing, though they're big companies, regulators
Speaker 1: are aware of them, and they try to be good
Speaker 1: corporate citizens In their role as on ramps and off
Speaker 1: ramps between traditional currencies and crypto. They do the same
Speaker 1: sorts of anti money laundering and know your customer checks
Speaker 1: that traditional banks and brokerages do. If you show up
Speaker 1: at coin base, a US public company, with a sack
Speaker 1: of dollar bills that you got from dealing heroin and
Speaker 1: try to convert them into bitcoin, coin Base will turn
Speaker 1: you away and probably report you to the police. The
Speaker 1: centralized exchanges are very much part of the regulated financial
Speaker 1: system these days. The days of crypto being a zone
Speaker 1: of utter lawlessness are mostly gone. This is a series
Speaker 1: of trade offs. Roughly speaking, the crypto exchanges of the
Speaker 1: olden days let you trade dollars for bitcoin without asking
Speaker 1: any questions, but they might steal your bitcoin. When the
Speaker 1: exchanges were unregulated and crime positive, the odds of them
Speaker 1: doing crime to you or having crime done to them
Speaker 1: were pretty high. The modern crypto exchanges ask a lot
Speaker 1: of questions that make it difficult for you to move
Speaker 1: tons of money in secret, but they probably won't steal
Speaker 1: your bitcoin. Two custodians. So you've opened an account at
Speaker 1: an exchange and sent the exchange one hundred dollars to
Speaker 1: buy one hundred dollars worth of bitcoin. What does the
Speaker 1: exchange give you for your hundred dollars? One possibility. It
Speaker 1: gives you point zero zero five to one five bitcoin.
Speaker 1: It sends you some instructions on how to set up
Speaker 1: a bitcoin wallet. It asks you for a public bitcoin address.
Speaker 1: It converts one hundred dollars to bitcoin at the current
Speaker 1: market price, and it sends you that number of bitcoin
Speaker 1: at your public address, and then you access those bitcoin
Speaker 1: using your private key for that address. This is suboptimal
Speaker 1: for the exchange for one thing. Dollar and bitcoin transactions
Speaker 1: have different time frames and finality. If you fund your
Speaker 1: account with a bank transfer or a credit card, and
Speaker 1: then you buy one hundred dollars of bitcoin, and then
Speaker 1: you call your bank and say I've been defrauded. I
Speaker 1: don't recognize that charge. There's a decent chance the bank
Speaker 1: will take the one hundred dollars from the exchange and
Speaker 1: give it back to you. Meanwhile, the bitcoin transfer to
Speaker 1: your wallet is fast and irreversible. For another thing, you know,
Speaker 1: the exchange will get some customers who don't write down
Speaker 1: their wallets seed phrase, or lose it or forget it
Speaker 1: and then can't access the bitcoin, and they'll call the
Speaker 1: exchanges customer service number and say I lost the password
Speaker 1: to my bitcoin account. Can you reset it? And the
Speaker 1: exchange will say, no, it doesn't work that way. Also,
Speaker 1: we don't have a customer service number, and the customers
Speaker 1: won't like it. I paid you one dollars for bitcoin
Speaker 1: and I don't have the bitcoin, they'll say and blame
Speaker 1: the exchange and complain to regulators and law enforcement and
Speaker 1: the press, and especially to their bank or credit card company. Now,
Speaker 1: these problems are annoying but solvable, and modern crypto exchanges
Speaker 1: do some amount of this, acquiring crypto for self custodying customers.
Speaker 1: But there's a simpler possibility that is also quite popular.
Speaker 1: The exchange could hang onto your bitcoin for you, instead
Speaker 1: of sending you point zero zero five to one five
Speaker 1: bitcoin on the bitcoin blockchain, it could go out and
Speaker 1: buy point zero zero five to one five bitcoin and
Speaker 1: put them into its own bitcoin wallet. Being a professional
Speaker 1: bitcoin exchange, it could put in the effort to keep
Speaker 1: these bitcoins safe and not lose the keys, And then
Speaker 1: instead of sending you point zero zero five to one
Speaker 1: five bitcoin, the exchange just keeps a database of its
Speaker 1: customers and their account balances, and your entry in the
Speaker 1: database includes your name, your driver's license number, your account number,
Speaker 1: your email address, your phone number, your password just kidding,
Speaker 1: a hash of your password, your mother's maiden name, and
Speaker 1: your account balance, and the exchange rights point zero zero
Speaker 1: five to one five in the balance field. And then
Speaker 1: when you log into your account, it displays point zero
Speaker 1: zero five to one five bitcoin as your account balance.
Speaker 1: And you think you own point zero zero five to
Speaker 1: one five bitcoin, and you're not exactly wrong, but really
Speaker 1: what you own is a claim on the exchange for
Speaker 1: point zero zero five to one five bitcoin. You don't
Speaker 1: own them directly, and you don't control the private key.
Speaker 1: You just have an entry on the ledger of the exchange,
Speaker 1: you know, like a bank If you have a bank account,
Speaker 1: the bank owes you money and you trust it to
Speaker 1: keep a record of that. If you have a crypto
Speaker 1: exchange account, it's the same, but the exchange owes you bitcoin.
Speaker 1: One thing this means is that if you lose your password,
Speaker 1: you can call the exchange and it can reset it
Speaker 1: for you. The customer service can be a bit better.
Speaker 1: There are some obvious downsides. One big one it's like
Speaker 1: a bank. If you got into bitcoin because you don't
Speaker 1: trust banks and you want to be in control of
Speaker 1: your own money. It's somewhat weird philosophically to just go
Speaker 1: and trust a crypto exchange to keep your money for you.
Speaker 1: These days, the big crypto exchanges seem to be mostly
Speaker 1: law abiding, and you can get rich enough running a
Speaker 1: legitimate crypto exchange that it seems silly to steal the
Speaker 1: money instead. But another downside is hackers. A crypto exchange
Speaker 1: has a giant pot of money, and it has to
Speaker 1: move that money around a lot to deal with customer transactions.
Speaker 1: It's an appealing target for hackers looking to steal private keys. Again,
Speaker 1: modern crypto exchanges spend a lot of money on information security,
Speaker 1: but that wasn't always the case, and there's a long
Speaker 1: history of bitcoin exchanges being hacked or quote unquote hacked.
Speaker 1: When all the bitcoin in it exchanges while it gets stolen,
Speaker 1: it can be hard to tell sometimes whether they were
Speaker 1: stolen by outside hackers or by the exchanges ceo. Also,
Speaker 1: while I suppose an exchange is less likely to lose
Speaker 1: its private keys than the average customer is, it can happen.
Speaker 1: In The CEO of Quadriga Fintech Solutions Corps. Died in
Speaker 1: somewhat mysterious circumstances while on vacation in India. At the time,
Speaker 1: the company's Quadriga c X was Canada's largest crypto exchange,
Speaker 1: and it was apparently run entirely off of its CEO's laptop.
Speaker 1: When he died, he took all of Quadriga's private keys
Speaker 1: with him, meaning its customers bitcoin were lost forever, or
Speaker 1: that's what it would have meant, except that before he
Speaker 1: died he also stole all the customers bitcoin, so the
Speaker 1: wall whose keys disappeared with him were empty. Anyway, when
Speaker 1: crypto exchanges are bad, they tend to be bad in
Speaker 1: all ways at once. Three also exchanges, though centralized crypto
Speaker 1: exchanges are on ramps to crypto for people with dollars
Speaker 1: and other traditional currencies, but they're also exchanges. If you
Speaker 1: have some bitcoin in your coin based account and you'd
Speaker 1: rather have ether, you can sell your bitcoin for ether.
Speaker 1: If you want to actively trade among cryptocurrencies to make
Speaker 1: bets on which will go up more, you can do
Speaker 1: that on an exchange. In traditional finance, there tends to
Speaker 1: be a division between exchanges and brokerages. If you want
Speaker 1: to buy stock, you open an account at a brokerage
Speaker 1: such as Charles Schwab, Fidelity or robin Hood, and you
Speaker 1: send your broker in order to buy stock. The stock
Speaker 1: exchange is the place for big brokerages and institutions to
Speaker 1: trade stock. Retail customers need an account with a broker
Speaker 1: to access the exchange. In practice, modern US stock trading
Speaker 1: is even more intermediated than this, and your order may
Speaker 1: get sent to an electronic trading firm and not the
Speaker 1: stock exchange. There are many layers of intermediation in crypto.
Speaker 1: That's not generally true. Big crypto exchanges such as coin
Speaker 1: base or f t X let anyone open an account
Speaker 1: and trade crypto directly on the exchange, and you wouldn't
Speaker 1: normally connect to the exchange through a broker, though traditional
Speaker 1: retail stock brokerages are increasingly getting into the business of
Speaker 1: buying crypto for their customers. Every step that goes into
Speaker 1: making a trade happen getting your money into the account,
Speaker 1: taking your by order, matching your order with someone else's
Speaker 1: cell order, settling the trade, putting the crypto in your account.
Speaker 1: Keeping track of your account is done by the exchange.
Speaker 1: Let me spend a bit more time on one of
Speaker 1: those functions providing leverage. If bitcoin isn't exciting enough for you,
Speaker 1: you can find an exchange that will let you borrow
Speaker 1: money to buy more of it. You put in one dollars,
Speaker 1: the exchange lends you nine dollars. You get one thousand
Speaker 1: dollars worth of bitcoin. If bitcoin goes up ten percent,
Speaker 1: you double your money. If bitcoin goes down ten percent,
Speaker 1: you lose everything. Bitcoin goes up and down by ten
Speaker 1: percent a lot, so this is an exciting way to gamble.
Speaker 1: Traditional finance also provides leverage, but it's a complex and
Speaker 1: intermediated system involving brokers and clearing houses. Crypto exchanges are
Speaker 1: more integrated, so in many cases of crypto exchange is
Speaker 1: basically in the business of managing market risk. Say, instead
Speaker 1: of bitcoin going down ten percent, it falls, you're not
Speaker 1: only down your original one dollars, but now you owe
Speaker 1: fifty dollars. Crypto exchanges have to decide when to make
Speaker 1: you post collateral, put up more money to ensure that
Speaker 1: you're good for your losses, and when to liquidate your
Speaker 1: position so you don't lose more than you can pay back.
Speaker 1: The crypto exchange may have customers with big leveraged bets
Speaker 1: on bitcoin rising they're long in the language of finance,
Speaker 1: and customers with big leveraged bets against bitcoin they're short.
Speaker 1: If Bitcoin moves too far in one direction too quickly,
Speaker 1: then the long or short customers will be out of money,
Speaker 1: which means there won't be money to pay back the
Speaker 1: short or long customers. On the other side, the exchange
Speaker 1: has to think about how volatile its assets are, set
Speaker 1: leverage limits so blow ups are unlikely, and monitor leverage
Speaker 1: levels to ensure no one is in imminent danger of
Speaker 1: blowing up. If someone is likely to blow up, the
Speaker 1: exchange has to seize their collateral and sell it ideally
Speaker 1: in an intelligent way that doesn't destabilize the market too much,
Speaker 1: and in periods of high volatility, the exchange might shut
Speaker 1: down trading rather than deal with all this. That's a
Speaker 1: lot of centralized decision making. We'll be right back with
Speaker 1: more from Bloomberg Business Week Special Crypto issue written by
Speaker 1: Matt levine a narrated by Mark Leadoff. See stable coins.
Speaker 1: Bitcoin is good at keeping track of who has bitcoin.
Speaker 1: This is technologically interesting and also useful in so far
Speaker 1: as bitcoin are a store of wealth. And if bitcoin
Speaker 1: were the dominant currency in the world, if it were
Speaker 1: digital cash and you could use it to buy stuff,
Speaker 1: and the prices of things were set in bitcoin, then
Speaker 1: it would be even more useful. But it isn't. You
Speaker 1: use dollars or pounds or yan or euros to buy stuff,
Speaker 1: and the price of bitcoin in dollars, etcetera is very volatile.
Speaker 1: One thing that would be cool is if crypto could
Speaker 1: keep track of who has dollars, then you could get
Speaker 1: the benefits of crypto decentralization, smart contracts skirting the law
Speaker 1: along with the benefits of dollars. Your bank account isn't
Speaker 1: incredibly volatile. You can buy a sandwich. A stable coin
Speaker 1: is a crypto token that's supposed to always be worth
Speaker 1: one dollar or one unit of some other traditional currency. Though,
Speaker 1: whilst two dollars, if you have a stable coin, then
Speaker 1: you have one dollar on the blockchain, you hope one collateralized.
Speaker 1: The simplest sort of stable coin is what sometimes called
Speaker 1: a fully backed stable coin. Popular examples include us DC
Speaker 1: and tether. The idea here is one some reasonably trustworthy
Speaker 1: institution sets up a stable coin factory to issue stable
Speaker 1: coins on one or more popular block chains. Two you
Speaker 1: give the issuer one dollar. Three it gives you back
Speaker 1: one stable coin. Four it puts the dollar somewhere safe.
Speaker 1: Five If you ever want your dollar back, you give
Speaker 1: the issuer one stable coin and it gives you back
Speaker 1: the dollar. Or maybe not you, but an institutional investor.
Speaker 1: This description makes a stable coin issue where an on
Speaker 1: off ramp between regular currency and crypto, which is risky
Speaker 1: for the reasons we discussed earlier regulatory credit, etcetera. If
Speaker 1: you want to hand the issue where a stable coin
Speaker 1: and and get back a dollar, it will probably at
Speaker 1: least want to do know your customer checks to make
Speaker 1: sure it's okay to give you dollars, or the issuer
Speaker 1: might limit redemptions to some list of large institutional investors.
Speaker 1: Rather than letting just anyone show up with a stable coin.
Speaker 1: This is probably fine. If there are enough institutions who
Speaker 1: can redeem stable coins for dollars, then they will buy
Speaker 1: stable coins for a round a dollar, and you can
Speaker 1: just sell your stable coins to them. Your stable coin
Speaker 1: lives on some blockchain and can be traded and used
Speaker 1: like any other token on that blockchain. Most of the
Speaker 1: big stable coin issuers issue on multiple blockchains. Tether lives
Speaker 1: mostly on Tron and Ethereum, USDC lives mostly on Ethereum,
Speaker 1: but is also on Salana, tron Avalanche, and to a
Speaker 1: lesser extent, for other blockchains. If you have ten thousand
Speaker 1: dollars stable coins on the Ethereum blockchain and you want
Speaker 1: to buy some Ether, you can buy ten thousand dollars
Speaker 1: worth of Ether with your stable coins without putting more
Speaker 1: dollars in, and if you have ten thousand dollars worth
Speaker 1: of either, you can sell it for ten thousand dollars
Speaker 1: stable coins. Having ten thousand dollars stable coins is like
Speaker 1: having ten thousand dollars, but the stable coins live on
Speaker 1: the blockchain in your crypto wallet rather than in a
Speaker 1: bank account. This is useful if, for instance, you don't
Speaker 1: have a bank account, or if you don't live in
Speaker 1: the US and it's hard for you to set up
Speaker 1: a dollar denominated bank account, or if you plan to
Speaker 1: use the ten thousand dollars to buy more crypto later
Speaker 1: and you don't want to move it back and forth
Speaker 1: between the regular and crypto financial systems, or if you
Speaker 1: want to send the ten thousand dollars to a smart
Speaker 1: contract which can deal directly with your crypto wallet, but
Speaker 1: which has a hard time talking to a bank. Banks
Speaker 1: are suspicious of crypto, and crypto is suspicious of banks,
Speaker 1: so it's always a bit painful to connect the cryptosystem
Speaker 1: to a bank. This smart contract will send me dollars
Speaker 1: if the Jets win this weekend. No bad, doesn't work.
Speaker 1: This smart contract will send me stable coins if the
Speaker 1: Jets win. Yes, fine. Stable coins are wrapped dollars dollars
Speaker 1: that live on the blockchain. More generally, this is useful
Speaker 1: if you think the crypto financial system is better than
Speaker 1: the traditional one. If sending tokens over a crypto blockchain
Speaker 1: is faster and cheaper than sending dollars by interbank transfer,
Speaker 1: then stable coins are a better way to send dollars
Speaker 1: If the blockchain lets you develop interesting derivatives, contracts, and
Speaker 1: trading applications in a quick and permissionless way, and the
Speaker 1: traditional financial system doesn't, you'll want to use stable coins
Speaker 1: instead of regular dollars. One important point about the collateralized
Speaker 1: stable coin model is that it requires you to trust
Speaker 1: the issuer. The dollar nous of the stable coin happens
Speaker 1: as it were, entirely off the blockchain. As a crypto matter,
Speaker 1: what you have is a receipt for one dollar from
Speaker 1: some institution that you trust. If that institution incenterates all
Speaker 1: the dollars, that receipt shouldn't be worth a dollar. One
Speaker 1: of the longest running and funniest controversies in crypto is
Speaker 1: about where Tether, the biggest stable coin, keeps its money.
Speaker 1: Tether is replete with colorful characters the Mighty Ducks Guy, etcetera,
Speaker 1: and they go around boasting about how transparent they are
Speaker 1: without actually saying where the money is. They also go
Speaker 1: around promising to publish an audit, but never do it.
Speaker 1: They probably have the money more or less, but they
Speaker 1: seem to be going out of their way to seem untrustworthy.
Speaker 1: Still people trust them. One you can collateralize other things.
Speaker 1: The collateralized stable coin model is a way to wrap
Speaker 1: non crypto assets and put them on the blockchain. You
Speaker 1: could imagine all sorts of assets getting wrapped. For instance,
Speaker 1: what if you wanted to trade stocks, but in crypto
Speaker 1: You might want to do this for reasons similar to
Speaker 1: why you might want to have dollars. But in crypto
Speaker 1: you like the cryptosystem, the smart contracts, the permissionless innovation,
Speaker 1: the decentralized exchanges, frankly, the lack of regulation. But you
Speaker 1: also like stocks, which represent ownership and productive enterprises, and
Speaker 1: are also a very popular tool for speculation. The cryptosystem
Speaker 1: doesn't talk all that well to the stocks system. Your
Speaker 1: broker is suspicious of crypto, and crypto is suspicious of
Speaker 1: your broker. Less and less so, but still putting the
Speaker 1: stocks on the blockchain lets you trade the things you
Speaker 1: want stocks the way you want in crypto. Conceptually, one
Speaker 1: way to do this is that some fairly trustworthy institution
Speaker 1: buys a bunch of Tesla ink stock and holds it
Speaker 1: in its vault, and then it issues wrapped Tesla tokens
Speaker 1: on some blockchain. Each w ts L a token corresponds
Speaker 1: to one share of Tesla that the institution has in
Speaker 1: its vault, and you can trade them on the blockchain
Speaker 1: exactly as you would Ether. And in fact this exists.
Speaker 1: F t X, a leading centralized crypto exchange, offers tokenized
Speaker 1: stocks on the Salana blockchain, though not to US customers. Binance,
Speaker 1: another leading exchange, offered tokenized stocks for a while, but
Speaker 1: then stopped. If you're going to try this, you'll want
Speaker 1: to run it by your local securities regulator. It's legally
Speaker 1: sensitive to find new ways to sell people new not
Speaker 1: quite stocks, But if it works, it's interesting for a
Speaker 1: crypto exchange. It's a way to keep your retail gamblers
Speaker 1: gambling on your platform. Someone who wants to bet on
Speaker 1: bitcoin and Ether and Tesla stock can do all of
Speaker 1: it on one crypto exchange. More broadly, though, it's a
Speaker 1: way for the crypto financial system to ingest the traditional
Speaker 1: financial system. Have a financial asset, put it in a box,
Speaker 1: and issue tokens about it. Now it's a crypto asset.
Speaker 1: If the crypto financial system is good, if the computer programs,
Speaker 1: payment rails, and institutional structures of crypto have competitive advantage,
Speaker 1: is against the programs, rails, and structures of traditional finance.
Speaker 1: Then some people will prefer to trade their stocks or
Speaker 1: bonds or other financial assets in the cryptosystem two algorithmic.
Speaker 1: The fully backed stable coin model has problems. One is
Speaker 1: that you might not trust the issuer of a backed
Speaker 1: stable coin. Another is that you might not want to
Speaker 1: trust any issuer. An issuer of a fully backed stable
Speaker 1: coin is by necessity using the US dollar financial system.
Speaker 1: It's keeping the backing dollars in a bank or in
Speaker 1: other traditional finance dollar instruments. It might be subject to
Speaker 1: the regulatory pressures of that system. What you want is
Speaker 1: something that's worth a dollar but exists purely on the blockchain.
Speaker 1: Can that be done one good algorithmic, sure, and with
Speaker 1: a fairly simple and traditional bit of financial engineering. It
Speaker 1: starts with leverage, or just borrowing money. Leverage is a
Speaker 1: way to amplify the risks and returns of betting on Krypto.
Speaker 1: Instead of putting in one hundred dollars and buying one
Speaker 1: hundred dollars worth of bitcoin and making ten dollars if
Speaker 1: bitcoin goes up ten percent, I put in one hundred
Speaker 1: dollars and borrow one hundred dollars and buy two hundred
Speaker 1: dollars worth of bitcoin and make twenty dollars. If bitcoin
Speaker 1: goes up ten percent, or I lose twenty dollars. If
Speaker 1: bitcoin goes down ten percent, or I lose everything if
Speaker 1: bitcoin goes down for me, that's a high risk, high
Speaker 1: reward proposition. But what if I borrowed the money from you?
Speaker 1: What does that proposition look like for you? Well, if
Speaker 1: bitcoin goes up ten percent, you get back one hundred dollars.
Speaker 1: I sell my bitcoin for two d twenty dollars, give
Speaker 1: you back one hundred dollars and keep the rest. And likewise,
Speaker 1: if bitcoin goes up, you get back one hundred dollars.
Speaker 1: I sell two hundred forty, give you back a hundred,
Speaker 1: and keep a hundred forty. If bitcoin goes down, you
Speaker 1: get back a hundred dollars. I sell for one hundred
Speaker 1: and sixty, give you a hundred and keep sixty. If
Speaker 1: bitcoin goes down forty nine point five percent, you get
Speaker 1: back one hundred dollars. I sell for one one, give
Speaker 1: you back a hundred, and keep one dollar. Let's stop
Speaker 1: there for no particular reason. At every point that I've
Speaker 1: named so far, you get back one hundred dollars. You
Speaker 1: put in one hundred dollars and you get back one
Speaker 1: hundred dollars no matter what. For me, this trade is
Speaker 1: very risky. If bitcoin fell forty nine point five percent,
Speaker 1: I lost. For you, this trade is very safe, very stable.
Speaker 1: What you have is a stable coin. You put in
Speaker 1: one hundred dollars and get back one hundred dollars. This
Speaker 1: basic idea is called an algorithmic stable coin. You put
Speaker 1: in one hundred dollars and get back a thing that's
Speaker 1: worth one hundred dollars, with that value guaranteed by a
Speaker 1: larger amount of a volatile cryptocurrency. I've described this as
Speaker 1: just a direct loan from you to me a con tract,
Speaker 1: but ordinarily this would be done as a smart contract,
Speaker 1: a computer program on a blockchain. The Talent describes a
Speaker 1: rudimentary form of this in the original Ethereum white paper,
Speaker 1: calling it a hedging contract. Here's a slightly different example
Speaker 1: that involves no dollars at all. Say you and I
Speaker 1: each put one thousand ether into a smart contract, and
Speaker 1: that when we do it, one thousand ether is worth
Speaker 1: one million dollars on some preset maturity date. The contract
Speaker 1: will send you one million dollars worth of either and
Speaker 1: I will get whatever either is left. If either doubled
Speaker 1: in value in that time, that means you'll get five
Speaker 1: ether worth one million dollars, and I'll get hundred either
Speaker 1: worth three million dollars. On the other hand, if either's
Speaker 1: dollar value fell, you get all the ether in the pool,
Speaker 1: So you get your one million dollars back and I
Speaker 1: get nothing. You get back one million dollars no matter what.
Speaker 1: The smart contract though never held any dollars at all.
Speaker 1: There's no bank account, no treasury bills, no trusted central intermediary.
Speaker 1: But you have a claim with a steady value in
Speaker 1: US dollars. We have, in a way, manufactured dollars purely
Speaker 1: out of crypto. A few points first, I'm being far
Speaker 1: too cute here in my original example. If the price
Speaker 1: of bitcoin falls by my two worth of bitcoin will
Speaker 1: be worth ninety eight dollars and I won't have enough
Speaker 1: money to pay you back. You're supposed stable coin is
Speaker 1: worth cents. Can the price of bitcoin fall by more
Speaker 1: than Oh? Yes, absolutely it did that this year. It's
Speaker 1: not easy to manufacture stable coins out of extremely unstable assets.
Speaker 1: Your algorithmic stable coin has some risk of becoming unstable,
Speaker 1: but you can do a little better than the crude
Speaker 1: version I've proposed here. You could have margin calls, for instance,
Speaker 1: so that if bitcoin falls by more than the smart
Speaker 1: contract sells the remaining bitcoin to pay me back immediately.
Speaker 1: Actual algorithmic stable coins die. The stable coin of Maker
Speaker 1: Dow is a big one work this way. Second, I
Speaker 1: am omitting interest. In the real world. If I'm borrowing
Speaker 1: one hundred dollars from you to buy a bitcoin, I'm
Speaker 1: not just paying you back one hundred dollars. I'm paying
Speaker 1: you back with interest add one dollars or whatever. An
Speaker 1: algorithmic stable coin, much like a dollar in a bank account,
Speaker 1: can potentially generate interest. Third, note that there are two
Speaker 1: sides to this trade. Some people want stable coins and
Speaker 1: will put money or ether, bitcoin, etcetera. Into this sort
Speaker 1: of smart contract to get stable coins. Others want leverage
Speaker 1: and will borrow money from this sort of smart contract
Speaker 1: to take leveraged positions in risky crypto assets. There are
Speaker 1: different appetites for risk, so there's a trade to be done. Fourth,
Speaker 1: do you know what a bank is not in crypto
Speaker 1: just in the world. Here's what a bank is. Some
Speaker 1: people want to borrow money to make investments. The main
Speaker 1: investments are one starting or expanding a business and to
Speaker 1: buying real estate. They borrow money from a bank. They
Speaker 1: get leverage. If their business does well or their houses
Speaker 1: price goes up, they pay back the money to the
Speaker 1: bank with interest. The bank has the senior claim on
Speaker 1: their business or house. If there isn't enough money for everyone,
Speaker 1: the bank gets paid first. Sometimes the bank loses money,
Speaker 1: but mostly it gets paid back on most of its loans.
Speaker 1: The bank then is just a pool of these loans,
Speaker 1: just a lot of senior claims on a lot of
Speaker 1: businesses and houses. These loans are called the bank's assets.
Speaker 1: Then the bank itself goes and borrows money. A bank
Speaker 1: with ten billion dollars of assets ten billion dollars of
Speaker 1: mortgages and business loans might have one billion dollars of
Speaker 1: its shareholders money equity or for a bank capital, and
Speaker 1: borrow the other nine billion dollars. It borrows the nine
Speaker 1: billion dollars from its customers in the form of deposits.
Speaker 1: A bank deposit is formally alone to the bank. If
Speaker 1: you deposit one dollars, the bank owes you that one
Speaker 1: dollars and it uses that hundred dollars to fund loans
Speaker 1: to businesses and homebuyers. Wait, though I said way way
Speaker 1: earlier that a dollar is just an entry in the
Speaker 1: bank's database. When you have a dollar, what you have
Speaker 1: is an entry on the books of the bank. That
Speaker 1: deposit is the dollar. The deposit is the dollar, and
Speaker 1: yet it's also the debt of the bank. Your entry
Speaker 1: on the bank's database shows both that the bank owes
Speaker 1: you a dollar and is the dollar that you own.
Speaker 1: Isn't that incoherent? How can the bank owe you the
Speaker 1: dollar if you have it already right there in your account. Yes,
Speaker 1: that's what a dollar is. A dollar is debt. The
Speaker 1: modern banking system is a machine that takes in risky
Speaker 1: assets at one end, takes senior claims on them, lending
Speaker 1: money against those assets with the right to be paid
Speaker 1: back first, and repeats that move a few times, taking
Speaker 1: an issuing senior claims on the senior claims. In practice,
Speaker 1: this can be repeated many times. Banks would sometimes buy
Speaker 1: senior tranches of collateralized debt obligations made up of senior
Speaker 1: tranches of mortgage backed securities made up of senior loans
Speaker 1: on houses. At the other end of all this, it
Speaker 1: spits out dollars a dollar is distilled from risky assets.
Speaker 1: The stable coin thing is nothing new. It's just banking,
Speaker 1: but banking in a particularly clear way and in a
Speaker 1: largely unregulated way at the moment, and without deposit insurance
Speaker 1: purified in smart contracts on the blockchain. Coming up next,
Speaker 1: you'll hear more from mt Levine's special Crypto issue of
Speaker 1: Bloomberg Business Week, narrated by Mark Leadoff. Two bad algorithmic
Speaker 1: To summarize the previous section, if you have a large
Speaker 1: quantity of risky tokens, you can, with a little financial engineering,
Speaker 1: issue a smaller quantity of claims on those tokens and
Speaker 1: call them stable coins. But recall also one of the
Speaker 1: simplest lessons of bitcoin, which is that you can make
Speaker 1: up an arbitrary token that trades electronically and people might
Speaker 1: pay you money for it worth a shot. No, these
Speaker 1: two insides, you can make up a token and it
Speaker 1: will be worth money, and you can use claims on
Speaker 1: risky tokens to make a stable coin can be combined
Speaker 1: in a natural way to create a disaster. Here's the disaster. One.
Speaker 1: I make up a cryptocurrency, call it share coin. I
Speaker 1: listed on exchanges and try to sell it to people
Speaker 1: for some money, maybe bitcoin or ether, or dollars or
Speaker 1: Korean one. It doesn't matter. Two. I make up another cryptocurrency,
Speaker 1: call it dollar coin. I set up a smart contract
Speaker 1: saying that one dollar coin can always be exchanged for
Speaker 1: one dollars worth of share coin. I can do this
Speaker 1: because I just made up share coin, and the smart
Speaker 1: contract can issue any old amount of it. If share
Speaker 1: coin trades at twenty dollars, the smart contract will give
Speaker 1: you point oh five share coins per dollar coin. If
Speaker 1: it trades at point oh one dollar, the smart contract
Speaker 1: will give you one thousand share coins. It doesn't care.
Speaker 1: It can make all the share coins it wants. Three. Conversely,
Speaker 1: if you want dollar coins, you buy one dollars worth
Speaker 1: of share coins and deliver them to the smart contract
Speaker 1: to get back a dollar coin. Four. As long as
Speaker 1: there's some price for share coin, the smart contract can
Speaker 1: issue a dollar's worth of share coins for any dollar
Speaker 1: coin that someone brings to exchange. Five. See a dollar
Speaker 1: coin should always be worth a dollar, I say, through
Speaker 1: the power of algorithms. The flaw in this logic is
Speaker 1: in step four. There's absolutely no reason for share coin
Speaker 1: to be worth anything. At all. I just made it up,
Speaker 1: and so no reason for a dollar coin to be
Speaker 1: worth a dollar. But of course everything in crypto was
Speaker 1: made up by somebody in the recent past, so this
Speaker 1: objection is not as compelling as you might think. People
Speaker 1: might believe in this story, or just in the general
Speaker 1: vibe of share coin and dollar coin, they might buy
Speaker 1: dollar coin and treated as worth a dollar, and buy
Speaker 1: share coin and treated as a valuable component of a
Speaker 1: thriving ecosystem. At some point, the process reverses. People start
Speaker 1: to want dollars rather than dollar coins, so some of
Speaker 1: them sell dollar coins for dollars on the open market.
Speaker 1: This pushes the price of dollar coins slightly below one dollar,
Speaker 1: perhaps to other people get nervous, so they go to
Speaker 1: the smart contract, which is supposed to keep the price
Speaker 1: of a dollar coin at one dollar, and trade dollar
Speaker 1: coins in for one dollars worth of share coins. They
Speaker 1: sell those share coins, which pushes down the price of
Speaker 1: share coin, which makes more people nervous. They trade even
Speaker 1: more dollar coins for share coins and sell those. This
Speaker 1: pushes the price of share cooin lower, which creates more nervousness,
Speaker 1: which leads to more redemptions at lower share coin prices
Speaker 1: and even more share coin supply flooding the market. This
Speaker 1: is a well known phenomenon in traditional finance. It happens
Speaker 1: when companies issue debt and commit to paying it back
Speaker 1: with stock, and it has the technical name death spiral.
Speaker 1: It's as bad as it sounds. A couple of algorithmic
Speaker 1: stable coins have death spiraled, the most famous one being
Speaker 1: Tara u s D. Tara was a blockchain ecosystem with
Speaker 1: a native currency like our share coin, called Luna, and
Speaker 1: a stable coin called Tara us D. Billions of dollars
Speaker 1: of Tara USD were issued, backed by algorithmic conversion into
Speaker 1: one dollar's worth of Luna. Terra USD was popular because
Speaker 1: stable coins are popular, and also to be fair because
Speaker 1: you could get interest rates on terra USD. The total
Speaker 1: amount of Terra usd reached eighteen point five billion dollars,
Speaker 1: the market capitalization of Luna rose above forty billion dollars.
Speaker 1: The system all worked, and then it didn't. A quick
Speaker 1: death spiral hit in May and tara unraveled completely. By
Speaker 1: the end of the month, terra USD was trading below
Speaker 1: two cents. Zillions of Luna had been issued and were
Speaker 1: trading at essentially zero and the whole Terra blockchain had
Speaker 1: burned to the ground. Terra's founder Do Kwan Colorful Character,
Speaker 1: was tweeting in September that he wasn't on the run
Speaker 1: from South Korean authorities. Those authorities responded that he was
Speaker 1: obviously on the rock. Thank you, Matt Levine and thank
Speaker 1: you Mark Liedoff. As a reminder, if you're looking for
Speaker 1: these episodes in the crypt So feed, will be publishing
Speaker 1: them every Sunday through December. If you'd like to read
Speaker 1: this issue in print form, you can head on over
Speaker 1: to Bloomberg dot com slash the Crypto story. This is
Speaker 1: Bloomberg Crypto, a daily podcast from Bloomberg and I Heart Radio.
Speaker 1: For more shows from I Heart Radio, visit the I
Speaker 1: Heart Radio app, Apple Podcasts, or wherever you get your podcasts.
Speaker 1: Send us your comments, questions, or suggestions for the show
Speaker 1: to Crypto at Bloomberg dot net or find us on Twitter.
Speaker 1: We're at Crypto. The supervising producer of Bloomberg Crypto is
Speaker 1: Vicky Vergolina. Our senior producer is Janet Babin. Our producers
Speaker 1: are Mohammed Faruke and Sharon Barriro. Our associate producers are
Speaker 1: Ty Butler and Moses on them. Desta wonder At is
Speaker 1: our engineer. Original music by Leo Sidrin, I'm Stacy, Marie
Speaker 1: schmal We'll be back tomorrow. And the ald A pass,
Speaker 1: the shot, and a pensant and the b ever