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 sixth 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. Mr.
Speaker 1: Previous chapter and need to catch up. You can find
Speaker 1: previous episodes right here in the Bloomberg Crypto podcast feed
Speaker 1: d Defy. The thing about centralized crypto exchanges is that
Speaker 1: they're centralized. Broadly speaking, you have to trust the people
Speaker 1: running the exchange to run it in a good way,
Speaker 1: not to steal customer money, not to get hacked, not
Speaker 1: to take advantage of their knowledge of customer orders to
Speaker 1: trade ahead, not to blow up by allowing too much leverage,
Speaker 1: et cetera. Sometimes that trust is misplaced and the exchange
Speaker 1: does steal the money. Sometimes the exchange is honest, careful,
Speaker 1: and well regulated by the responsible national authorities. But still,
Speaker 1: you're in crypto. You want to avoid trusting centralized intermediaries
Speaker 1: and national regulation. Also, you're in crypto you want smart contracts.
Speaker 1: A financial products exchange can be thought of as a
Speaker 1: computer program. Most stock exchanges long ago got rid of
Speaker 1: trading floors with human traders and are now just computer
Speaker 1: servers matching electronic buy and sell orders. Certainly every crypto
Speaker 1: exchange works like that. A centralized crypto exchange is fully electronic.
Speaker 1: It has computers that keep ledgers of customer assets and
Speaker 1: run the programs, matching orders and moving assets between customers.
Speaker 1: The blockchain is already designed to keep a ledger of
Speaker 1: customer assets, so why keep your assets on an exchanges ledger?
Speaker 1: And you can on computer programs on Athereum or most
Speaker 1: other modern blockchains, why not run the exchange programs there?
Speaker 1: A venue for trading tokens that isn't a company but
Speaker 1: is instead a set of smart contracts on a blockchain
Speaker 1: is called a decentralized exchange or d e X, and
Speaker 1: the broader idea of having a financial system with lending
Speaker 1: and derivatives and everything else that runs as smart contracts
Speaker 1: on a blockchain is called decentralized finance or DEFY. A
Speaker 1: few more points of terminology. Decentralized finance is DEFY, so
Speaker 1: centralized finance, meaning specifically the bits of crypto that use
Speaker 1: centralized trusted intermediaries, mainly exchanges and lenders, is c FI,
Speaker 1: and I will sometimes refer to defy things as protocols.
Speaker 1: A protocol is a set of smart contracts, the computer
Speaker 1: programs that run on the blockchain and do stuff, or
Speaker 1: at least a set of rules for creating them. A
Speaker 1: decentralized ex change isn't an exchange in the traditional sense.
Speaker 1: It certainly isn't a building in New York where traders
Speaker 1: meet in person to shout orders at each other. And
Speaker 1: it also isn't a data center in New Jersey where
Speaker 1: an exchange company keeps its computer service to match orders
Speaker 1: with each other. It's a protocol, a set of smart
Speaker 1: contracts that let people move cryptocurrencies around. There might be
Speaker 1: a company involved, and surely someone is making money somewhere,
Speaker 1: But even if the company goes away, the smart contracts
Speaker 1: will keep running as long as the blockchain does. One
Speaker 1: some background on exchanges and market makers one clob Here's
Speaker 1: what an exchange is. People send it orders buy one
Speaker 1: hundred shares at one hundred, sell one hundred shares at
Speaker 1: a hundred two dollars, etcetera. The exchange is, at its heart,
Speaker 1: a system for matching those orders, finding a buyer for
Speaker 1: each seller, and vice versa. The orders come in at
Speaker 1: different times. When the exchange gets an order to buy
Speaker 1: one hundred chairs at one hundred dollars, it puts the
Speaker 1: order on its order book, just an electronic list of
Speaker 1: orders that haven't been executed yet. When it gets its
Speaker 1: next order to sell one hundred shares for a hundred
Speaker 1: two dollars. It looks at its order book to see
Speaker 1: if there are any orders to buy one hundred chairs
Speaker 1: at one hundred two dollars. Nope, not yet. The one
Speaker 1: hundred dollar buyer doesn't want to pay one hundred two
Speaker 1: dollars and the one two dollars seller doesn't want to
Speaker 1: accept one hundred dollars. It puts the cell order on
Speaker 1: the order book to the one hundred dollar buy order,
Speaker 1: and the one D two dollars cell order rest on
Speaker 1: the order book. Then another order comes in to buy
Speaker 1: a hundred shares at a hundred and two dollars. The
Speaker 1: exchange sees in the order book that a ha, yes,
Speaker 1: there's an order to sell a hundred shares at a
Speaker 1: hundred and two dollars. So the matching engine matches the
Speaker 1: one D two dollar buy and the one D two
Speaker 1: dollars cell order. They pair off with each other and
Speaker 1: do their trade, and then the orders are removed from
Speaker 1: the order book they've been filled, and the exchange waits
Speaker 1: for the next order. In general, a centralized exchange will
Speaker 1: have lots of orders resting on its order book at
Speaker 1: any time. All the resting by orders will have lower
Speaker 1: prices than all the resting cell orders. If a buy
Speaker 1: order has a higher price than arresting cell order, those
Speaker 1: two orders will pair off and execute with each other.
Speaker 1: If I want to pay one three dollars and you
Speaker 1: will accept a hundred two dollars, the exchange has found
Speaker 1: a mutually beneficial trade. And this way of running an
Speaker 1: exchange is usually called a central limit order book or
Speaker 1: c l OB. You could certainly build a smart contract
Speaker 1: to do this on the blockchain. The contract would take orders,
Speaker 1: keep them on a central limit order book, and execute
Speaker 1: them against each other. And smart contracts like this do exist,
Speaker 1: but most d x is don't work this way. Two
Speaker 1: market makers. You may ask, where do all these resting
Speaker 1: orders come from? Who's going around thinking up these specific
Speaker 1: prices they want to pay for a stock or prices
Speaker 1: they want to sell for. Ordinary people might not bother
Speaker 1: with this. If they think a stock is a good investment,
Speaker 1: they will often send in market orders just buy from whoever,
Speaker 1: selling at whatever the best prices. Resting orders come mainly
Speaker 1: from professional investors called market makers, who help make fast
Speaker 1: and efficient trading possible. Their job is to sell stock
Speaker 1: or crypto or whatever to people who want to buy
Speaker 1: and buy from people who want to sell and collect
Speaker 1: the spread, the difference between their bid or buying price
Speaker 1: and their offer or selling price. If you send a
Speaker 1: market order to buy, you buy immediately, but you pay
Speaker 1: a bit of money the spread to the market maker
Speaker 1: for that service. The market maker, meanwhile, is in the
Speaker 1: business of providing that service and collecting that spread. It's
Speaker 1: not really betting that prices will go up or down.
Speaker 1: In modern stock and crypto markets, market makers are also
Speaker 1: largely computer programs, and their programs are pretty simple. This
Speaker 1: is oversimplified, but not by that much. One post a
Speaker 1: bid and an offer for a stock. Two. If someone
Speaker 1: sells you stock at your bid price, lower your bid
Speaker 1: and offer slightly. If someone immediately hits your bid, then
Speaker 1: you might worry that your bid was actually too high
Speaker 1: and you could have paid less. Anyway, Now you own
Speaker 1: some stock and want to get rid of it, so
Speaker 1: you might as well put it on sale. Three, if
Speaker 1: someone buy stock from you at your offer price, raise
Speaker 1: your bid and offer slightly for similar reasons. For keep
Speaker 1: doing this. The system is self correcting. The more stock
Speaker 1: people want to sell you, the less you pay them
Speaker 1: for it. The more they want to buy from you,
Speaker 1: the more you charge them. Hopefully it all balances out
Speaker 1: and you end up flat. You sell all the stock
Speaker 1: you bought and buy all the stock you sold, and
Speaker 1: you collect the spread along the way. Five. Also, you're
Speaker 1: probably keeping an eye on general market conditions and raising
Speaker 1: and lowering your bids and offers based on what's happening
Speaker 1: in other markets. Market Makers in US stocks are often
Speaker 1: called high frequency traders or sometimes even flashboys, and part
Speaker 1: of what that means is that they're constantly changing the
Speaker 1: prices of their orders as their information changes. And the
Speaker 1: result is that when you want to buy a share
Speaker 1: of stock, you can send in a market order and
Speaker 1: you will quickly trade with a market maker at a
Speaker 1: price that's pretty much the market price, one that's updated
Speaker 1: continuously to reflect supply and demand and all available information. Three. Nope,
Speaker 1: this doesn't work on the blockchain. The problem with the
Speaker 1: blockchain is that it's a slow computer. Ethereum runs computer
Speaker 1: programs by sending them to thousands of nodes to confirm transactions,
Speaker 1: and that takes time. You wouldn't want to run a
Speaker 1: self driving car on the Ethereum virtual machine. It turns out,
Speaker 1: you wouldn't want to run a high free concete trading
Speaker 1: platform there either centralized exchanges in traditional finance and in
Speaker 1: crypto have lots of very fast computers with very fast
Speaker 1: connections that allow market makers to constantly update their prices
Speaker 1: in response to trades and new information. Traders build fancy
Speaker 1: fiber optic lines to get their orders to the exchange
Speaker 1: a few milliseconds faster than the competition speed matters, and
Speaker 1: they update their orders many times a second. This is
Speaker 1: harder when the computers are on the blockchain. It's also
Speaker 1: more expensive. Every action in Ethereum requires gas fees, and
Speaker 1: sending a message to a smart contract saying cancel my
Speaker 1: buy order at one point oh one dollars and put
Speaker 1: in a new order at one point two dollars would
Speaker 1: use Ethereum's computer power and cost gas. It turns out
Speaker 1: this is nearly fatal for clob market making. In Ethereum,
Speaker 1: market making is very expensive. Vitallicquterian wrote as creating an
Speaker 1: order and removing a order both take gas fees, even
Speaker 1: if the orders are never finalized. Two automated market makers
Speaker 1: one mechanics. So Vitallic proposed a different idea here. It
Speaker 1: is the mechanism would be a smart contract that holds
Speaker 1: A tokens of type T one and be tokens of
Speaker 1: type T two, and maintains the invariant that A times
Speaker 1: B equals K for some constant K. In the version
Speaker 1: where people can invest, K can change, but only during
Speaker 1: investment withdrawal transactions, not trades. Anyone can buy or sell
Speaker 1: by selecting a new point on the X Y equals
Speaker 1: K curve and supplying the missing A tokens and in
Speaker 1: exchange receiving the extra B tokens, or vice versa. The
Speaker 1: marginal price is simply the implicit derivative of the curve
Speaker 1: x y equals K or y slash x. That's just
Speaker 1: a comment that he wrote on Reddit. Later, a whole
Speaker 1: business model grew out of it. Here's the simplified version.
Speaker 1: I decided to be a market maker in some token pair,
Speaker 1: say ethereum and U s d C. A dollar denominated
Speaker 1: stable coin. Let's say one Ether currently trades for six
Speaker 1: d U s d C six hundred dollars. I set
Speaker 1: up a smart contract. Again, that's a computer program on
Speaker 1: the blockchain, but in this case it might be easier
Speaker 1: to think of it as a pot of money managed
Speaker 1: by the computer program. I can deposit both ether and
Speaker 1: USDC into this pot. Anyone who wants to buy ether
Speaker 1: with U s DC or sell either for U s
Speaker 1: DC can come to my smart contract and make that
Speaker 1: trade with it, and the contract will adjust its prices
Speaker 1: to reflect supply and demand. But it will do it
Speaker 1: in an absurdly simple manner that doesn't require much in
Speaker 1: the way of computation or updating prices. It will just
Speaker 1: try to keep one number constant. When I set up
Speaker 1: the contract, I deposited equal values of ether and U
Speaker 1: s d C. If one ether was worth sixteen hundred
Speaker 1: U s DC, I put in one hundred ether and
Speaker 1: one hundred sixty thousand U s DC each set of
Speaker 1: tokens worth a hundred and sixty thousand dollars. The program
Speaker 1: multiplies those two numbers one hundred times one hundred sixty
Speaker 1: thousand is sixteen million, and then it will just hold
Speaker 1: that product constant. That is, the number of Ether multiplied
Speaker 1: by the number of U s DC will always be
Speaker 1: sixteen million. A trader will try to buy, say ten Ether,
Speaker 1: that would leave ninety ether in the fund. Sixteen million
Speaker 1: divided by ninety is one hundred seventy seven thousand, seven
Speaker 1: hundred and seventy seven point seventy eight. The pot has
Speaker 1: one hundred sixty thousand U s DC now, so it
Speaker 1: will need seventeen thousand, seven hundred and seventy seven point
Speaker 1: seventy eight more U s DC to keep the product constant.
Speaker 1: That's what my smart contract charges. The trader has to
Speaker 1: pay me seventeen thousand, seven hundred seventy seven point seventy
Speaker 1: eight U s d c one thousand, seven seventy seven
Speaker 1: point seven seventy eight U s DC per Ether to
Speaker 1: do this trade. Someone wants to buy ether from my
Speaker 1: smart contract, So my smart contract automatically raises its price
Speaker 1: for Ether. But it doesn't have to go around constantly
Speaker 1: updating prices and posting new prices on central limit order books.
Speaker 1: It just advertises its constant product and that updates prices
Speaker 1: on its own. It's a kind of automated market maker,
Speaker 1: or a m M. That's cool. I don't know it's cool.
Speaker 1: This isn't a thing that really exists in traditional finance.
Speaker 1: It was developed almost by accident, as a workaround to
Speaker 1: a novel problem that the computers are too expensive in
Speaker 1: decentralized finance. You might be asking, wait, how do I
Speaker 1: know the price charged by the smart contract is correct?
Speaker 1: Is the computer program ever checking Ether's price quoted on say,
Speaker 1: coin base to make sure it's price makes sense? No,
Speaker 1: insofar as demand for ether by people interacting with the
Speaker 1: contract reflects demand for either in the rest of the world,
Speaker 1: than the price created by the contract is the price.
Speaker 1: Sometimes different smart contracts and different centralized exchanges could have
Speaker 1: different prices for ether, But if they get two out
Speaker 1: of whack, people can try to buy ether where it's
Speaker 1: cheap and sell it where it's expensive for a quick
Speaker 1: profit and close that gap two LPs. In my description above,
Speaker 1: I assume that I want to be a market maker
Speaker 1: in some currency pair, so I set up a smart
Speaker 1: contract to do it on my own. In reality, the
Speaker 1: way d X is normally work is that a MM
Speaker 1: smart contracts pool liquidity. If you want to be a
Speaker 1: market maker in stocks, it helps to be a large
Speaker 1: financial institution in crypto. Anyone who wants to be a
Speaker 1: market maker in a pair of tokens can contribute that
Speaker 1: pair to a liquidity pool and get back liquidity tokens
Speaker 1: representing their stake in that pool. Their call liquidity providers.
Speaker 1: They collect fees in crypto for providing liquidity in the pool.
Speaker 1: There's a risk though in general, if you provide liquidity
Speaker 1: in an asset in defy or centralized finance, in crypto
Speaker 1: or otherwise, and the asset price steadily goes down, you'll
Speaker 1: find yourself buying more and more of it, and it
Speaker 1: will be worth less and less. In an a MM
Speaker 1: liquidity pool, if the price of one token keeps going
Speaker 1: up against the other token, the pool will have more
Speaker 1: and more of the token worth less and less. This
Speaker 1: is a risk that all market makers take in traditional finance,
Speaker 1: it's sometimes called adverse selection. In defy, though it delights
Speaker 1: in the name impermanent laws. I don't know why, but
Speaker 1: I love it. There's nothing particularly impermanent about it unless
Speaker 1: the price bounces back, of course, but that's what it's called.
Speaker 1: Crypto is so optimistic. How can you not be charmed.
Speaker 1: We'll be right back with more from Berg Business Week
Speaker 1: special Crypto issue, written by Matt Levin a narrated by
Speaker 1: Mark Ladoff. Three lending exchanges providing liquidity between different tokens
Speaker 1: are a key function of defy, but there are others.
Speaker 1: One important function is lending one secured. Most defied lending
Speaker 1: is what you would call in traditional finance margin lending.
Speaker 1: You have a volatile asset ether, say, and you want
Speaker 1: to borrow some money a dollar like USDC stable coin, say,
Speaker 1: using that volatile asset as collateral. Perhaps you're borrowing that
Speaker 1: money to buy more volatile assets, or perhaps you're borrowing
Speaker 1: against your ether to buy a sandwich or a house
Speaker 1: without selling your either. If you went to a broker
Speaker 1: for a margin loan against one d dollars of stock,
Speaker 1: the broker might lend you fifty dollars. It's over collateralized
Speaker 1: because the stock is worth more than the loan, which
Speaker 1: makes the broker feel safe. If the stock then fell
Speaker 1: to seventy dollars, the broker might send you a margin call.
Speaker 1: Pay down fifteen dollars of this loan, or I'll liquidate
Speaker 1: your stock. That way, it's less likely the broker will
Speaker 1: end up holding the bag for your loss if the
Speaker 1: stock keeps falling. If you failed to meet the margin call,
Speaker 1: the broker would sell your stock clear, say sixty dollars
Speaker 1: for it, keep enough money to repay the loan, and
Speaker 1: give you what's left. This is pretty straightforward to automate
Speaker 1: with smart contracts. There are robust. Defied lending systems such
Speaker 1: as compound Lenders put up tokens and earn interest. Borrowers
Speaker 1: borrow tokens overcollateralized by other tokens and pay interest. And
Speaker 1: automatic liquidation provisions make sure that if the value of
Speaker 1: the collateral goes down, it's sold to pay back the
Speaker 1: loans two unsecured. What's much harder in defied are the
Speaker 1: main businesses of traditional finance, unsecured lending and lending secured
Speaker 1: by physical assets such as houses. Defy is good at
Speaker 1: lending crypto secured by crypto. The collateral lives on the blockchain,
Speaker 1: the loan lives on the blockchain. They're connected by smart
Speaker 1: contracts on the blockchain. It's all pretty neat, but this
Speaker 1: sort of lending crypto against crypto doesn't do much. It's
Speaker 1: mostly useful for crypto speculation. You lend ether, get us
Speaker 1: DC and use it to buy even more ether. By contrast,
Speaker 1: a mortgage lets you buy a house and then pay
Speaker 1: for it with your future income. An unsecured business loan
Speaker 1: helps you build a business and then pay off the
Speaker 1: loan with the business's future earnings. Finance at its heart
Speaker 1: is about moving future wealth into the present by borrowing,
Speaker 1: or moving present wealth into the future by saving. There
Speaker 1: are deep philosophical reasons that crypto is bad at this.
Speaker 1: An unsecured loan is essentially about trust. It's about the
Speaker 1: lender trusting that she'll be repaid not out of a
Speaker 1: pool of collateral, but out of the borrower's future income.
Speaker 1: She has to trust that the borrower will have future
Speaker 1: income and that he will pay. Relatedly, an unsecured loan
Speaker 1: requires identity. You need to know who's borrowing the money,
Speaker 1: what their payment history looks like, what their income is.
Speaker 1: The default approach and much of crypto is pseudonymity. Anyone
Speaker 1: can set up any number of crypto wallets or bitcoin
Speaker 1: account numbers, and they're generally not tied to a name.
Speaker 1: If you borrow money against crypto collateral, all your lender
Speaker 1: needs to know is that the collateral is on the blockchain.
Speaker 1: If you borrow money against your future income, your lender
Speaker 1: needs to know who you are. That said, there's nothing
Speaker 1: in principle to prevent unsecured lending in defy, and there
Speaker 1: are projects such as Goldfinch that do it. You get
Speaker 1: together a smart contract where people deposit money in exchange
Speaker 1: for tokens and a DOW, a decentralized autonomous organization that
Speaker 1: controls the money. The tokens give them a share in
Speaker 1: the tao's profits and the right to vote on who
Speaker 1: gets the money. People propose potential borrowers, token holders consider
Speaker 1: them and vote, and if the holders vote yes, then
Speaker 1: they make a loan. As with any dow, the token
Speaker 1: holders can get together in a chat room and consider
Speaker 1: off chain information. If they want, they could make the
Speaker 1: borrowers send in a driver's license in two bank statements.
Speaker 1: You can build some incentive mechanism to punish members for
Speaker 1: proposing borrowers who default and reward them for proposing good borrowers.
Speaker 1: Decentralized finance is made up of smart contracts, but it's
Speaker 1: also made up of people, and if they want to
Speaker 1: do unsecured lending, they can. We've talked about web three
Speaker 1: as a source of online reputation about soul bound tokens
Speaker 1: that could be used to verify a person's actions, connections,
Speaker 1: and characteristics. A soul in this terminology is something close
Speaker 1: to a credit report. It's a list of stuff that
Speaker 1: a person has done that should make you trust them.
Speaker 1: A decent centralized and blockchained source of reputation information. The
Speaker 1: right assortment of degrees and endorsements might make you feel
Speaker 1: good enough about a person or rather a soul an
Speaker 1: address on the blockchain that you give them an unsecured loan,
Speaker 1: and then I suppose if they default, you can take
Speaker 1: their soul four token omics of defy. The basic mechanism
Speaker 1: of defy is that you put some tokens up in
Speaker 1: a smart contract to generate fees or interest. You put
Speaker 1: your tokens in an automated market making contract to get
Speaker 1: liquidity provider fees, You put your tokens in a lending
Speaker 1: protocol to get interest, etcetera. Generally, this is referred to
Speaker 1: as locking your tokens because they're being used for lending
Speaker 1: or whatever, you can't get them back for some period,
Speaker 1: and people often talk about defy protocols in terms of
Speaker 1: their TVL or total value locked. Mechanically, the way this
Speaker 1: generally works is that you send your tokens to the
Speaker 1: smart contract and it sends you back other tokens that
Speaker 1: are basically receipts for the tokens you locked up. Instead
Speaker 1: of having ether or USDC, you have liquidity provider tokens.
Speaker 1: Saying you've put some ether and USDC into a smart contract.
Speaker 1: What do you do with those liquidity provider tokens. Well,
Speaker 1: in theory, you hold them until you want your locked
Speaker 1: tokens back, and then you hand them in and get
Speaker 1: back the underlying tokens. The liquidity provider tokens are just
Speaker 1: a receipt. But at some point people realized that those
Speaker 1: tokens represent something of value. We can do something with them.
Speaker 1: If you have a token representing a receipt on some
Speaker 1: ether that you locked into a smart contract, then that's
Speaker 1: almost as good as having some ether, and someone might
Speaker 1: give you some money for it. Now you can borrow
Speaker 1: against those receipt tokens and defied too. Everything is like this.
Speaker 1: In proof of steak ethereum, you can steak ether to
Speaker 1: earn staking rewards. A protocol called Leedo runs a big
Speaker 1: steaking pool. If you stake your ether with Lido, it
Speaker 1: will give you back a token called s t e
Speaker 1: t H, basically a receipt for your staked ether. The
Speaker 1: ether that you staked with Ledo will earn staking rewards,
Speaker 1: while the st E t H that you get back
Speaker 1: can be sold or invested in other defied protocols to
Speaker 1: earn more money. More broadly, the business of DeFi is
Speaker 1: about reusing tokens as much as possible. You have some tokens,
Speaker 1: you lock them up in a smart contract that does
Speaker 1: a thing and pays you a return. The smart contract
Speaker 1: gives you some sort of receipt token, and you turn
Speaker 1: around and lock up those receipt tokens in another smart
Speaker 1: contract that does another thing and pays you some more.
Speaker 1: People talk about yield farming, the process of bouncing between
Speaker 1: DeFi protocols to try to earn the maximum yield reusing
Speaker 1: tokens and getting paid in protocols own tokens to make
Speaker 1: as much money as possible. This can create a self
Speaker 1: reinforcing cycle, by which I kind of mean a ponzi.
Speaker 1: It goes like this. One there's a protocol that does
Speaker 1: some stuff with ether or stable coins or whatever. Two,
Speaker 1: if you put your ether or stable coins or whatever
Speaker 1: into the protocol for lending or liquidity provision or whatever,
Speaker 1: it will give you some of its own tokens. This
Speaker 1: is no problem. It can print those tokens for free.
Speaker 1: Three if you put those tokens back into the protocol,
Speaker 1: locking them up rather than selling them it will give
Speaker 1: you even more of those tokens. It'll pay you ten
Speaker 1: percent interest every hour if you want. Who cares? The
Speaker 1: tokens are free for by this token. It pays ten
Speaker 1: percent interest every hour. The promoters of the protocol can
Speaker 1: say more or less accurately. They can quote an a
Speaker 1: p y an annual percentage yield, a normal finance concept
Speaker 1: that's much beloved and defied, yield farming with an enormous
Speaker 1: number of digits, and people will get very excited. Five,
Speaker 1: So they'll buy the token and it will go up.
Speaker 1: Or they'll put their ether or stable coins into the
Speaker 1: pro a call to earn its tokens, and the protocol's
Speaker 1: total value locked will go up. Six. Look at this protocol.
Speaker 1: Its tv L is huge and rising. It's token has
Speaker 1: doubled in price this week, people will say, and they'll
Speaker 1: buy more of it. Seven. People keep getting paid comical
Speaker 1: interest rates in the token, which is fine as long
Speaker 1: as the token price keeps going up or stays flat,
Speaker 1: or goes down at a slower rate than the interest rate.
Speaker 1: Even though the market is being flooded with tokens, people
Speaker 1: still seem to be making money and will do so
Speaker 1: as long as new money comes in eight, the amount
Speaker 1: of tokens issued rises inexorably toward infinity, the amount of
Speaker 1: new money coming in does not, and tragedy ensues. The
Speaker 1: greatest of these protocols is probably Olympus Dow, which is
Speaker 1: run by a pseudonymous founder called Zeus Colorful Character, has
Speaker 1: a group of loyal investors called Omi's, and at its
Speaker 1: peak offered yields of seven thousand percent and was worth
Speaker 1: three billion dollars. According to a coin Desk article titled
Speaker 1: Olympus Dow might be the future of money, or it
Speaker 1: might be a ponzi. Since then it's lost about its value,
Speaker 1: so there's your answer. Olympus Dow also sparked an even
Speaker 1: funnier copycat called Wonderland on the Avalanche blockchain, which offered
Speaker 1: yields of more than eighty percent and was partly run
Speaker 1: by a pseudonymous person who it turned out, also co
Speaker 1: founded quadriga colorful Character. Last year, I needed physical therapy
Speaker 1: from my knee, and I ended up bonding with my
Speaker 1: therapist by talking about crypto. He was heavily invested in Wonderland,
Speaker 1: which he cheerfully described as a ponzi, but one that
Speaker 1: was making him a lot of money. Olympus became particularly
Speaker 1: famous for the three three meme, based on the notation
Speaker 1: of game theory. The idea is that the payoff in
Speaker 1: a two player game can be written as X Y,
Speaker 1: where X is what I get and why is what
Speaker 1: you get. These outcomes could be dollars, but often they're
Speaker 1: written as abstract utility numbers. A payoff of three three
Speaker 1: is better for both of us than a payoff of
Speaker 1: two negative one without worrying too much about what those
Speaker 1: numbers mean. Olympus Is pitch was that if everybody buys
Speaker 1: home and locks it up, then everybody's payoff will be
Speaker 1: good i e. Three three, while if everybody does bad
Speaker 1: things like sell their home, then everybody's payoff will be
Speaker 1: negative three negative three. Those numbers are abstract and unitless,
Speaker 1: and actually the payoff was negative negative. This, of course,
Speaker 1: exactly describes any PONDSI. As long as people keep investing
Speaker 1: new money and not withdrawing it, everyone will get richer
Speaker 1: on paper, but it will unravel when people start taking
Speaker 1: their money out. Olympus always struck me as charmingly forthright
Speaker 1: about what it was up to. It's the future of money,
Speaker 1: because as long as every one keeps buying, it will
Speaker 1: keep going up. People have tried that one before. Five
Speaker 1: Some arbitrages in traditional finance. People devote their careers to
Speaker 1: finding arbitrages circumstances in which they can buy something at
Speaker 1: a low price and instantly sell the same thing at
Speaker 1: a high price. This is hard to do because traditional
Speaker 1: finance is very competitive and people aren't regularly leaving twenty
Speaker 1: dollar bills on the sidewalk. Even if you think you've
Speaker 1: spotted an arbitrage the same thing trading at different prices
Speaker 1: in different places, you have to worry about some legal
Speaker 1: or operational reason that you can't actually move between those places.
Speaker 1: Maybe there's a five percent tax to move the stock
Speaker 1: off shore, maybe short selling isn't allowed, etcetera. Most of
Speaker 1: what people call arbitrage in traditional finance is buying one
Speaker 1: thing at a low price, simultaneously selling a slightly different
Speaker 1: thing at a higher price and hoping they turn out
Speaker 1: to be the same thing, or buying one thing at
Speaker 1: a low price, selling the same thing a bit later
Speaker 1: and hoping it turns out to be at a higher price. Meanwhile,
Speaker 1: the centralized finance is new enough that pricing anomalies exist,
Speaker 1: but efficient enough that everything happens visibly on a virtual
Speaker 1: computer running public code, so you can reliably exploit them.
Speaker 1: There are magical possibilities one flash loans. Let's say you're
Speaker 1: a smart young person and you discover an arbitrage stock
Speaker 1: x y z is trading at ten dollars on Exchange
Speaker 1: A and eleven dollars on Exchange B. You can buy
Speaker 1: it on Exchange A for ten dollars and sell it
Speaker 1: on Exchange B for eleven dollars, making an easy one
Speaker 1: dollar profit. That's fine. Now you have one dollar. But
Speaker 1: you want to buy ten million shares on Exchange A
Speaker 1: for one hundred million dollars and sell ten million on
Speaker 1: Exchange B for one ten million dollars. Then you'd have
Speaker 1: ten million dollars, which is much more worth doing. The
Speaker 1: only problem with this plan is, while you're a smart
Speaker 1: young person, you don't have one million dollars. Why would you.
Speaker 1: In financial theory, the solution is simple. You borrow the
Speaker 1: one hundred million dollars at the market rate of interest
Speaker 1: by the stock, sell it, pay back a little interest,
Speaker 1: and keep your profits. In practice, no one is going
Speaker 1: to lend you one million dollars. I mean If you
Speaker 1: really have found a perfect arbitrage, maybe you'll be able
Speaker 1: to raise one million dollars. You can work your connections,
Speaker 1: cold call some hedge funds, maybe get some meetings where
Speaker 1: you present your strategy and say, see, it's a perfect arbitrage.
Speaker 1: I just need a hundred billion dollars. Are you in
Speaker 1: and they'll just do the strategy and leave you out.
Speaker 1: Maybe they'll pay you a small finders fee, Or you
Speaker 1: could start small. Do your arbitrage for one thousand dollars,
Speaker 1: make a hundred dollars, do it again for eleven dollars, etcetera.
Speaker 1: Until you have a huge bank roll. But that's not
Speaker 1: great either. The longer it takes you, the more likely
Speaker 1: it is that the clever arbitrage you've spotted will go away.
Speaker 1: In particular, the more you do the trade, the more
Speaker 1: likely someone else is to notice and do it in
Speaker 1: a big size and make the arbitrage go away. In
Speaker 1: crypto finance, the situation is different. If say you spot
Speaker 1: ether trading at two different prices on two different decentralized exchanges,
Speaker 1: you can just write a program that does the following.
Speaker 1: One borrows a hundred million dollars from some decentralized lending protocol,
Speaker 1: such as A two uses the hundred million dollars to
Speaker 1: buy a token on decentralized exchange. A three sells the
Speaker 1: token on decentralized exchange B for hundred ten million dollars.
Speaker 1: Four returns the hundred million dollars to the lending protocol
Speaker 1: plus a small fee. Five sends the leftover ten million
Speaker 1: dollars to you. Six, all in the same transaction that
Speaker 1: executes all at once. The lender in step one can
Speaker 1: make the return in step four a condition of the loan.
Speaker 1: The loan and the payback occur simultaneously in the same
Speaker 1: computer program, executing in the same block of the blockchain.
Speaker 1: As far as the lending protocol is concerned, there's no
Speaker 1: credit risk. If any of the intermediate steps fail, if
Speaker 1: it turns out you're wrong about the arbitrage and you
Speaker 1: can't sell the token for more than you paid for it, etcetera,
Speaker 1: then the whole thing never happens and the loan isn't made.
Speaker 1: The lending protocol isn't evaluating your credit worthiness, your resume,
Speaker 1: or your track record as an investor. It's just making
Speaker 1: sure that the code works. This is clever and neat
Speaker 1: and feels like a good way to build a financial system.
Speaker 1: It's an egalitarian, decentralized, permissionless, computerized way for anyone who
Speaker 1: spots an arbitrage to be able to exploit and close it.
Speaker 1: It should make markets more efficient and prices more accurate.
Speaker 1: The problem is, in crypto an arbitrage often means a
Speaker 1: mistake in a smart contract. Of course, this is true
Speaker 1: and traditional finance to some do he notices a flaw
Speaker 1: in a loan agreement or credit default swap contract, buys
Speaker 1: up a bunch of the bond or CDs, then goes
Speaker 1: to court to try to extract money from the person
Speaker 1: who wrote the contract wrong. This, however, is a lengthy
Speaker 1: and risky process, and one of the main risks is
Speaker 1: that the court will say, oh, come on, that's not
Speaker 1: what they meant. Get out of here, whereas a smart
Speaker 1: contract will never say that. Somebody writes some contract that
Speaker 1: has some bug that occasionally lets a user put in
Speaker 1: one token and get back to Then somebody notices and
Speaker 1: writes a program to use flash loans to put in
Speaker 1: one billion tokens and get back two billion tokens and
Speaker 1: blow up the smart contract Entirely. People sometimes leave money
Speaker 1: lying around in crypto, and crypto has built very efficient
Speaker 1: ways for other people to take their money. It's not
Speaker 1: clear that that is a good way to build a
Speaker 1: financial system. Two m e v. It gets stranger. Let's
Speaker 1: say you notice that a token is trading at ten
Speaker 1: dollars on decentralized exchange A and eleven dollars on decentralized
Speaker 1: exchange B. So you send an order to exchange A
Speaker 1: to buy one thousand tokens for ten thousand dollars, and
Speaker 1: a simultaneous order to sell one thousand tokens for eleven
Speaker 1: thousand dollars. What happens to those orders in the US
Speaker 1: stock market, Whole books have been written about that question.
Speaker 1: People get really mad about it. Your order goes to
Speaker 1: your broker, who routes it to different exchanges at different
Speaker 1: times through different pipes. High frequency electronic traders who see
Speaker 1: your order execute on one exchange might raise ahead to
Speaker 1: another exchange to push up the prices. There are controversies
Speaker 1: about colocation, where the high frequency traders pay fees to
Speaker 1: the stock exchanges to keep their computers in the same
Speaker 1: room as the exchanges computers so they can get a
Speaker 1: tiny speed advantage by connecting to the exchange through a
Speaker 1: fairly short wire. In crypto, the answer is different. It's
Speaker 1: easiest to understand if you start with how trades worked
Speaker 1: on Ethereum before the switch to proof of steak. When
Speaker 1: you made a trade, your transaction would be broadcast out
Speaker 1: to the entire network and included in the list of
Speaker 1: transactions that miners were working on executing but that hadn't
Speaker 1: yet made it into a block. When a block was finalized,
Speaker 1: miners would include your transaction in the block. But the
Speaker 1: miners decided which transactions got included in a block and
Speaker 1: in what order, and they also earned gas fees for
Speaker 1: executing transactions. Users could specify how much they wanted to
Speaker 1: pay for gas, and transactions with higher gas fees were
Speaker 1: usually prioritized. This created a trade. One you find an
Speaker 1: arbitrage and send some orders to decentralized exchanges to do
Speaker 1: that arbitrage. Two, I see those orders on the network
Speaker 1: and think, hey, that's a good trade. Three I send
Speaker 1: the same orders to the exchanges to do the same transaction.
Speaker 1: For I pay a higher gas fee to get priority
Speaker 1: over you so that I can do the trade ahead
Speaker 1: of you. Five. By the time you get to do
Speaker 1: the trade, it's no longer available. I bought everything available
Speaker 1: at the good price. Hah ah. This is usually called
Speaker 1: m e V, which originally stood for minor extractable value,
Speaker 1: because one winner in this scenario was the miner, who
Speaker 1: got to charge higher gas prices to people who wanted
Speaker 1: to front run trades or avoid getting front run. It's
Speaker 1: the subject of a twenty nineteen paper by Philip dion
Speaker 1: at All titled Flashboys two point oh, a reference to
Speaker 1: the high frequency traders in US stock markets who purportedly
Speaker 1: raise ahead of other traders orders to extract value from them.
Speaker 1: Rather than solve this concern about traditional markets, crypto made
Speaker 1: it explicit. Time priority was subject to an explicit gas
Speaker 1: auction where whoever paid the most to the transaction orderers
Speaker 1: got to go first. Sure, yes, in crypto you could
Speaker 1: get front run all the time by more sophisticated electronic traders,
Speaker 1: but in a transparent and descent realized way. As Ethereum
Speaker 1: moved to proof of steak, m e V was rebranded
Speaker 1: maximal extractable value. There's still money to be squeezed from
Speaker 1: traders by the people maintaining the network, but the mechanics
Speaker 1: have changed in today's ethereum. There's a division of labor
Speaker 1: between block builders who compile and order transactions and validators,
Speaker 1: the replacement for minors who do the proof of steakwork
Speaker 1: to make blocks official. And if you're doing arbitrages, you
Speaker 1: can send your transactions privately to block builders. You can
Speaker 1: still pay for speed and priority, but you can't see
Speaker 1: everyone else's trades to front run though. Coming up next,
Speaker 1: you'll hear more from Matt Levine's special Crypto issue of
Speaker 1: Bloomberg Business Week, narrated by Mark leadoff E Reinventing two
Speaker 1: thousand and eight. In two thousand and eight, Stoshi Nakamoto
Speaker 1: invented bitcoin. One thing that seems to have motivated him
Speaker 1: was a distrust of banks and financial intermediaries. This was
Speaker 1: understandable because it was two thousand and eight. The modern
Speaker 1: banking system was at a low EBB. Banks had taken
Speaker 1: risks that few people understood and ended up losing tons
Speaker 1: of money on supposedly safe investments. High levels of leverage
Speaker 1: in the banking system and in the more opaque and
Speaker 1: less regulated shadow banking system made those systems fragile. A
Speaker 1: bank that borrowed thirty dollars for every one dollar of
Speaker 1: shareholders equity would go bust if the value of its
Speaker 1: assets fell for the high leverage and lack of transparency
Speaker 1: caused contagion, an assets price would fall. The highly leveraged
Speaker 1: banks and funds that held it would get margin calls
Speaker 1: and they'd have to sell whatever they had on hand.
Speaker 1: That would cause more prices to fall, which would lead
Speaker 1: to more margin calls, which would bankrupt some the banks
Speaker 1: and funds, which would lead to more fire sales and
Speaker 1: more price jobs. Meanwhile, the lenders to those banks and
Speaker 1: funds who thought their money was safe would have losses.
Speaker 1: Many were also highly leveraged and might go bust. All
Speaker 1: of this was opaque enough that even banks and funds
Speaker 1: that hadn't taken big risks or lost a lot of
Speaker 1: money were treated with suspicion by lenders, which could cause
Speaker 1: them to fail to Ultimately, the banking system was bailed
Speaker 1: out by massive infusions of money from central banks. All
Speaker 1: of this was gross. Satoshi didn't like it, and he
Speaker 1: built a new payment mechanism that escaped the need to
Speaker 1: trust banks. It was irreversible and decentralized. Everyone was responsible
Speaker 1: for their own mistakes. No one could be bailed out
Speaker 1: by central banks printing money. It was transparent, Every transaction
Speaker 1: was recorded on the blockchain. There were no hidden chains
Speaker 1: of leverage. In a deep sense, it wasn't built on
Speaker 1: debt at all. To some bitcoiners, the central sin of
Speaker 1: the banking system is that every bank deposit is a liability.
Speaker 1: It's a debt payable on demand from the bank to
Speaker 1: its depositors, and so every dollar that you keep in
Speaker 1: the bank necessarily adds to the leverage of the system.
Speaker 1: This complaint is not limited to bitcoiners. After the two
Speaker 1: thousand and eight crisis, there was a lot of interest
Speaker 1: in the Chicago plan of narrow banking, where every bank
Speaker 1: deposit would be backed by real dollars reserves at the
Speaker 1: Federal Reserve, and lending financed out of equity. But in
Speaker 1: today's world, dollars are debt. Meanwhile, bitcoin are not debt.
Speaker 1: They're just bitcoin. They exist in themselves on the block chain,
Speaker 1: rather than being liabilities of banks. In early two thousand
Speaker 1: and nine, when Satoshi mind Bitcoin's genesis block, this message
Speaker 1: resonated with a lot of people. A new financial system
Speaker 1: with transparent and irreversible transactions, with no special power for
Speaker 1: governments or big banks had an appeal Over time, though
Speaker 1: there was another, much more obvious appeal to bitcoin. It's
Speaker 1: price kept going up. If you bought a bitcoin for
Speaker 1: a hundred dollars, you could soon sell it for a
Speaker 1: thousand dollars. This got a lot of people very interested
Speaker 1: in crypto, not for philosophical or monetary structure reasons, but
Speaker 1: because getting rich is nice. Many of these people came
Speaker 1: from traditional finance because they saw that crypto finance was fun.
Speaker 1: It was wide open, it allowed for permissionless innovation, and
Speaker 1: everyone was getting rich. These people, the people who left
Speaker 1: trad vi for crypto because the money was better, didn't
Speaker 1: necessarily have strong philosophical commitments to all that Setoshi stuff.
Speaker 1: They weren't like leverage is bad banks or evil. Monetary
Speaker 1: soundness is what matters. Some came from banks. They were
Speaker 1: there to make money. One way to make money is
Speaker 1: by finding good trade aids, finding cheap ways to borrow money,
Speaker 1: and then borrowing as much as possible to put into
Speaker 1: those trades. And so somehow crypto had itself a two
Speaker 1: thousand and eight. In two the crypto financial system rediscovered
Speaker 1: what the traditional system had discovered in two thousand and eight.
Speaker 1: It was honestly kind of impressive. One Terra in two
Speaker 1: you'll recall the algorithmic stable coin Terra USD collapsed. If
Speaker 1: you had money in Terra Luna, odds are that you
Speaker 1: lost roughly all of it. Many of the people who
Speaker 1: lost money were regular retail savers who had been suckered
Speaker 1: by Terra usd s promises of stability and of a
Speaker 1: safe interest rate, or regular retail cryptocurrency investors who speculated
Speaker 1: on Luna and lost, but not all of them. One
Speaker 1: victim of the Terra collapse was a hedge fund called
Speaker 1: Three Arrows Capital, run by two former Credit Suite Group
Speaker 1: currency traders colorful characters and also former trad FI guys.
Speaker 1: Speaking from an undisclosed location in July three, a c
Speaker 1: S founders explained to Bloomberg News that what they'd failed
Speaker 1: to realize was that Luna was capable of falling to
Speaker 1: effective zero in a matter of days, and that this
Speaker 1: would catalyze a credit squeeze across the industry that would
Speaker 1: put significant pressure on all of our liquid positions. Meanwhile,
Speaker 1: the Federal Reserve was raising rates and speculative assets generally
Speaker 1: were losing value. It turns out that crypto is basically
Speaker 1: a speculative asset and that it's not particularly a hedge
Speaker 1: for stock market volatility. Everything in crypto went down. Bitcoin
Speaker 1: was worth more than sixty seven thousand dollars at the
Speaker 1: peak in October, it fell below twenty thousand dollars in June.
Speaker 1: Ether went from forty eight hundred dollars to less than
Speaker 1: a thousand dollars. The total market value of all cryptoc
Speaker 1: enci's fell from about three trillion dollars in late to
Speaker 1: about one trillion dollars in June two. Two thirds of
Speaker 1: all crypto wealth just vanished. That's just a very traditional story,
Speaker 1: isn't it. Leveraged hedge funds piled into crowded trades that seemed,
Speaker 1: on the basis of a fairly short series of historical
Speaker 1: data to be safe. This made the trades unsafe, so
Speaker 1: the hedge funds lost money, so their lenders sent them
Speaker 1: margin calls, so they were forced to sell off other
Speaker 1: better assets, assets that were more liquid and could be
Speaker 1: sold to meet the margin calls, which made those better
Speaker 1: assets bad too. In a crisis, correlations go to one.
Speaker 1: Traders say losses on bad trades force leveraged hedge funds
Speaker 1: to sell good assets, and so everything goes down at once.
Speaker 1: Two contagion. Three a C the leveraged hedge fund. When
Speaker 1: it blew up, the people who loaned it money didn't
Speaker 1: get their money back. Three a C went into a
Speaker 1: complicated cross border insolvency process that will presumably eventually recover
Speaker 1: some money for its creditors, but they'll lose at least
Speaker 1: some of their money, and it will take a while
Speaker 1: to get back the rest. Who are these creditors, Well,
Speaker 1: a little of everyone, really. Documents filed in three a
Speaker 1: c's insolvency process reveal that the hedge fund was borrowing
Speaker 1: from de FI platforms, but also from an assortment of
Speaker 1: big name centralized or c FI crypto lenders borrowing platforms
Speaker 1: and exchanges. The de FI platforms mostly did fine. They
Speaker 1: had collateral, they had automatic liquidation mechanisms, they liquidated the collateral,
Speaker 1: and they got their money back. The centralized lenders did
Speaker 1: less well. It turns out a lot were less strict
Speaker 1: about demanding collateral than you might have wanted. Three a
Speaker 1: C was one of the biggest and best known hedge
Speaker 1: funds in crypto, working with three A C was a
Speaker 1: stamp of approval for many lending platforms. It was prestigious
Speaker 1: to say our customers include three arrows. Also, three A
Speaker 1: C was viewed as a smart fund doing clever, low
Speaker 1: volatility arbitrage trades with good risk management rather than taking
Speaker 1: wild gambles. So if three A C came to a
Speaker 1: lending platform and said, hey, we'd like to borrow five
Speaker 1: million dollars unsecured, the platform might say yes, oh boy
Speaker 1: did they. Voyager Digital, a crypto brokerage that let customers buy, sell, borrow,
Speaker 1: and lend crypto, is a public company listed in Canada.
Speaker 1: It had two point three billion dollars of assets at
Speaker 1: the end of June, about six fifty million dollars of
Speaker 1: which was unsecured loans of USDC and bitcoin to three
Speaker 1: A C. Oops, it went bankrupt too. Celsius Network is
Speaker 1: the same basic idea, but worse. It offered customers willing
Speaker 1: to lend out their crypto up to eight percent interest
Speaker 1: on deposits, with pretty vague descriptions on how it earned
Speaker 1: that yield. CEO Alex Maschinsky, colorful character once explained to
Speaker 1: Bloomberg Business Week that it's ridiculous that banks take deposits,
Speaker 1: used them to make loans, and then don't pay eighteen
Speaker 1: percent interest. Somebody is lying, Mashinsky said, either the bank
Speaker 1: is lying or Celsius is lying. Only one possible answer.
Speaker 1: Celsius had also loaned three A C money, though that
Speaker 1: was the least of its problems, and it was in
Speaker 1: some of the same trades as three A C, which
Speaker 1: blew up. When three A C did, it also went bankrupt.
Speaker 1: The leverage of these platforms is pretty astonishing. Celsius was
Speaker 1: levered about nineteen to one. It had almost ninety dollars
Speaker 1: of debt, mostly customer deposits, and about five dollars of
Speaker 1: equity for every hundred dollars of assets. Voyager was levered
Speaker 1: twenty three to one. A fairly small loss could wipe
Speaker 1: it out entirely, and did that. Some banks were levered
Speaker 1: thirty to one. Going into the two thousand and eight
Speaker 1: financial crisis became a matter of intense scandal, and post
Speaker 1: crisis reforms require much higher capital levels for banks. Also,
Speaker 1: banks mostly invest in mortgages and stuff. These guys were
Speaker 1: investing in crypto loans, hugely volatile stuff with nothing in
Speaker 1: the way of long term through the cycle history, and
Speaker 1: they were doing it with five percent capital ratios three
Speaker 1: non contagion. In many ways, this looks like two thousand
Speaker 1: and eight, but it's striking how little effect the loss
Speaker 1: of two trillion dollars of crypto wealth had on anything else.
Speaker 1: The two thousand and eight crisis in the banking and
Speaker 1: shadow banking system led to a global recession, foreclosure, crisis,
Speaker 1: and real political instability two crisis, and crypto seems to
Speaker 1: have been pretty walled off from real world effects. Two
Speaker 1: trillion dollars of market capitalization were lost without much of
Speaker 1: a visible impact outside crypto. Why Part of the answer
Speaker 1: is about who lost money and how they thought of
Speaker 1: the money they lost. A lot of people who put
Speaker 1: money into crypto, we're using their gambling money, and when
Speaker 1: their bets didn't pay off, they thought, ah, well, that
Speaker 1: was fun. Too bad. Almost everything about the world of
Speaker 1: crypto screams high risk to anyone who knows at all
Speaker 1: what to look out for. And so if you do
Speaker 1: know what to look for, you take your crypto risks
Speaker 1: with money that you can afford to lose, and in
Speaker 1: ways that account for the risks, you don't take your
Speaker 1: life savings lever them up ten to one and invest
Speaker 1: everything in doge coin. The great lesson of two thousand
Speaker 1: and eight is that the real systemic risk is in
Speaker 1: the safest assets. The problem isn't banks and investors buying insane,
Speaker 1: risky securities that promise returns and then go to zero.
Speaker 1: The problem is banks and investors buying triple A rated
Speaker 1: bonds that promise an extra point oh three percent of
Speaker 1: yield and borrowing of the money they used to buy
Speaker 1: those bonds, then finding out those securities shouldn't have been
Speaker 1: rated triple A. People invest money they can't afford to lose,
Speaker 1: and often money they borrowed in safe assets, and when
Speaker 1: those assets lose money, the system breaks. By two the
Speaker 1: crypto financial system was working on creating safe assets. That's
Speaker 1: what Celsius and Voyager and tara U s D promised,
Speaker 1: safe and stable ways to earn high returns without a
Speaker 1: lot of volatility. But in crypto some people were taken
Speaker 1: in by those promises and invested their life savings. Some
Speaker 1: hedge funds bet on those promises and levered up those bets,
Speaker 1: but mostly look the guy who promises eighteen percent yields
Speaker 1: and says either the bank is lying or Celsius is lying,
Speaker 1: isn't going to persuade that many people to entrust him
Speaker 1: with their life savings. Part of the answer, though, is
Speaker 1: about the traditional financial system. Traditional big financial companies have
Speaker 1: been dipping their toe into crypto, but for the most part,
Speaker 1: the traditional and crypto financial systems have stayed pretty separate.
Speaker 1: You don't hear a lot about banks keeping of their
Speaker 1: assets in bitcoin, and in fact, banking regulators have been
Speaker 1: rather stern about letting banks own crypto, so when crypto
Speaker 1: prices collapsed, banks and other financial institutions weren't particularly harmed.
Speaker 1: This matters a lot. If you want to buy a
Speaker 1: house or open a store, you go to a bank
Speaker 1: for a loan. When banks are in crisis, as they
Speaker 1: were in two thousand and eight, they will be less
Speaker 1: likely to lend you money, so you won't buy a
Speaker 1: house or open a store. There will be less credit,
Speaker 1: less economic activity, less growth in the real economy. Government's
Speaker 1: bailed out banks in two thousand and eight, not because
Speaker 1: they love bankers, but because banks matter for the rest
Speaker 1: of the economy. The crypto financial system is very fun
Speaker 1: and cool and has invented a lot of interesting stuff,
Speaker 1: but it's mostly not where people go to get money
Speaker 1: to buy a house or open a store. Bitcoin and
Speaker 1: ethereum and defy could all vanish tomorrow without a trace,
Speaker 1: and most businesses that make stuff in the physical world
Speaker 1: would be just fine. Thank you Matt Levine, and thank
Speaker 1: you Mark Ledoff. As a reminder, if you're looking for
Speaker 1: these episodes in the Crypto Feed, will be publishing them
Speaker 1: every Sunday through December. If you'd like to read this
Speaker 1: issue in print form, you can head on over to
Speaker 1: Bloomberg dot com slash the Crypto story. This is Bloomberg Crypto,
Speaker 1: a daily podcast from Bloomberg and I Heart Radio. For
Speaker 1: more shows from I Heart Radio, visit the I Heart
Speaker 1: 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 Vergelina. Our senior producer is Janet Babin. Our producers
Speaker 1: are Mohammed Farouk 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 Sidron. I'm Stacy Marie Schmaal.
Speaker 1: We'll be back tomorrow.