Thank goodness the commanding heights of our financial system are run on the soundest of principles, rather than the sort of delusional faddishness that caused self-obsessed millennials to pay $3.4 million for a cartoon of a monkey.
In truth, though, crypto-land isn’t so much a looking-glass parody of the modern financial system, as its sibling.
Part of that comes down to the fact that many of its participants cut their teeth in traditional capital markets, and replicated their structures in the institutional architecture of decentralized finance. There’s a deeper resemblance, though.
Conventional finance doesn’t differ from Bitcoin, Ethereum and their ilk because its founders were fundamentally wiser and more judicious than Changpeng Zhao, Sam Bankman-Fried, Do Kwon, and Caroline Ellison. Go back to its origins, and the real difference is that modern capitalism got away with it, and became institutionalized in the process.
That’s a lesson not just for this bubble, but for others that will blow up over the coming years.
A degree of chaos comes with the territory of finance, an industry based on predictions about a future whose uncertainty compounds over time. The invention of paper money in the Song and Yuan dynasties of medieval China led to repeated bouts of hyperinflation as the government used note-printing to finance its deficits, ultimately leading people to abandon the money-system altogether and return to the relative stability of barter before the empire reverted to a silver standard.
Still, it’s the turmoil of the financial revolution in early modern Europe that most closely resembles the wild west of crypto.
In a notorious episode of Bloomberg’s Odd Lots podcast last year, Bankman-Fried explained “yield farming” — a dubious process for creating investable crypto assets out of thin air. People could deposit their digital savings in a “box,” he said, receive an IOU in return, and then get paid interest on the assumption that the code in the box will be a “world-altering protocol that’s gonna replace all the big banks.”
Whether the echo is deliberate or not, his account is weirdly similar to the way that the goldsmiths of 17th century Amsterdam and London developed fractional reserve banking. Investors who deposited precious metals in their vaults would get an IOU in return, tradable as a form of quasi-money — what we now call a banknote. Once the goldsmiths realized they could get away with issuing more notes than they had gold in their vaults to back them — a practice that some heterodox economists still regard as little better than fraud — they started paying interest, too. That innovation did indeed turn out to be a world-altering protocol.
By the 1690s, the ruinous costs of the Nine Years’ War against France were causing England to seek more and more ingenious ways of raising state funds. Financial innovation went into overdrive.
State lotteries attracted thousands of gamblers who established a vibrant secondary market in tickets, which paid interest and were traded in the same coffee house where the London Stock Exchange was born. The government sold annuities to the public, borrowed money from the East India Company, and even set up a new East India Company backed by a rival faction in parliament and took out a separate loan from it.
A Scottish slave trader named William Paterson had a better idea, suggesting in a 1694 tract not much longer than a Substack post that a Bank of England should be established to lend 1.2 million pounds to the government at 8% interest. Once established, the new national lender found itself in bitter competition with the goldsmiths, who conspired to engineer a bank run two years later.
Never short of ideas, Paterson persuaded Edinburgh’s trading monopoly, the Company of Scotland, to establish a colony in Panama to control commerce between the Atlantic and Pacific. Backed by roughly a fifth of Scotland’s national wealth, the so-called Darien Scheme was abandoned within nine months as the colonists fell victim to starvation, thirst, disease, shipwreck, a Spanish blockade and English obstruction. Scotland’s economy came close to collapse, hastening the union with England nine years later.
Paterson then proposed restructuring England’s own national debt by swapping it for equity in a new business with a royal monopoly on commerce with Spain’s American colonies, most of it slave-trading. Supported by a shadow bank posing as a sword-maker’s shop and with minimal revenue or prospect of earnings, the so-called South Sea Company bribed members of parliament and sold stock on margin to investors borrowing from the Bank of England, sending its shares soaring and then plummeting in one of the first true stock-market bubbles.
If you can see any trace in these scams of the august modern financial industry that employs only clean-cut, respectable types with an ingrained sense of prudence and fiduciary duty, you’ve got a better eye than me.
And yet there’s one thing that the financial con artists of restoration London got fundamentally right, and crypto gets fundamentally wrong. When the chips were down in the casino of early modern capitalism, the early investors could count on the government to bail them out. That’s a far cry from the situation now. When US regulators have rescued banks popular with the crypto crowd, such as SVB Financial Group and Signature Bank, it’s been to maintain the stability of the conventional financial system, not the alternative, digital one.
Britain’s victory in continental wars was all the evidence needed in the 18th century to show that the new innovations, for all their chaotic effects, were socially useful. The state came up with fresh taxes on land, imports, key goods and even windows to ensure that its creditors were made whole. Public trust in the government’s revenue-raising ability meant that its credit was believed to be as safe as — well, as the Bank of England.
The rejection of that lesson was the fatal flaw of crypto. The original white paper laying out the theory behind Bitcoin was written within weeks of the 2008 collapse of Lehman Brothers Holdings Inc. To libertarians, that crisis had exposed how the alliance between the financial system and the state was little better than a confidence trick, held together by assurances that could evaporate within hours. Bitcoin was built on cryptographic proof, rather than what it called “the inherent weaknesses of the trust based model.”
Trust, though, remains essential. That we have a society at all is testament to the ability of trust to extend bonds of commitment and obligation between millions of people, across time and geographies. This power is only amplified by the awesome ability of the state to harness and organize our mutual dependency to achieve common goals. By rejecting trust and disavowing any social purpose beyond personal enrichment, crypto doomed itself from the start.
Can crypto, like early modern capitalism, be reborn from its ashes? It’s hard to be optimistic. There’s been plenty of proposals to harness the blockchain to a cause as existential as the early modern period’s continental wars — climate change. The World Bank is trying to use the technology to clean up the mess of emissions reporting. Carbon offsetting and ESG investment, two fast-growing fields rich in both investor interest and scammy self-promotion, are badly in need of standardization.
Making that proposition work will be challenging, though, especially as many blockchain innovations seem to be running into the ground. The world’s biggest container shipping line AP Møller-Maersk A/S and Australia’s stock exchange owner ASX Ltd. both abandoned plans to use blockchain in their operations last year.
If this technology is to be harnessed for the public good, it’ll have to find a way that it can be used to increase trust levels, rather than evade the issue or, worse, treat trust itself as pernicious. That’s going to be hard to do in the wake of a multi-trillion market collapse and a flurry of lawsuits. Still, it’s probably crypto’s last shot at turning itself into something lasting, rather than a bubble that glittered for a moment, but was forgotten as soon as it popped.
More From Bloomberg Opinion:
• The CFTC Comes for Binance: Matt Levine
• The Crypto Bros Are Fast Becoming Unbankable: Lionel Laurent
• SVB Collapse Shows Fickleness of Crypto Money: Andy Mukherjee
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
David Fickling is a Bloomberg Opinion columnist covering energy and commodities. Previously, he worked for Bloomberg News, the Wall Street Journal and the Financial Times.
More stories like this are available on bloomberg.com/opinion
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