The Only Crypto Story You Need?

The Only Crypto Story You Need?

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Matt Levine’s witty and engaging ‘The Crypto Story’ ultimately fails to grasp crypto’s fatal flaw.  He comes perilously close to revelation, but frustratingly remains mired in illusions and disinformation that have been internalized by the public.  Levine, at length, paints the portrait of a new economic frontier.  Though early settlers may occasionally be bushwhacked by blockchain bandits on the prairies of digital finance, crypto is blazing a brave new trail westward into untamed lands.

The stated goal for the piece is to convince the reader that crypto is interesting, that we can learn from it, that it has potential.  The author and I agree on the first two points.

"Conversely, I didn’t sit down and write 40,000 words to tell you that crypto is dumb and worthless and will now vanish without a trace. That would be an odd use of time. My goal here is not to convince you that crypto is building the future and that if you don’t get on board you’ll stay poor. My goal is to convince you that crypto is interesting, that it has found some new things to say about some old problems, and that even when those things are wrong, they’re wrong in illuminating ways."

Levine’s overall conclusion? With so many exceptional hands tilling crypto’s fertile soil, you should pay attention, the future of finance may be blossoming as we speak.  Crypto matters, not only for what it teaches us, but for what it might become.

"The crypto system has attracted a lot of smart people who want to solve these problems, in part because they’re intellectually interesting problems and in part because solving them will make these people rich."

As a general picture of crypto, Levine brilliantly covers the broad brush strokes, but something about the shading leaves me deeply uneasy.  Relevant criticisms are omitted, misplaced, and generally diluted by a torrent of prose, making it all too easy for readers to drown their doubts in the bathtub.

Speculation

Let’s consider speculation. Crypto is entirely speculative, people mine or buy digital tokens because they think they can profit.  Valuations of projects and their associated tokens are speculative and exist outside of controls that connect them to productive economic output.  Levine uses some version of the word speculation 15 times in the article, but only once as a very strong unequivocal criticism:

"It turns out that crypto is basically a speculative asset and that it’s not particularly a hedge for stock market volatility.”

This quote comes almost 9/10ths of the way into the article and is given within the context of Terra, one of the industry’s most obvious and famous grifts.  Why is the most forceful statement about speculation made in the context of Kwon artistsWhen discussing speculation in relation to Bitcoin words like “might be” and “big business” are used.  This characterization seems odd to me.  If this is The Only Crypto Story You read, you would be forgiven for thinking that the issue of speculative mania applies more to web3 than it does to Bitcoin or Ethereum.

In contrast, speculation is used twice to promote crypto and bookends the article.  Near the start,

“Whatever is left in crypto is not just speculation and get-rich-quick schemes.”

and close to the end.

“Now the speculative frenzy has, if not disappeared, at least cooled.”​

The implicit assertion here is that what’s left in crypto is worthwhile and valuable.  Yes there were scams and speculation, but that’s been dealt with.  This framing doesn’t let the reader consider the possibility that crypto is still a giant dumpsterfire full of swindlers.

Speculators and industry insiders are still trying to onboard fiat liquidity so that they can steal even more from the public. There’s even a campaign of political bribery (lobbying) attempting to loosen regulation so new fiat in-flows can be created.  There’s no mention of this, instead it’s implied that the blaze of crypto winter had scoured away the rot in the industry.  Usually I would roll my eyes and move on, but combined with other issues and omissions, it makes me think Matt’s perspective on crypto is deeply flawed.

Market Cap

Disinformation is dangerous and harmful not just because it’s dishonest, but because it’s deceptive.  It attempts to implant falsehoods into the unconscious mind of the victim.  If successful, the perception of reality shifts, and the target is more easily manipulated.

Nowhere in ‘The Crypto Story’ is the concept of crypto market cap challenged or explained in detail.  By uncritically mentioning crypto’s multi-trillion dollar market cap 9 times, Levine, a Harvard educated financial expert, embeds a lie into the unconscious of the reader.  Levine remarks:

“But it’s striking how little effect the loss of $2 trillion of crypto wealth had on anything else.”

Yes.  That’s because the industry’s market cap was and still is a lie.  Crypto market cap is fictional, it’s not analogous to market capitalization for equities.  While the calculation is the same, share (token) price * # of shares (tokens) = market cap, token and share prices are determined in vastly different ways.  Unlike tokens, share price is supported by a company’s underlying cash flow.

Stocks are governed by a legal and regulatory framework that incents the production of positive economic output (utility).  Publicly traded companies have requirements around financial disclosure, auditing, governance and must demonstrate existing, or future potential, cash flow.  The rules provide a reasonable guarantee that you aren’t being scammed and that useful work is occurring.  Thanks to this regulation, share price, and hence market cap, for a stock is justified because the company’s current or potential cash flow supports it.  There is an underlying connection between cash flow and the utility provided to the market.  This is why a company’s market cap is roughly equivalent to what it’s worth.  It’s not hard to find buyers for an undervalued stock with solid earnings, investors like dividends.

As Levine points out, crypto projects lack typical regulatory mechanisms, requirements for cash flow, and in many cases a product.  How then are crypto’s speculative digital tokens priced? As it turns out, the important question here is not just how, but who.

"Crypto exchanges are companies—Coinbase, Gemini, Binance, FTX, Kraken, and Bitfinex are some big ones—that accept regular money for crypto."
...
"In the olden days, the stereotype was that a lot of crypto exchanges were run by criminals or incompetent teenagers, or incompetent teenage criminals."
...
"Modern crypto exchanges are less like that. For one thing, they’re more careful and technically adept, so they’re less likely to lose your Bitcoin. For another thing, though, they’re big companies, regulators are aware of them, and they try to be good corporate citizens."

Token prices are determined by what Levine calls ‘good corporate citizens’, also known as centralized crypto exchanges, such as Coinbase, FTX, and Binance.  We can’t know how the sausage is made short of an audit, but in theory buy/sell orders on the exchange set token prices.  These under- and un-regulated exchanges set token prices which then determine market cap.  For Bitcoin, the current ~$17k $21k price (at time of writing) puts the market cap at around $320B $400B.  But is Bitcoin actually worth that much?

Estimates put the number of unrecoverable tokens, tokens that can never be sold, at anywhere from 10% to 25%, but even if you could sell all 19M tokens, the demand for the tokens doesn’t exist because its based on finding a greater fool.

While market cap is a useful measurement in the world of equities because cash flow is tethered to real world utility, crypto has no such anchor.  Token price is supported by the belief that you can fob off your magic beans to someone else for more than you paid for them.  Market cap in the world of crypto is blisteringly stupid as it’s impossible to measure what supports it:  the willingness of people to buy a useless speculative digital token that doesn’t even qualify as an asset.

Amazingly though, it gets worse!

Exchanges

Centralized exchanges are responsible for the majority of the fiat money being ingested by crypto.  The very same people setting token prices that determine market cap have a vested interest in seeing the value of these tokens increase by as much as possible.  Even excluding the money extracted from the public by exchange owners through the sale of personal crypto holdings or outright embezzlement, greater valuations serve as a recruitment tool to ingest more fiat liquidity, and more marks (customers) result in more fees.

As there is no underlying source of economic productivity and cash flow in crypto, Exchanges view customer deposits as cash flow.  This is the inevitable result as crypto is a negative sum game where fiat liquidity is ingested from the real economy, redistributed through ‘tokenomics’ to whales and industry insiders, then deposited back into different bank accounts in the fiat financial system.  The goal of the exchange is to seize client funds, either explicitly by betting against them and charging high fees, or implicitly, by gambling with funds without the consent of the depositor.

Much to the shock of libertarians, combining a profit motive with lawlessness and anonymity creates a steaming pile of corruption the size of Kevin O’Leary’s ego.  This intrinsic conflict of interest helps explain why exchanges are subject to Saylor’s law: In the absence of regulation, whatever unethical behaviour that can occur, will occur.

Lack of regulation means that exchanges can lend to customers to create leveraged positions and then use inside information to front run their clients and liquidate them.  Exchanges can steal client assets because they have the power to order transactions and manipulate prices.  It’s painfully easy to obscure this behaviour by colluding with outside parties or by disguising yourself as one.  The same tactic is used by loan sharks – extend credit and sabotage the borrower so that you can exploit them and turn a healthy profit.

Levine focuses on the most famous cons and never mentions that crypto’s biggest players might currently be engaged in bad behaviour.  Exchanges potential involvement in the price manipulation that continues to occur in the crypto ‘ecosystem’ is never mentioned.

Instead, Levine legitimizes crypto’s market cap, its centralized exchanges, and even the biggest scammiest elephant in the room, Tether.

Tether

The lack of critical discussion about ‘The Crypto Story‘ is shocking, more so when you consider gems like this:

“They also go around promising to publish an audit but never do it. They probably have the money, more or less, but they seem to be going out of their way to seem untrustworthy. Still, people trust them.”

Believe it or not, that’s a comment on Tether and it’s a bold departure from what most crypto industry observers think.

Many would argue that the folks at Tether are liars and criminals who applied the lessons of creative writing courses to their balance sheets and spawned a digital token used to manipulate and prop up the price of cryptocurrencies.  But Levine doesn’t discuss Tether as a blight on the industry, it’s just another little quirky crypto factoid.  Bloomberg should consider notifying the NY State Attorney General’s office to let them know they made a grave error about Tether’s trustworthy owners.

Tether is worth discussing in detail because it’s integral to crypto’s dependence on recruitment for new fiat money inflows.  Glossing over Tether’s effect on crypto is like skipping over the subject of cocaine at a seminar on drug cartels.

If you’re running an investment fraud, you have a few problems. The first is that you’re a shitty person.  Next is that you better make damn well sure that the amount of money being removed from the scheme doesn’t exceed the total amount of liquidity available.  This can get tricky, you want to service withdrawals so people can be seen making money from your scheme, but you can’t have too many people taking out their money or the whole thing will come crashing down faster than an algorithmic stablecoin.

The whole point is to keep the scam running for as long as possible.  Duration drives credibility, and credibility drives recruitment.  More suckers means more money, which means greater ‘returns’, which means more people, which means more money… and voilà.  A beautiful ‘positive feedback loop’ of value is created.  To sustain it we must minimize withdrawals and maximize deposits.  If only we weren’t subject to the limitations of fiat currency that are imposed by reality and the demands for cold hard cash.  Enter Tether, stage left.

Tether helps minimize outflows and maximize inflows in our investment fraud.  Fiat withdrawals are limited, instead of walking away with cash, participants are given digital tokens ‘valued’ at a dollar, and incentives are created to encourage investment into new scams (tokens).  Tether also helps with inflows, exchanges don’t need to cook their books with fake fiat deposits and risk investor confidence or the ire of law enforcement should they be discovered.  There’s a better way to create buy/sell orders that manipulate token prices.

If I accept deposits in a fake currency (Tether) and consider those deposits to be equivalent to fiat, then I’m not breaking any laws.  Better yet, I don’t have to worry about real cash deposits needed to pump my scam and I don’t have to move fiat around when wash trading.  So Tether fulfils the function of maximizing deposits as well.  Not only does it create synthetic liquidity, but by manipulating the prices of tokens skyward, Tether helps create fiat inflows from new suckers.  Is anyone else reminded of Galbraith’s bezzle?

Imagine colluding with the only grocery store in town to raise prices.  The store owner needs to justify price increases to the Mayor, so instead of arbitrarily raising prices, you agree to use monopoly money to buy groceries and increase demand.  More ‘money’ chasing after a finite amount of groceries increases the price (fraudulently and arbitrarily), and you and the owner split the excess fiat profits.  The store owner has plausible deniability, you have a bunch of free money, and the public is left holding the grocery bag.

In return for providing fake liquidity to the industry, Tether can buy tokens through intermediaries and sell them for real fiat currency, exchanging their funny money for the real thing.

Of course, this only applies if Tether is a criminal enterprise and their reserves are fraudulent.  So take what I said with a grain of salt, but you start to understand why people are so interested in the details of Tether’s holdings and business operations.

If I wrote an all encompassing Crypto Story, I might be inclined to discuss the possibility for a vast criminal conspiracy at the heart of the industry, but that’s just me. Levine on the other hand may consider it to be another one of those things that’s an “odd use of time”.

Et Cetera

Speaking of criminality not worth mentioning, Levine doesn’t appear to cover wash trading in crypto, despite it being rampant.  Amazingly, this topic is avoided even in the context of “Rare monkey JPEGs”, or NFTs.

Painting the tape is a common enough occurrence with standard crypto tokens, but I didn’t think it was possible to talk about NFTs and avoid the subject of wash trading entirely.  It’s as if someone wrote a comprehensive biography about the life of Rick Astley without ever letting the words “Never Gonna Give You Up” touch the page.  You’re missing the point of the whole thing.

Levine’s article is positioned as “The Only Crypto Story You Need” but it rarely peers at what lay beneath crypto’s surface. On the other hand, I enjoy Matt’s writing, and some of his insights are valuable and informative, one of my favorites is from the section on trust:

“Crypto is in a way about rejecting the institutions of society, about being trustless and censorship-resistant. But it quietly free-rides on people’s deep reservoir of trust in those institutions.”

Levine hits it out of the park on that one.

Which makes me scratch my head as to why he can’t call the industry on their bullshit in so many other cases.  Speculation, market cap, exchanges, front running, wash trading, Tether, these are just a few of the things that are wrong with the article, but there’s so much more.

Not least among them the belief that blockchain has desirable properties as a database, the idea that blockchain or crypto is somehow useful for video games, the quoting of Poleg’s technological pseudo profundity to imply that there are web3 use cases, or the implication that crypto fraud isn’t THAT effective when it’s managed to fund the DPRK’s nuclear weapons program.

After reading through my notes, there’s at least another dozen problems worth covering, but I can’t because this article already risks being longer than ‘The Crypto Story’.  The issues range from minor misunderstandings, to the flat wrong, to internalized crypto propaganda.

Money For Nothing

The thing that bothers me the most is that Matt gets it. He understands what the economy and financial system should be, he knows the difference between real wealth and simulated value, but there’s some invisible force stopping him from taking the final logical step.

“A financial system is good if it makes it easier for farmers to grow food and families to own houses and businesses to make awesome computer games, if it helps to create and distribute abundance in real life. A financial system is bad if it trades abstract claims in ways that enrich the people doing the trading but don’t help anyone else.”

"Crypto, meanwhile, has built a financial system from first principles, pure and pleasing on its own, unsullied by contact with the real world."

Levine identifies what’s good for the economy and he points out that crypto doesn’t do these good things, but he never manages connect the two facts and just say out loud that crypto is bad for the economy and for the civilization that depends on people doing useful things.

“Before the rise of Bitcoin, the conventional thing to say about a share of stock was that its price represented the market’s expectation of the present value of the future cash flows of the business. But Bitcoin has no cash flows; its price represents what people are willing to pay for it. Still, it has a high and fluctuating market price; people have gotten rich buying Bitcoin. So people copied that model, and the creation of and speculation on pure, abstract, scarce electronic tokens became a big business”

Not only does he understand that providing utility to a market is what underpins value, but Levine even identifies HOW crypto undermines productive economic output.  Its network effects have NOTHING to do with being useful, and everything to do with demanding money up front!

"It’s hard to build a network-effects business from scratch. Early users of a network-effects business won’t get much out of it, because there’s no network yet. You might as well just wait until there are more users. The economics of crypto tokens reverse that."

Networks are useful to users, that’s why they spread, and it’s also the reason why users value the network. The network is valuable because it is useful, that incentivizes network operators to make useful things and do useful work. “The economics of crypto tokens reverse that.”

Instead of being incentivized to make something useful that people want to use, crypto is costly, it demands value from users.  The incentive for economic agents in such a system is to onboard as many participants as possible while doing as little real work as is required.  Rather than supply side incentives for the production of positive economic output, we get weird distributed corporate bonds (tokens) where, in the case of PoW, the invested value is destroyed instead of transferred to a corporation (as with PoS).

Utility is what drives real network effects and the production of wealth for our society.  The artificial network effects that crypto creates (the demands for invested value that scale with participation) remove capital and supply side economic incentives from the real economy.  Levine recognizes that finance is anchored to real world utility and that a similar issue of expanding value for the few, and contracting utility for the many has been creeping into our present financial system for decades.

“Over many centuries a financial system grew up, as an adjunct to the real world. That financial system enabled people to do more stuff in the real world. They could build railroads or semiconductor factories or electric cars, because they could raise money from strangers to fund their activities. They could buy bigger houses, because they could borrow money from banks. They could also trade out-of-the-money call options on GameStop, because that’s fun and you can make memes about it, but that’s an accidental feature of a financial system that mostly does serious stuff in the real world.

By 2008, or 2022, that system looked pretty abstract. When you think about modern finance, you often think about things like those GameStop options, or the system of payment for order flow that enables their trading, or synthetic collateralized debt obligations referencing other CDOs referencing pools of mortgage-backed securities. There’s a house there somewhere, under the CDO-squareds. All the sophisticated modern finance can be traced back, step by step, to the real world. Sure, it’s a lot of steps now. But the important point is that sophisticated modern finance was built up, step by step, from the real world. The real world came first, then finance, then the more complicated epiphenomena of finance.

But there’s no realization that crypto is a weaponization of the forces in our economy that extract value without providing meaningful utility.  The truth is that society is impoverished when we allow monopoly rents to be extracted by the already fabulously wealthy.  Rampant economic inequality destroys aggregate societal wealth.

"But another part of the answer might be that the real world—growing food, building houses—is a smaller part of economic life than it used to be, and that manipulating symbolic objects in online databases is a bigger part. "

"A financial system is bad if it trades abstract claims in ways that enrich the people doing the trading but don’t help anyone else.”

The corruption and injustice of the existing financial system, the de-industrialization and financialization of our economy, has driven millions into the waiting arms of crypto con artists.  The public has been made desperate from decades of stagnating or declining real wages, and Cryptovangelists have been quick to inculcate the flock and prepare the faithful for a good fleecing.  Despite identifying all of its pieces, this cruel irony appears to be lost on Levine.

“Also, I have to say, as someone who writes about finance, I have a soft spot for stories of fraud and market manipulation and smart people putting one over on slightly less smart people. Often those stories are interesting and illuminating and, especially, funny.”

The article’s final judgement echoes the liturgical refrain we’ve heard shouted down to us from crypto’s pulpits and rarefied peaks for over a decade. After 40,000 words, the reader is told, ‘We’re still early!

"And the answer is, you know, maybe, give it time."

"If the world is increasingly software and advertising and online social networking and, good Lord, the metaverse, then the crypto financial system doesn’t have to build all the way back down to the real world to be valuable. The world can come to crypto."

The ‘Crypto Story’ is a comprehensive tour de force and an excellent general overview of crypto’s past and present, however, its view on crypto’s future is at best naive, and at worst potentially harmful to the unaware.  Despite all of Levine’s warnings, mockery, and colourful language, the failure to identify and highlight crypto disinformation puts those unfamiliar with the industry’s fundamental flaws at risk.  Though I do not think Levine intended it, his portrayal of crypto as the early days of an innovative new technology could cause members of the public to invest money into an industry whose collapse is inevitable.

Far from being “The Only Crypto Story You Need”, Levine has authored what might be the most subtle example of mainstream journalism’s crypto credulity.  This piece should not be consumed by the uninitiated in isolation, rather it should be paired with a hearty dose of more critical voices like Castor, Diehl, Gerard, and White. To those familiar with crypto’s landscape, whether skeptic or true believer, I very much recommend reading ‘The Crypto Story‘.

Unfortunately, Levine has drunk from the poison chalice of accepted crypto industry narratives and in so doing has fallen victim to useful delusions.  Though there is hope, as I have begun to write these last sentences, the story of FTX’s spectacular meltdown has begun breaching the waters of social media and the tide of institutional momentum may finally be turning.  Many journalists, politicians, and investors will soon be forced to confront reality by asking uncomfortable questions, and little room will be spared for convenient excuses.

Long after the last miner lay abandoned and the echoes of cryto punditry have become a scarlet letter, Levine’s Story will remain, a testament to folly and greed’s bitter ashes.  Future pilgrims will come seeking answers about history’s greatest deception, and as they travel through its pages, The Crypto Story will serve as a reminder to ignore the whispers about the future of finance from the devil on our shoulder.

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