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Isaac Khor

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Cryptocurrencies: dreams and tragedies

In my dreams, I dreamt of a future: of cycles and re-invention, of walking paths already well-traveled; of re-discovery of the old, releaning lessons already learnt before.

In the beginning, we had gold.

Kings and Emperors minted coins in gold bullion, and the value of a physical coin was the value of the precious metals contained within. People all agreed that the shinies were valuable, and used them to exchange for goods and services.

But then, some people figured out a better system: instead of carrying all these heavy sacks of precious metals around, which is cumbersome and really annoying, why don’t we store all these metals in a giant vault and carry around paper claims on said currency.

And thus paper currency was born.

Instead of carrying around 10 pounds of gold, I had a piece of paper that entitled me to reclaim 10 pounds of gold from my bank of coice. If I were buying wool from my supplier, instead of carting over a literal ton of gold, which is expensive and a pirate magnet, I just handed him a piece of paper and they could go claim the gold when they wanted to.

Then another guy had a clever idea: since you’re storing the gold in my vault anyways, and most people just left the gold in the vault forever since the paper notes were much more convenient, what if I lent out some of the gold in the vault in the meantime? This way you don’t have to pay me for my vault, I would pay you instead. We both win.

And thus fractional reserve banking was born.

Then after some time people had another idea: remember those pieces of paper that entitled you to some gold in a vault? What if they don’t anymore?

And thus fiat currency was born.

What does this have to do with crypto?

Today, we’re pretty firmly at the stage where people are getting to the stage of agreeing that bitcions and ethereum and whatever else insert favourite coin has non-zero value.

But really, crypto is annoying to actually use. To trade crypto, you have to pay outrageous transfer costs, in terms of time, price, electricity, the environment, and more. There are no legal protections for anything: if you got hacked, you’re not seeing those coins ever again, unlike banks that have legal protections around these kinds of things happening that have been developed over the past century+ of modern banking.

This makes crypto appealing to own, but not to actually have those coins in your crypto wallet. Much more appealing to have a 3rd party handle all of the custody stuff and you just trade bitcion the same way you trade good ol’ freedom dollars.

But once again, the bitcoins are great, the blockchain not so much. You have to wait several minutes (minutes!) for a trade to settle in bitcoin, or you have to pay sky-high gas fees for ethereum, or something equally ridiculous. What if a bitcoin-bank held all the coins, issues (not paper) claims on a bitcoin in their bitcoin-vault, and we just traded those instead?

And thus bitcoin ETFs were born (yes I know there’s more to it but let’s not worry about it for now).

Now, we can extend this further. Bitcoin ETFs aren’t a claim on a bitcoin somewhere the same way you could walk into a bank with a dollar and walk out with gold in the days of the gold standard. But there’s no reason it couldn’t make it that way: somebody needs to buy a bunch of bitcoins, hold them in their wallet, and then issue tokens (very fungible tokens) that people can trade on the (non-blockchain) market. To hold exposure to bitcoin without actually holding any real bitcoins in your wallet.

This already happens with stocks: nobody actually owns any stock, the DTC owns all the stocks on behalf of brokers, who own it on behalf of you. The DTC has a massive ledger with “Schwab owns 1000 Apple shares”, and Schwab has a database that says “Isaac owns 10 Apple shares”.

Now history repeats itself: the crypto-bank issues crypto-tokens on real crypto that it holds, and people just trade the tokens. But it has a better idea: since most people don’t actually want to hold the crypto, and it’s sitting in their bank anyways, they can just loan out some of the crypto they have. We can even call them crypto-dollars.

And thus fractional-reserve crypto-banking will (should?) be born.

As crypto-banking becomes a larger part of the financial system, at one point the government will step in and consolidate and regulate the crypto-banks to real-bank standards, and we’ll end up with the federal-crypto-reserve owning all the bitcoins, maintaining a normal ledger of normal banks who own crypto-dollars, who in turn maintains a ledger of real persons who own crypto-dollars in their crypto accounts.

Or even more likely, all big financial institutions agree to transfer their crypto in whatever form they own it to the federal reserve, who then maintains a USD ledger and an additional one for each relevant cryptocurrency.

Then one day, the future generations will look back and think: “geez, what on earth was grandpa thinking, who puts currency on the blockchain”. And then some smart future economist will propose that we move off the crypto-standard, since having a currency tied so closely to a finite supply of 21 million bitcions is extremely limiting for crypto-monetary policy. Then by the stroke of a pen crypto-dollars will no longer be pegged to real crypto.

And thus the cycle will have completed itself. We will have re-invented USD in a worse form.

The more things change, the more things stay the same.

I dream of a future, of fiat currency reborn.

But in a more stupid way.

What’s the lesson from all this? I don’t know. I think crypto is stupid, but because of the game-theoretic payoff matrices you can’t really ignore it. It’s not your own perception of value that matters, but how you think others think everybody else values crypto. It’s a feedback loop: if everybody agrees that something is valuable, then it is valuable, even if you don’t agree.

The internet doesn’t help either. Subreddits have formed crypto cults, where they only hear news from other crypto-bros that all think crypto is Jesus Reborn. This forms a minimum baseline for crypto’s value, since even if everybody wakes up one day and decides that it’s dumb at least you can dump it on the crypto cults, and since everybody knows the crypto cults will at least be around to scoop up the pieces it makes the market less likely to crash. The same way FDIC prevents bank runs by its mere existence. At the end of the day, currency is a co-ordination game. Nobody wants to be left holding the bag, so the existence of crypto-cults garuantees that you won’t be the sucker at the end.

One day I’ll put together enough material to do a writeup on the tale of r/WSB, on how reddit puts together fairly benign people to turns them into conspiracy theorists. But threading through GME threads is like reading a flat-earth/q-anon/etc forums: I know they’re wrong, but I can see the foces that have led well-meaning and intelligent people into the wrong conclusion. It’s genuinely saddening to me, and in my mind one of the the great tragedies of the modern age.

All this to say I’m sad; sad that the structure of human society causes all of the above; sad at how I can see the incentive structures and systemic forces acting us poor apes; upset that I can see no way out.

/rant over