Bonus: The Crypto Story by Matt Levine - Part 7

Matt's gone deep into the blockchain to break down its origins, it's possible, futures, and the current state of a technology that's showing up everywhere in industries ranging from finance to shipping too, of course video games. And we're going to be bringing his exploration to you in audio form thanks to the talents of Bloomberg editor and professional voice actor Mark Ledoff. You'll get weekly chapters of the special Crypto

issue of Bloomberg Business Week. Welcome to the seventh chapter of the special audio edition of the Bloomberg Business Week Crypto issue, written by Matt Levine and narrated by Mark Ladoff. If you need to catch up on a previous chapter. You can find episodes right here in the Bloomberg Crypto podcast feed. Part four Trust Money Community. Let me tell a couple of stories about crypto and society. A trust one story goes like this, We live in a world

of trust, that trust pervades everything we do. We're spoiled. The institutions we deal with every day are trustworthy. Not all of them, not all the time, not in every way, but quite a lot of them to a high degree. We put money in the bank, and when we go to take it out, it's there. Crypto Satoshi Nakamoto and his disciples said no, no, no, trust is bad. Don't

trust your bank. Use immutable code, verify every transaction for yourself, or download open source code and verify that it works correctly, and then use it to verify every transaction for yourself, or at least use a network in which that's possible and in which economic incentives demonstrably make it likely that it will happen. And do all of this in a system that's resistant to changes, that can't be controlled by governments or banks, that's immune to the rules of wider society.

This had an appeal, and crypto became very valuable, and people looked to put their money to work in crypto, and they trusted people over and over again. They trusted Quadriga and Terra and Voyager and Celsius and dozens of other projects that failed or ran off with their money or got hacked. They just fell over themselves to trust people. Why did they do this, Well, there's a common thread in these kinds of things. The people who are easiest to pull in are often the ones who think they're

the most independent minded and cynical. Either the bank is lying or Celsius is lying. Celsius told people flattering their unjustified belief that they know the real score. But there's something else too. The people who trusted Celsius weren't tripped up only by their belief that they were outsmarting the system, though there was that. They also they thought Celsius was a bank. It looked sort of like a bank. It did things with crypto that were banklike. They were familiar

with how banks work. They understood that banks are safe, that if you put money in a bank you can get it act. They looked at Celsius and thought, well, this is a big thing. It has a nice website. It's available to Americans. Surely, if it was a problem, someone would have done something about it. Why didn't anyone do anything about it? Why were these platforms allowed to take money from retail customers, run high levels of leverage,

and blow themselves up. I think the basic answer is that regulatory authorities are still very much catching up to how crypto works and who should regulate it. There's a very well understood system for regulating a bank. There are bank examiners who know how banks work, and who visit

banks regularly to make sure they're working properly. In crypto, big platforms are often decentralized and vaguely stateless, and even in the US, there's a lot of jurisdictional jousting over which regulators get to regulate crypto and how they should do it. If you launch a terrible crypto platform, it might take regulators a long time to get around to understanding what you're doing and figuring out how to stop you.

You and crypto has been very much in a move fast and break things mode, so it broke a lot of things before the regulators could catch up. There's something a bit alarming about all this 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. People are so used to trusting banks that when Celsius told them not to trust banks, they said, ah, yes, okay, then trusted Celsius to work like a bank, to be regulated like a bank. They didn't worry about celsius opacity and leverage. They didn't do their own due diligence on its loans and audit its defied positions, and demand irrefutable proof of its soundness. It promised to pay them back, and that

was good enough for them. But there's something hopeful about it too. Trust in institutions is so strong and resilient that all of crypto's bluster can't stamp it out. Not your keys, not your coins, Put your trust only in verifiable code. Crypto evangelists yelled, and people heard them and said, yes, that is nice, but I'm busy. I'm going to trust

these nice strangers with my bitcoin. Crypto in its origins, was about abandoning the system of social trust that's been built up over centuries and replacing it with cryptographic proof, and then it got going and rebuilt systems of trust all over again. What a nice vote of confidence in the idea of trust. One thing crypto has done is show just how valuable trust is b money. There's a related story about money. One way to think of money

is that it's a system of social credit. Society has mechanisms capitalism, politics, etcetera to allocate resources with a rough heuristic of the more good stuff you do for society, the more good stuff you get for yourself. Money is a rough way of keeping track of that. If you do good stuff for other people, they give you money which you can use to buy good stuff for yourself. Another way to think about money is that it's some

sort of external objective fact. If you have money, it's your money, and society has nothing to say about whether you can keep it or what you can do with it. Crypto starts from the second view. Your bitcoin are yours immutably. They're controlled only by your private key, and no government or bank can take them away from you. But the history of crypto since Satoshi has undermined this view. If you got your bitcoin illegitimately, the government can trace them

and stop you from spending them. There are still gatekeepers crypto exchanges and FIAT off ramps and banks that decide what you can do with your money. Crypto might be immutable and censorship resistant, but its interactions with the real world are not. Not just that crypto isn't even immutable, not really. In twenty sixteen, an important smart contract on the Ethereum blockchain called the Tao got hacked. Dow is now a generic term, but this was the DOW, the

first of its name. There was a flaw in the contract that allowed a hacker to drain a lot of money from it, and he did. Ethereum was a new technology, so the hack was a big deal. This hack was controversial. There was controversy about whether it was even a hack. Some people said, look, if the code of the smart contract allowed the hacker to do this, then it was allowed. There's no external standard of validity, just the code, and

if it happened in the code, it's fine. If we reverse this transaction, we will destroy the essence of the blockchain, which is the irreversibility of transactions. Other people said, no, that's nuts. This was a big hack and lots of people lost money. It was clear enough to humans anyway that this was not how people intended the smart contract to work. Even if it was in fact how the

smart contract worked, sometimes the code is wrong. The Ethereum network decided to roll back the blockchain and reverse the hack. That's hard to do. You couldn't just amass a bunch of computer power yourself and hack the Ethereum blockchain and reverse transactions. But if everyone in Ethereum agrees to do it, they can, or if enough of them did. In fact, a minority of dissenters split off, forking the Ethereum blockchain

and starting their own network, now called Ethereum. Classic cryptocurrency isn't money that's totally immune to censorship, that's atomic and individual and immutable. It's money that's controlled by consensus, much like dollars are. It's a different form of consensus, proof of work, mining, proof of stake, validation, decentralized communities, dows, discord chats. But the thing that gives you the money,

and that makes the money valuable is that consensus. Money is a social fact, even when the money is bit point or ether see community. Here's another more speculative story. The most valuable thing in human life. This story begins, is connection, being with your friends, making friends, feeling esteemed by your peers. These are the things that give life meaning. Sure, sure, sure, whatever you say, because this feels fuzzy and fake. But

look how rich Mark Zuckerberg is. If you'd said a giant contributor to us gross domestic product is the friends we made along the way, that wouldn't have made any sense. Now Facebook is worth almost half a trillion dollars, though to be fair, it's changed its name to meta platforms, to markets pivot away from friendships and to markets pivot

to the metaverse. I don't know what the metaverse is, but I gather that the metaverse means something like our lives, our social lives, are intellectual lives, are professional lives, are esthetic lives. The things that we do all day and that give our lives meaning will take place increasingly on interconnected computers. Our reality will be intermediated increasingly by computers and the Internet. Human social life moving to the Internet has economic value, it turns out, though, if you explain

the mechanism, it seems remarkably trivial. If people talk to their friends about vacuums and you show them an ad about vacuums. They'll probably buy a vacuum. If we intermediate between people's friendships, we can serve ads. A key lesson of crypto is a bunch of people can get together online and make their community have economic value and then capture that value for themselves. If you explain the mechanism for that, it sounds even worse. Well, see, there's this

token of membership in the community, and it's up this week. Also, the tokens are JPEGs of monkeys. But look, pretty soon, what are we going to sell each other? Online communities are valuable. There's money to be made. Why shouldn't the community members get the money. We'll be right back with more from Bloomberg Business Week Special Crypto issue, written by

Matt Levine a narrated by Mark Leedoff d Finance. There are lots of online communities, though one is board Ape Yacht Club, a self selected club where you become a member by buying an expensive membership token. The value of that community is I guess you feel cool and exclusive. Maybe you befriend a celebrity or a venture capitalist. Bonding over your apes or their social networking Facebook is valuable. Make a neo Facebook. Give people a token, let them

keep the value for themselves. Advertise can get your data only if they pay you in tokens you tell them. Or you can earn tokens for posting, which you can then use to pay other people for posting why not. Or gaming. If you buy a laser in this game, it's an n f T and it's yours to keep forever. Maybe you can use it in another game why not. These are standard claims about web three that leave me

mostly cold. I don't want to be in the advertising, data selling, or computer game arms dealing businesses, but other online communities are defy like in some crude sense, what decentralized finances is a big community of people who get together to pretend to trade financial assets, or rather who trade financial assets in a sort of virtual world. They've built derivatives exchanges and secured lending protocols and new ways

to do market making. But instead of trading stocks or bonds, they trade tokens that they made up, and those tokens are value able in part because they're linked to other online communities. You can use defy to buy ether that you then use to buy n f T s to become a board ape owner, but also in part because defy is itself an online community or cluster of communities, and the tokens it trades are points in that community.

If you build a cool trading platform or execute a cool trade, you'll earn tokens, which you can spend on other cool trading platforms or trades. Talented financial traders are willing to work on projects to get those tokens. If you had some of those tokens, you could hire those traders. A problem and an advantage of crypto is that it financializes everything. What if reading your favorite book made you an investor in its stock. It's a story that only

a venture capitalist could love. On the other hand, it's a story that venture capitalists love. A minimalist case for crypto is it's an efficient way to get venture capitalists to put money into software projects, or it's a ponzi. The Web three vision of having the customers of every project also be its investors works well in times of

speculative excess, but is disastrous in a crash. All our customers have a stake in our success is great when token prices go up, but it also means that all your customers become poorer when token prices go down, which makes it hard to attract customers. But we've only really seen the boom. The problem with making every product also a ponzi is that you can't be sure if your customers are there for the product or the ponzi. But

when it collapses, you can if they're still there. If they still use your product without getting rich off the token, then that means your product is promising. If not, well, you ran a ponzi. The great speculative frenzy of crypto and Web three over the last few years drew a lot of money and attention and talent into the crypto world.

A great deal of that money and attention and talent went strictly to optimizing the speculative frenzy, to tweaking the token omics and leveraging the bets so that people could make as much money as possible without actually building anything. Some of it probably went into building, though now the speculative frenzy has, if not disappeared, at least cooled. Now if you're trying to raise money for a Web three project, it should probably do something besides issuing a token that

goes up. If it creates value for people. If the product is something that people want, then the tokens will take care of themselves. Crypto people have a lot to prove on that front. One reason Crisis and Crypto didn't spark a contagion is that it has so few connections to things that matter to people. They play games and gamble on the blockchain, but they don't have mortgages there.

Perhaps this is all a self referential sinkhole for smart finance people, but honestly, it would be weird if that's all it ever turned out to be. If so many smart finance people have moved into the crypto financial system, if they find it so much more enjoyable and functional and productive than the traditional financial system, surely they'll eventually figure out how to make it, you know, useful. Here's another way to tell this story. There's the real world,

and people do stuff in the real world. They grow food and build houses. 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 game stop 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 two thousand and

eight or two, that system looked pretty abstract. When you think about modern finance, you often think about things like those game stop options, or the system of payment for order flow that enables their trading, or synthetic collateralized debt obligations referencing other c d O s, referencing pools of mortgage backed securities. There's a house there somewhere under the CDO squares. 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. Crypto, meanwhile, has built a financial system from first principles, pure and pleasing on its own, unsullied by contact with the real world.

Coming up next, you'll hear more from Matt Levine's special Crypto issue of Bloomberg Business Week, narrated by Mark Ladoff. I exaggerate the basic function of sending money using crypto. Satoshi's original goal is fairly practical. But otherwise that's interesting as an object of esthetic contemplation. And I've enjoyed contemplating it, and I hope you have to. And it's attracted a lot of finance people who also enjoy contemplating it and

getting rich. And their task is to build back down, step by step, to connect the elegant financial system of crypto to the real world. You've built a derivatives exchange, cool, cool, but can a real company use it to hedge a real risk facing its real factory. You've built a decentralized lending platform, awesome, But can a young family use it to buy a house? And the answer is, you know,

maybe give it time. The cryptosystem 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. 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. Modern life is lived in databases, and crypto is about a new way of keeping databases on the blockchain. If you build a financial system that has trouble with houses but is particularly suited to financing video games, one that lets you keep your character on the blockchain and borrow money from a decentralized platform to buy a cool hat for her or whatever.

I don't know, then that's system might be increasingly valuable as video games become an increasingly important part of life. If you build a financial system whose main appeal is its database, it will be well suited to a world lived in databases. 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 worth a shot. No, thank you Matt Levine, and thank you Mark Ledoff. As a reminder, if you're looking for these episodes in the Crypto feed, will be publishing them every Sunday through December. If you'd like to read this issue in print form, you can head on over to Bloomberg dot com slash the Crypto story. This is Boomberg Crypto, a daily podcast from Bloomberg and I Heart Radio. For more shows from I Heart Radio, visit the I Heart Radio app, Apple Podcasts,

or wherever you get your podcasts. Send us your comments, questions, or suggestions for the show to Crypto at Bloomberg dot net or find us on Twitter. We're at Crypto. The supervising producer of Bloomberg Crypto is Vicky ver Galina. Our senior producer is Janet Babin. Our producers are Mohammed Faruk and Sharon Barriro. Our associate producers are Ty Butler and Moses on Them. Desta wonder At is our engineer. Original music by Leo Sidron. I'm Stacy Marie Schmal. We'll be back tomorrow