DeFi versus TradFi

other concepts in crypto. This is particularly clear right now as crypto experiences its own version of a beer Stearns moment, which all begs the question, our concepts like Defy or decentralized finance just reinventing traditional finance with more complexity and a sprinkling of the blockchain, or is their genuine novelty Here for more on these questions, I'm joined by Bloomberg opinion columnist Matt Levine and Bloomberg reporta muy Sen Matt, we are this is a truly exciting moment in the

history of the pod. We have none other than Matt Levine, who, if you're not reading him, for his takes on Elon Musk you should be reading him for his takes on crypto, like what is wrong with you? Get it together? Subscribe to his newsletter. And Muyao, who has been you know since joining Bloomberg, just absolutely on fire as it relates to covering everything defy which all seems to be melting

down in one in one direction right now. So what we're gonna do today with these two fantastic guests is explore a little bit how what we're seeing into centralized finance and centralized finance have echoes of what we've seen before. And without revealing just how old Matt and I are, I can say that we were both around in two thousand and eight and we're aware of the financial crisis of that time, and we're going to make a couple

of other historical references. Does that work for you both? Yeah? Alright, let's get started. So we are what's defy defies, you know,

show forced decentralized finance. It is one of the narrative or innovation crypto wants to uh sort of created to replace the traditional finance, which you know, crypto people like to say trifi and it's basically tokenalized in every financial instrument on blockchain and matt as two of us who have covered you know, trad fire or whatever heard referred to even more disparagingly as old FI, which, wow, rude, we are we are old five. Um what about DEFY looks to you like old five? Well, you know, I

want to be careful. I think that like there is a sort of like core element of DeFi that is

truly decentralized, and that is different and interesting. But what's been interesting in the last like you weeks two months has been that so many people who were in sort of broadly speaking, the DEFISE space turned out to be much more centralized than people thought, and to look a lot like the financial system of sort of you know, late two thousand seven, where it was a lot of like very levered players lending to each other in opaque ways where it was hard from the outside to know

who was going to blow up when someone else blew up. So like you know, when like Lehman Brothers collapsed, that was that was an investment bank. For those of you who are you know, nineteen, when Lehman by this collapse, there is a lot of like who has exposure to Lehman? What commercial paper flunt, what you know, money market funder, what investment bank or what commercial bank is going to

go down because they were lending money too, Lehman. And there there are worries like that that are repeating and propagating through the cryptosystem where you know, there were a couple of very high profile failures in crypto. One was the Terra Lunar ecosystem, which I think you'd probably called DeFi um, and the other was it was a hedge fund called Three Arrows Capital, which is like a hedge

fund that defied stuff some other crypto stuff. And both of those, basically, like the fallout of that has been interesting to trace, and it wasn't I think necessarily obvious to everyone where that fallout would go until you know, other platforms started declaring bankrupts. And you know, you mentioned commercial paper, which I remember when none of us cared about commercial people, and then we all have to care

about commercial people. And I feel like I'm there again because that's also at the center of a lot of speculation around stable coins. Or anytime you're caring about commercial paper, it's a bad sign, right, Yeah, No, it's just it's not good. So you know, I know you're not nineteen And I know you know what Lehman Brothers is, but what are you seeing, especially as it relates to some of the folks from you know, TRADFI who are interested

in crypto or even disparaging of too. Where do you find yourself saying yeah, actually that's how that's similar, but this is how that's different. Yeah, for sure, I think, yes, I'm not that old. Oh I'm not that young. But I want to say, like, all of my knowledge from

finance is actually from what I learned in DeFi. You know, there are a lot of cons of in DeFi that was claimed to be innovations, but after I talk to people who are you know, had a ull Street experience, So tell me, oh, that's been long existing in in traditional finance. However, I think a classic example recently would be uh steak East own Lato, which is easier and

steaking platform. What it is is basically, if you stake your East with this platform, light though that you get a deridive token called steak East instead, and can use the stakes to trade and or to use the as a clatteral on different other defied platform for lending and brawling and things like that, and often time I heard from people who had a Trifi experience that it will

tell me that sounds like security back back loans. And you know, Matt's as you have written about, I mean everything, but as you've written about elements of these, including this concept of shadow banking, which really came up in that two thousand and eight context. Are there things where you're sort of looking at this and you're like, really, really, we're reinventing this again. Oh sure, I mean just like just like the very simple core of like shadow banking.

I mean, Chad, you know, a bank is an entity that borrows short term and lends long term. Classically, there's a lot of you know, nuance around that, but basically, a bank is something that takes deposits that people can take, can withdraw on demand, and it makes like mortgage lens where people don't have to pay them back for thirty

years and so that is profitable. That's like a you know, in vary those terms, it's an arbitrage because the mortgages pay more than the deposits and so you can collect the interest difference. Um. But it's conceptually very risky business, right like, uh, if there's a run on the bank and you don't have any money in the vault, then

you know you're getting big trouble. And so banking is a business that has existed for hundreds of years and ran into a lot of problems around runs on the bank and around various sorts of shenanigans and related party loans and whatever, and so in modern America, banking is like pretty regulated and so like that's that's banking, right, Like, banking has a lot of rules, and those rules are all sort of from from bad experience, right, Like those

rules exist because something went wrong and people like, oh, we need a new rule. And in two thousand and eight they were like two thousands, you know, five to two thou seven, there were there were a lot of there's a lot of talking about shadow banks, and a shadow bank is basically something that does that business of borrowing short to len long, but it's not a bank, and so can do stuff that banks are not allowed to do. One thing that sometimes shadow banks do is

is they are even more leveraged than a bank. Right where a bank typically has you know, like in the ballpark of three to ten percent equity, so like most of its loans are funded by deposits, but some of their funded by shareholder money, and so if some of the loans go bad, the shareholders is money off the depositors. Shadow banks can be you know, a hundred times lever to you know, a money market mutual fund. Arguably, shadow

bank can be like sort of almost infinitely levered. In crypto, you sort of look around and I don't think people knew this until like platforms like Voyager and Celsius sort of blowing up. But you look at like these crypto platforms and their leverage ratios are are somewhere between very high, like you know, like four or five percent equity two practically infinite. And if you look at like if you look at tethers balance sheet, they're like, oh, we're totally backed,

we are super solid. And then you like do the math and it's like they have like zero point two percent equity and you're like, well that's very low, right, and like and you know, you look at their assets and you know the question is how much equity do you need for like the kind of assets you have?

And if tether was a thing that took deposits from like stable creint investors and invested them in like accounts at the fed then running at zero point equity would be great, would be like you know, more than you need. But like, in fact, they're list of assets is like commercial paper, which no one knows what it is, and everyone sort of assumes the worst about their commercial paper.

But it's also it's like crypto back loans, loans to crypto headphones and and other platforms that some of whom have gone bankrupt and tell it's like, oh, we got out in time, it's fine. Um, And it's like cryptocurrencies, which like maybe those are stable coins that are fine. Maybe those are stable coins that are not fine. Maybe

those are bitcoin, which is super volatile. And so you look at their asset and you think, you know, is there enough volatility in this, like in the asset side of the balance sheet that they should have more than zero point two equity? And I don't know, man, I'm just like a simple old five guy, but like that seems like a really low amount of equity for like the asset mix that they have. And I think, you know, if you ask, you know, tell people they're like, no, no,

it's fine, it's totally great. Like nothing can ever lose money. Our commercial paper is money. Good. We get out of all of our bankrupt companies just before they go back there. If it's great, it's no problem. We'll be right back with more from Mual and Matt on how a lot of the complex DeFi so called innovations have existed in trad fy for a very long time. We all you have reported on defy for a long time. You have

spoken to people who supported Tara and Luna. You've spoken to people who lost money on Tara and Luna, either because they were retail investors or because they were counterparties of Is there anything about what Matt is describing to you in the context of, you know, how we navigated our way through two thousand and eight that you're seeing folks now trying to do a better job of or is this more like you're like, wow, two thousand eight, see like we were in better shape than we are

right now. One thing I've been thinking about, Lady, most majority of platforms or complaints we're talking about here, who have felt in crypto they're all centralized entities versus truly defied. Even Terra itself, which is quite complicated in consistent that you know, it is a defied platform, as you know, just everything runs on terror blockchain, but you do have do Ka and Terra Phone Labs, all these entities and

individuals behind this this platform. Like you know, literally when do k On tweet about something and people would believe it and then people would you know, trust his kind of intent in terms of how he's going to save this project and whatsoever. And all other platforms such such as you know Voyager, which bankrupt as a result of the contention of Serio Arrows, Touch Fund. These are all centralizentis that had a very little transparency in terms how

how healthy their business had had been. I think this is the one thing that I would say potentially similar what to what happened in the Great Financial Crisis, which I don't have much experience with, but Defy itself because it's transparency and also because you know, majority loans that was made on Defy are overly are overcladaized, and you we have not really see any D five projects has

collapsed or felt in the latest crypto crash. As my last question to both of you, is there anything when you're talking to folks and Defy that they are looking to transfy and they're like, hmm, maybe we should do that and Matt. Same for you. You know, have you observed any like defy ifications That is a terrible phrase, but have you observed any examples of traditional lenders or more traditional Wall Street banks adopting any DFI practices that

seem useful. That's a really good question. I think in general, something I am confused about when I Oftentine talked to not just Defy people, for crypto people that you know, Defy is supposed to completely replace the whole traditional finance, But every time when we see kind of headlines within the involvement of Goldman Sex or Morgan Stanley with crypto, all the crypto people get excited. They're like, oh my god, they're doing something in Defy. They're doing something in crypto.

I think that's that's to me, it's just fascinating because I cannot imagine any of these investment banks would take advantage of whatever Defy is trying to create in terms as like better than Trify for example, the transparency. But I think, just based on what my experience talking to all all the people in Trify and Defy, there's this kind of this is just like a very contradictory sort of phenomenon that they wanted Wall Street to do more in defy, but in reality is that like that's should

not be the direction they are going. If they truly believe in defy, they should think more that like we are going to like beat them up and we're going to replace them instead of oh, we're going to embrace all these investment thanks going or other or Street giants

going to defy. Yeah. I mean what I'd say is, um, defy is is cool, Like like if you're a person with a certain mindset, if you're like a technologist or like market structure person, like DeFi is like we have built all new market structures for you to play with.

Isn't that fun? Right? And so there are efficiency reasons why you might find like some aspects of you know, smart contracting or whatever compose ability of functions, you might find those things appealing, But there's also just like it's intellectually appealing to someone who sort of works in like the minds of the financial markets all day to like they kind of like go over into this like holy new territory. And so you certainly see people at banks

get excited a at like defy buzz words. I mean like like this is sort of old news by now, like in like two seventeen, like you couldn't go a day without a bank announcing a blockchain project, right, Like no one knew what it meant, but it was just like banks like, oh my gosh, a blockchain and like that's like, you know, that's like a sort of DEFY is concept of like we're going to like have this sort of shared ledger of our transactions where like there'll

be some sort of like you know, decentralization and like open ledger of the transactions rather than like us faxing you know, our lawyers, like the confirms or whatever. Right, Like it just seems so shiny and efficient. Um. But the other thing I'll say is that like a lot of people in trad FI feel that way, but rather than implementing a DeFi project at their bank, they quit

and become you know, like crypto hedgeman managers. Right, So, like you mentioned Sam Bankman Freed, like he's a guy who's like a market structured guy at a you know, traditional market maker. And then it was like crypto crypto seems really fun, but also I can make so much money there, Like I said, like DeFi is like cool and possibly more efficient in some ways. But also just

like the spreads, are you insane? And so you can make a lot of money, and so like a lot of people are trying to find ways for their banks to make more money, but like these are regulated entities, and like custody and crypto is challenging, and you know, regular like supervisors don't necessarily like it and all this stuff. But if you quit and just start your own crypto hedge fund, there's like so much money to be made. And so I think that's a lot of what's happening

in traditional finances. Everyone's scorting to do crypto, or they were before cryptocrash, right, And on that note, thank you both, thank you, thank you. You can find more of Muya Shan's reporting on the Bloomberg Terminal on Bloomberg dot com and on Twitter. She's at Muya Shen That's m u y a O s h e N. You can also find more of Matt Levin's columns on the Bloomberg Terminal on Bloomberg dot com or follow him on Twitter. He's at Matt underscore Levine. On the next episode of bloom Crypto,

Mary Catherine later has a story to tell. She was a rising star at Black Rock when she left Wall Street and traditional finance for crypto and decentralized finance. She's now Chief operating Officer at unit Swap Labs, which is the creator of the world's biggest decentralized exchange protocol. She'll join my colleague Bloomberg Reports a Lga Karif to talk about her belief in blockchain, what comes after the terror collapse,

and how she sees decentralized folence shaping the future. I'm Stacy Marie Ishmael and this is Bloomberg 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. Email your questions, comments, or suggestions for the show to Crypto at Bloomberg dot net and you'll find us on Twitter at Crypto. The supervising producer of Bloomberg Crypto is Vicky ver Galina. Our

senior producer is Janet Babin. Our producer is Mohammed Perup. Our associated producers Osanam Sidiki and Moses and um dast to wonder At is our engineer. Original music by Leo sidron h