My friend Nilesh posted this:
I remember walking back from a conference at the European Central Bank in late 2008 accompanied by the then Head of Risk Management for the ECB. We discussed what the long-term impact of the Global Financial Crisis that we were experiencing was likely to be. My comment was that regulation would take centre stage post-crisis, particularly since the major private financial institutions had both sought and been granted support from their regulators. My prediction proved correct as, in fact, the banking business has been beaten up and dumbed down by the regulators post-GFC. The banking community has been fined and restructured almost out of existence, forced to ‘pay the piper’ or lose its future…
As the phenomenon that is Crypto rages around us, I cannot help but reflect on that conversation. It’s only a matter of time before the gravity-defying Crypto bubble collapses back to the fair-value price of the electrons that these assets are actually worth. In the meantime, great quantities of wealth will have been redistributed from one socio-economic group to another. The winners, those who substituted their electrons for worldly riches, will live large but remain largely silent through fear of retribution. The losers, those who traded their families’ means of existence for a handful of electrons (at least Jack traded his for a handful of magic beans!), will shout loudly and for a long time…and they will naturally turn to the Government for compensation.
Irrespective of what one’s view is of the value of a crypto-currency, the innovation shares features with the FinTech world which have brought benefits to the financial sector. Crypto related FinTech benefits include (i) the Blockchain which has potential to cut transaction costs for every investor, (ii) the fact that regulators have been forced to review their securities laws and (iii) the electronic issuance of new crypto related securities such as ‘Asset-backed tokens’ and ‘Stapled-tokens’ may well lead to efficiencies in the IPO markets generally. But if Governments are convinced to step in to avert a ‘systemic crisis’ during a Crypto-crash then the easiest reaction is to shut the whole thing down. Regulators already have their fingers on the trigger and it would be a shame if the whole FinTech sector was punished for the excesses of a few.
Throwing the FinTech baby out with the Crypto bathwater is a real risk if regulators are forced to write cheques to those who suffer losses in the impending Crypto-bust. Moreover, if the regulators shut the whole thing down, Cryptoland will never be able to regenerate itself in the way that the more intelligent use of the internet grew out of the dotcom bust.
The lesson from the GFC for Crypto-land is don’t put your hand out for support when the fuse blows. Shut up and die like a motherboard.
I post this because when I see stock action like I saw in Kodak, I smell a rat. The best thing I laughed about on Twitter yesterday was that Lehman Bros, Bear Stearns, MySpace, Tandem, Radio Shack, and other failed companies will be launching cryptos soon.
The reason I get excited about blockchain is that it takes core classical economic concepts and brings them to everyone. It’s a game changer. However, I don’t think it’s a game changer in the way a lot of social scientists want it to be. Blockchain is going to enable a much more efficient distribution of capital. That doesn’t mean poor people will not be poor anymore. It means capital will flow faster and more efficiently to the places it (capital) can get the best return. It’s a free market on steroids.
It’s clear to me that some guidelines need to be established via regulation for crypto. The other thing is that like the internet in 1997, no one knows which blockchain is going to succeed and which one is going to fail. That means a lot of people will lose a lot of money. It also is totally irrational to put money in a blockchain company, yet at the same time being totally rational. I liked this tweet by Cliff Asness of AQR because he referenced irrationality.
As a serial offender myself I can say that regardless of the issue (and I generally believe in irrationality more than John) @JohnHCochrane is 100% class and @delong is, well, not. https://t.co/8lM7QLeM4N
— Clifford Asness (@CliffordAsness) January 10, 2018
Irrationality is a great concept in economics. Would love to hear what Richard Thaler has to say about blockchain. I think it’s an area that he and Eugene Fama could find some agreement.
My friend Michael Lotus of ChicagoBoyz sent me this paper by Nick Szabo which I found interesting: Money, blockchains, and social scalability. In the paper, it introduces the concept of social scalability. You should read the whole thing. The paper starts by talking about Bitcoin in terms of traditional economics,
The secret to Bitcoin’s success is certainly not its computational efficiency or its scalability in the consumption of resources. Specialized Bitcoin hardware is designed by highly paid experts to perform only one particular function – to repetitively solve a very specific and intentionally very expensive kind of computational puzzle. That puzzle is called a proof-of-work, because the sole output of the computation is just a proof that the computer did a costly computation. Bitcoin’s puzzle-solving hardware probably consumes in total over 500 megawatts of electricity. And that is not the only feature of Bitcoin that strikes an engineer or businessman who is focused on minimizing resource costs as highly quixotic. Rather than reduce its protocol messages to be as few as possible, each Bitcoin-running computer sprays the Internet with a redundantly large number of “inventory vector” packets to make very sure that all messages get accurately through to as many other Bitcoin computers as possible. As a result, the Bitcoin blockchain cannot process as many transactions per second as a traditional payment network such as PayPal or Visa. Bitcoin offends the sensibilities of resource-conscious and performance-measure-maximizing engineers and businessmen alike.
Clearly, there are opportunity costs to Bitcoin. It eats energy. It eats storage. These are real costs. On the flip side, the socially scalable costs it creates are benefits that so far are outweighing the opportunity costs of energy and storage. Szabo introduces Adam Smith and Hayek into his thinking. Adam Smith was an extremely elegant thinker and the father of modern economic thought. Smith says in The Wealth of Nations,
Observe the accommodation of the most common artificer or day-laborer in a civilized and thriving country, and you will perceive that the number of people of whose industry a part, though but a small part, has been employed in procuring him this accommodation, exceeds all computation. The woolen coat, for example, which covers the day laborer, as coarse and rough as it may appear, is the produce of the joint labor of a great multitude of workmen. The shepherd, the sorter of the wool, the wool-comber or carder, the dyer, the scribbler, the spinner, the weaver, the fuller, the dresser, with many others, must all join their different arts in order to complete even this homely production. How many merchants and carriers, besides, must have been employed in transporting the materials from some of those workmen to others who often live in a very distant part of the country! How much commerce and navigation in particular, how many shipbuilders, sailors, sail makers, rope makers, must have been employed in order to bring together the different drugs made use of by the dyer, which often come from the remotest corners of the world! What a variety of labor, too, is necessary in order to produce the tools of the meanest of those workmen! To say nothing of such complicated machines as the ship of the sailor, the mill of the fuller, or even the loom of the weaver, let us consider only what a variety of labor is requisite in order to form that very simple machine, the shears with which the shepherd clips the wool. The miner, the builder of the furnace for smelting the ore, the feller of the timber, the burner of the charcoal to be made use of in the smelting-house, the brick maker, the brick layer, the workmen who attend the furnace, the millwright, the forger, the smith, must all of them join their different arts in order to produce them. Were we to examine, in the same manner, all the different parts of his dress and household furniture, the coarse linen shirt which he wears nest his skin, the shoes which cover his feet, the bed which he lies on, and all the different parts which compose it, the kitchen grate at which be prepares his victuals, the coals which he makes use of for that purpose, dug from the bowels of the earth, and brought to him perhaps by a long sea and a long land carriage, all the other utensils of his kitchen, all the furniture of his table, the knives and forks, the earthen or pewter plates upon which he serves up and divides his victuals, the different hands employed in preparing his bread and his beer, the glass window which lets in the heat and the light, and keeps out the wind and the rain, with all the knowledge and art requisite for preparing that beautiful and happy invention, without which these northern parts of the world could scarce have afforded a very comfortable habitation, together with the tools of all the different workmen employed in producing those different conveniences; if we examine, I say, all these things, and consider what a variety of labor is employed about each of them, we shall be sensible that without the assistance and co-operation of many thousands, the very meanest person in a civilized country could not be provided, even according to what we may falsely imagine the easy and simple manner in which he is commonly accommodated.
How many lawyers, accountants and institutions are setup because we need trust? Because we need proof of work? However, coordination across markets can be achieved more efficiently and simpler using a blockchain. I don’t have to know you, have a relationship with you, or pay you. Once I see it’s validated and posted on a chain, I know it to be true and I can respond or react accordingly.
Blockchain will have a gigantic outsize effect on regulation eventually causing the entire cost of government to drop.
I am reminded of Milton Friedman’s video, I Pencil, which no doubt I have shared before. It is similar to EconTalk’s Russ Roberts It’s a Wonderful Loaf. I hear a lot of naysayers around free market principles today but the data proves them wrong over and over again.