The implosion of the market for digital assets in May 2022—the coming of the crypto winter—signals yet another Minsky Moment, in which the bursting of a speculative bubble sends shockwaves through the financial system. There is an inevitability to the convulsions seizing the world of crypto assets.
Crypto finance emerged in the wake of the global financial crisis of 2008, which turned the spotlight on the leveraged world of shadow finance and the speculative excesses of big banks. Amidst the wreckage of the crisis, Bitcoin, the first crypto token, was championed with the promise of supplanting the tyranny of central banks and predations of big finance with the neutral, faceless arbitration of digital technology. More than a decade later, the continual metamorphosis of finance with the steady march of financial innovations and the emergence of crypto finance has evidently not transcended nor suppressed its inner logic. As Karl Marx argued, the growth of finance with the evolution of capitalism “develops the motive of capitalist production, enrichment by exploitation of others’ labor, into the purest and most colossal system of gambling and swindling and restricts even more the already small number of exploiters of social wealth.”1
This susceptibility to fragility and crisis, the inexorable tendency to fuel inequality, and the concentration of wealth plagues the brave new world of crypto finance. The recent crypto meltdown has laid bare the fragile underpinnings of crypto finance, dispelling the delusion that code and algorithms can, on their own, immunize cryptocurrency from the inexorable pathology of capitalist finance.
A Brief History of the Cryptoverse
Bitcoin was launched a few months after the collapse of Lehman Brothers as a prototype for a secure, permissionless digital currency that would be created, without the guarantee of a financial intermediary as the basis for its credibility, by “mining”—the energy-intensive process of deploying a large amount of computing power to solve a cryptographic puzzle (also called proof of work) validating a transaction. While currencies are conventionally underpinned by trust in a powerful central authority, Bitcoin relies on this cryptographic proof, drawing on open-source software and a network of servers sharing data to verify and record transactions so that a multitude of users can anonymously validate the cryptocurrency. Time-stamped, cryptographically proven transactions, immutably recorded in ledgers, are shared and replicated across servers, forming the blockchain—the technological bedrock of the decentralized logic of the cryptoverse. A limit on the maximum number of bitcoins that can be mined (21 million) is built into the trustless mechanisms on the grounds that this technologically imposed scarcity acts as a bulwark against inflation and the profligate impulses of the state. But perversely, this artificial scarcity ensured the allure of Bitcoin as a speculative asset.2
Bitcoin has now been joined by a vast number of other cryptocurrencies. Crypto coins are subject to stomach-churning price swings, a painfully slow settlement process, and a huge environmental footprint, undermining their utility as a stable, liquid, and efficient means of settlement. Rather than offering an alternative form of privately created money, crypto tokens are essentially a financial asset that is held and transacted in the hope of making speculative gains. The frenzy for collecting and trading these digital assets has not established cryptocurrencies as a means of payments outside the murky world of money-laundering, illicit and illegal trades, and the darknet. It has, however, opened a new frontier for finance—a novel, zero-sum, early-bird game similar to a Ponzi scheme, where those who get in early win at the expense of latecomers.3 It has also been a playground for scamsters, developers who launch and talk up a new crypto token, drawing in a rich harvest of investors and then abscond with the loot—the classic rug pull.4
The launch of Tether in 2014 introduced a new class of crypto assets—stablecoins that are designed to maintain a peg to a conventional currency. Stablecoins promote speculation in crypto assets by providing an anchor against price fluctuations and a place to store value within the cryptoverse. Stablecoins are typically managed by a centralized platform that oversees the creation, redemption, and adjustment of the portfolio of assets backing the stablecoin. The assurance that stablecoins would always be redeemable on par with conventional currency lures in investors; stablecoins also serve as a source of liquidity within the sphere of crypto finance, allowing crypto traders to move in and out of crypto assets without needing to use conventional currencies. Stablecoins can be lent as collateral to support trading or used to earn returns in the form of interest payments. Acting as the bridge between more volatile cryptocurrencies like bitcoin and fiat currencies like the U.S. dollar, stablecoins stand at the apex of the hierarchy of crypto finance, lubricating the engines as it evolves to become a full-fledged, complex financial ecosystem replicating the functions and services of conventional finance. They also reflect crypto’s ultimate dependence on conventional currencies as a source of credibility and stability.
The entry of ether and its associated blockchain, Ethereum, in 2015 was a game-changer that fueled the surge of decentralized finance, also known as DeFi. With the launch of DeFi, the crypto sphere broadened to embrace a range of financial activities traditionally offered within the domain of conventional finance. This includes not just crypto asset trades, but trades in crypto derivatives, as well as loans and investments through crypto lending platforms and investment vehicles. What distinguishes DeFi from conventional finance, however, is the use of codes that automatically execute transactions when specified conditions are met based on preset protocols. With this innovation, the alternative world of DeFi, in principle, dispenses with the central role of financial intermediaries in brokering financial transactions, while replacing conventional contracts with the arcane magic of code running constantly on trustless blockchains—so called “smart contracts.” The lucrative promise and growth of DeFi notwithstanding, the actual functioning of the cryptoverse remains dependent on centralized exchanges for buying and selling crypto assets (such as Coinbase, Binance, and FTX), centralized lending platforms (such as Celsius and BlockFi), and centralized investment vehicles (such as Grayscale and Galaxy). Here, a third-party private entity coordinates, mediates, and clears transactions, while maintaining off-chain records and retaining custodial rights over client accounts.5
The scope of speculative profits that can be reaped in the crypto sphere has widened beyond the capital gains from the rising crypto token values that fueled the early crypto boom. A Pandora’s box has been opened, and crypto enthusiasts scour this unregulated crypto Wild West for yields from lending and investing, as well as from leveraged bets on price fluctuations. By the end of 2021, the ecosystem of cryptocurrencies had mushroomed to cross $3 trillion, of which stablecoins constituted $120 billion.6 Meanwhile, the magnitude of capital within the DeFi sector rose to over $230 billion. Fueled by easy money policies in the wake of the pandemic, this euphoria reached a peak before the global spillovers of the Russian invasion of Ukraine manifested in skyrocketing food and fuel prices, interest rate hikes, and soaring debt burdens that upended the bull run.7
The crisis was triggered when the crypto coin Luna and its stablecoin twin, Terra, collapsed in May. While stablecoins like Tether are supposed to be secured on basis of reserves of safe liquid assets and fully redeemable in dollars, the stability of Terra rested on algorithmic checks and balances pegging to its paired crypto token, Luna. Terra’s peg was maintained by automatic, programmed arbitrage against the floating Luna. If Terra’s price fell below the peg with Luna, Terra would be bought at a discount and traded with Luna, thus bringing its price back in line. Luna holders were offered a stake in the governance of the Terra-Luna system and profits from mining Terra. The demand for Terra was in turn stoked by the Terra lending platform Anchor, which had recently raised the interest rates offered on Terra deposits to an outsized 20 percent. These high returns sucked in investors who bought Luna in order to mint Terra, pumping up Luna values. When the tide turned and demand flagged, the algorithm-based arbitrage mechanism broke down. The widespread pull-out from Terra-Luna precipitated a downward spiral of its $40 billion market that reverberated through the cryptoverse in May.8
The impact brought down the crypto lender Celsius when its crypto token, CEL, plunged from its peak of $8 to just 30 cents, while half of the value of Celsius’s total assets evaporated. Celsius had drawn huge inflows on the offer of lucrative interest yields of 18 percent to holders of its token. These whopping returns were founded on the reckless pursuit of risky bets in the sphere of DeFI (including the Terra-Luna-based Anchor fund) using customer funds. In February 2022, even before the collapse of Terra, red flags were being raised about questionable practices of Celsius that disguised losses and asset values. The growing problems of Celsius after the Terra-Luna collapse were initially dismissed as a temporary liquidity mismatch, as Celsius borrowings of Ether got locked into a new venture on the Ethereum network, which had itself run into snags. But that was not all—Celsius used a derivative based on this so-called locked Ether as collateral to borrow further, including $450 billion from the crypto lender Aave. A gaping hole of nearly $2 billion was discovered on Celsius’s balance sheet, and the platform was no longer in a position to meet growing demands for withdrawals. As investors rushed to the exits, Celsius froze accounts, pleading “extreme market conditions,” and announced major layoffs, finally filing for bankruptcy in July.9
Three Arrows Capital, a prominent Singapore-based crypto hedge fund, which had recently shifted its headquarters off-shore to the British Virgin Islands while facing censure from the Singapore Monetary Authorities, was the next domino to fall. As crypto tokens plummeted, the value of the assets it had used as collateral to borrow also fell. Falling collateral values triggered demands to top up the collateral to match the loan amount—known as margin calls—by investors like the crypto lender Voyager, which had loaned $650 million to Three Arrows, and BlockFi, which had loaned $80 million. When Three Arrows failed to meet these margin calls, default notices were issued and liquidation proceedings were launched.10
The reverberations of the collapse engulfed the largest stablecoin and key vehicle crypto token, Tether. In a moment echoing the day the money market fund Reserve Primary broke the buck in 2008, Tether—supposed to be locked to the U.S. dollar—fell to 95 cents. Tether’s peg to the dollar relied on being fully backed by a reserve of safe assets. As investors rushed to pull money out of the token—compelling asset sales to fund dollar redemptions—the defenses of the stablecoin against market gyrations were tested. The peg fell apart. Much of the asset backing of Tether is from less-liquid commercial paper (used for short-term funding needs by corporations) and treasury bills, with less than 3 percent in actual cash reserves. In fact, Tether rose to become one the largest investors in the U.S. commercial paper market, alongside asset management funds like Vanguard and BlackRock. To meet investor demands to redeem Tether for dollars, the platform needed to sell its reserves of commercial paper. A persistent run on Tether could have repercussions for corporations relying on this market for short-term funding.11
The panic that stalked crypto markets in May made the fragile foundations of crypto finance starkly visible. Bitcoin, which had topped at over $69,000 per bitcoin in November 2021, tumbled to about $20,000 by July 2022. Ether, which had climbed to a high of nearly $5,000 in 2021, fell to around $1,300. The total value of all crypto tokens plunged from above $3 trillion to less than $900 billion. As loans were called in amid the chaos of plunging token values, DeFi fell by more than 60 percent, to about $124 billion.12
The Anatomy of a Crisis
The unwinding of Terra-Luna, Celsius, and Three Arrows, as well as the tumble of Tether, are crypto avatars of the classic bank runs that have dogged the U.S. financial system since before the institution of Federal Deposit Insurance in 1933. The resurgence of finance since the 1980s and neoliberal deregulatory pushback led to the eclipse of traditional commercial banking, based on loans and deposits, by intermediation through financial markets outside the regulatory ambit of monetary authorities.13 The ensuing proliferation of shadow banking—where capital lending through the process of securitization is funded by short-term borrowing from the money market—was fueled by the predatory pursuit of sub-prime mortgages.14 When the collapse of Lehman precipitated the global financial crisis in 2008, it signaled a new type of bank run, where falling collateral values decimated the basis of short-term lending between banks, and investors pulled money out of money-market funds, bringing the credit system to a stop. We are now witnessing bank runs in the cryptoverse—the new, unregulated frontier of finance. Echoes of the mechanisms of the runs on the shadow banking system can be discerned in the current unraveling.15
The foundation of the pyramid of credit in the shadow banking world is collateral. Securities are pledged to borrow funds to buy more securities. Sometimes the same collateral is re-hypothecated multiple times or securities are bought by borrowing against themselves. These mechanisms of generating liquidity drive the growth of finance. This house of cards came crashing down in 2008, but the ascendancy of finance and the inexorable pull of financial innovations in search of greater returns has not abated in the aftermath. As securities plummeted in value, gaping holes were revealed in banks’ balance sheets. The collateral pledged to borrow funds was an insufficient guarantee for the loans at these new prices, triggering margin calls to fill the gap. Collateral-based lending is inherently pro-cyclical. In booms, asset values rise, fueling a surge in lending. When the bubble bursts and assets plunge in value, the credit machinery grinds to a halt.
The pseudo-anonymity of blockchain mechanisms—espoused as a means of breaking away from the traditional modes of risk assessment based on screening, credit rating, and guarantees centered around the authority and reputation of big finance—has reinforced the critical role of collateral in underpinning trust in crypto lending and stablecoins. Collateral provides a necessary cover for risk. In the absence of any information about the borrower, crypto lenders rely on over-collateralization, posting assets of greater value than what they want to borrow. A fall in the value of the collateral assets below a stipulated liquidation ratio (required to be greater than one so that the collateral remains higher than the value of the loan) triggers the liquidation of the loan and the seizure of the collateral. To illustrate, a loan of $100 would require assets valuing between $120–$150 to be placed as collateral. If market movements push the value of the assets below $110, the loan would be liquidated, and the assets taken over. The wrinkle is that the loan process of liquidation is not initiated by the lender but by anyone acting as a liquidator. Liquidators are basically bots that troll the cryptoverse in search of liquidation opportunities, pocketing a share of the residual collateral after the repayment of the original loan. Collateral rules supersede any discretion in a lending relationship, while over-collateralization exacerbates the pro-cyclicality inherent in collateral-based lending.16
The fragility of crypto lending is further compounded by the practice of recursive borrowing and collateral chains, where the borrowed collateral is re-hypothecated to garner returns from multiple crypto ventures on a narrow base of capital!17 Thus $100 of stablecoins borrowed against $120 worth of collateral can be used as collateral to borrow an additional $80 worth of another crypto asset, which can again be used for further borrowing of $65, and so on. In this example, the initial collateral of $120 is used to borrow more than $245, building up debt and leverage. The high returns promised by Celsius depended on such recursive borrowing.
DeFi also has a reflexive character, in that lending in crypto tokens for the purpose of investing in crypto assets is itself secured by even more crypto assets. Crypto borrowings are channeled into rent-seeking speculation, rather than being used to finance real economic activity. When the market is booming, more and more debt is incurred to fund riskier and riskier financial bets. When market sentiment turns and prices tumble, there is a snowball effect as the distress sale of assets sets off a downward spiral. The pyramid of crypto lending is thus erected on the shifting sands of volatile crypto collateral.18
Stablecoins like Tether, which keep the wheels of crypto investment turning, are critical to the stability of crypto finance. Trust in stablecoins would be undermined by the lack of transparency around the quality of reserves—but, instead of regular audits of their balance sheets, stablecoin issuers simply present snapshots as an attestation of robust reserves. Furthermore, as a study of the 2017 bitcoin boom revealed, instead of being driven by the growing appetite of investors for Tether, the boom was propelled by the ramping up of the volume of Tether in order to inflate the bitcoin bubble. The incentive to squeeze reserves and pump volume is exacerbated by the opacity of the attestations on which stablecoins like Tether depend. When investor trust is shaken and funds begin to be pulled out, the peg to real currencies is jeopardized, as was seen in Tether’s recent turmoil.19
The impact of runs on stablecoins, which facilitate transfers across crypto platforms, is similar to that of conventional bank runs. But unlike conventional banks, they are not subject to any regulatory oversight or scrutiny, nor do they possess any reserves they can draw upon to absorb the shock of crashing asset values. The evaporation of liquidity with the collapse of stablecoins ruptures the workings of crypto finance, with potential spillovers into the conventional financial sector. If a fire sale of conventional assets that form the reserve backing stablecoins is launched to meet the deluge of redemptions, the panic would spread to these conventional markets.
Thus, crypto finance is also beset by liquidity mismatches between assets and liabilities, the Achilles heels of conventional banking. Stablecoins are issued against less liquid assets like commercial paper, as the Tether debacle showed, or else against risky, volatile crypto tokens, as the collapse of Terra revealed. The long history of such recurrent asset mismatches and meltdowns in the sphere of conventional banking cemented the critical role of central banks as a lender of last resort. At times when banks face a liquidity crunch due to a surge of withdrawals, central banks can shore up the crumbling institutions by extending loans and advances or purchasing distressed assets. The evolution of Bank of England policies through the nineteenth century testifies to the emergence and maturation of the central bank in the role of a lender of last resort. The panic of 1907 in United States paved the way for the creation of the U.S. Federal Reserve, with the mandate to provide a backstop to the market for short-term bills. The bank failures of the Great Depression led to the institution of deposit insurance in United States and the setting up of a safety net for commercial banks. The global financial crisis saw the extension of the U.S. Federal Reserve’s safety net to the shadow banking system at the center of the storm—but there is no central banking safety net for crypto finance.20
Recurrent financial crises historically have led to the recognition of a collective stake in preventing market collapse from bringing the whole financial edifice crashing down through centralized, coordinated interventions. As the reverberations of tumbling asset prices spread through the financial system, threatening to bring down the house of cards, dominant financiers with clout and capital stepped into the breach, injecting funds to shore up the collapsing financial markets. These initiatives can also come from within the private financial sector itself, as was seen in the life-boat operations coordinated by J. P. Morgan during the panic of 1907, before the inception of the Federal Reserve. These privately coordinated initiatives recognized that the whole structure of relations on which finance had thrived was in jeopardy.
We see this recognition, once again, in the recent initiatives of Sam Bankman-Fried, the head of a leading crypto trading platform FTX and the crypto venture fund Alameda, to set up loan facilities of $485 million and $250 million to shore up Voyager and BlockFi respectively when the crumbling markets brought these crypto lenders to the brink. The potential fallout from the collapse was contained when Bankman-Fried, like J. P. Morgan more than a century earlier, jumped into the fray to bail out these crypto institutions. The mantra of decentralization ceded ground to the imperative for centralized, coordinated rescue actions to stem the spillovers. These privately initiated lender-of-last-resort actions also underscore the hidden hierarchy of the decentralized world of crypto finance.21
The Vampire Squid Spreads its Tentacles
Belying the pipe dream that these decentralized, trustless, anonymous, peer-to-peer, blockchain-enabled mechanisms can be wielded to challenge the stranglehold of big finance and big tech, crypto finance has merely expanded the hunting grounds for the speculative vampire squid of finance. The financial system is a powerful mechanism of concentration and centralization, with the distribution of financial assets heavily skewed toward the top. Crypto finance perpetuates this same logic, with the distribution of crypto assets following the same pattern of concentration.
To illustrate, bitcoin, the original crypto asset, can be purchased or acquired by mining. Miners receive a certain amount of the newly mined crypto tokens as a reward for verification. In theory, anyone in the world with access to computers with the requisite computing capacity can mine bitcoin. However, a study of bitcoin from 2015 to 2021 found that 0.1 percent of miners controlled 50 percent of mining capacity. The distribution of ownership was also highly concentrated, with 0.01 percent of individual bitcoin holders owning 26 percent of the asset in 2021. Another study of bitcoin distribution focused on its initial years (2009–2011) found that the bulk of bitcoin was mined by a small number of agents, and further revealed the emergence of a classic Pareto distribution of bitcoin earnings, even at this early stage. Wealth and property income typically follow a Pareto distribution—a skewed distribution in which about 20 percent control about 80 percent of the wealth. The emergence of a Pareto distribution in bitcoin ownership implies that the decentralized logic of blockchains is not enough to curb the inherent tendency of finance toward concentration and unequal distribution.22
The structure and incentives of crypto, where miners validating transactions are rewarded with tokens that are ploughed back into the crypto sphere, propels concentration. Furthermore, given the length of time and magnitude of computing power involved to keep up with expanding volumes of transactions, crypto tokens impose a hard limit on the frequency of transactions, creating congestion. In order to reward profit-seeking miners enough to maintain the integrity of the platform and prevent hucksters and scamsters from overwhelming the system, higher “gas fees” are imposed upon miners as transaction volumes approach these limits. Thus, the cap for Ethereum has been as low as thirty transactions per second, with gas fees rising from $1 when traffic is low to more than $75 as the pace picks up to this cap. There are thus huge rents to be accrued in the so-called democratic sphere of crypto tokens.23
While the early crypto boom was fueled by crypto price movements, the evolution of crypto finance has opened the way for the pursuit of speculative returns from lending and investment. The self-referential sphere of crypto lending and DeFi, where transactions primarily involve exchanging one crypto asset for another, embodies the logic of finance for its own sake. Rather than funding real economic transactions such as trade and investment, lending and borrowing are solely for speculative and arbitrage purposes. The dependence of DeFi on over-collateralization further fuels concentration, with those with larger asset holdings being in a position to borrow more and stake even larger volumes of crypto assets in crypto lending platforms—what is called “yield farming.” Such staking functions are like deposits in money markets, and the staked funds are lent out to high-return, high-risk crypto protocols. Part of the risk of smart contracts underlying crypto lending arise from the impossibility of devising contracts that cover all eventualities. More fundamentally, the risks arise from incentives to venture into increasingly perilous, even fraudulent, zones.24
Along the way, those who control the platforms and whose large asset base allows them to weather the storm harvest huge returns, while small holders and ordinary people drawn into the world of crypto by the promise of quick returns see their holdings evaporate. Even in the wake of the decimation of crypto fortunes during the most recent collapse, some big players, like FTX, Binance, and Circle, are holding ground and gearing up to shape the future trajectory of crypto finance. At the same time, big asset management funds, led by BlackRock—which recently announced a tie-up with Coinbase—are set to invade the crypto sphere. Institutional investors are increasing their exposure to crypto assets. Goldman Sachs, Citigroup, and JPMorgan Chase have been wading deeper into this sphere, undeterred by the convulsions. The crypto winter is, paradoxically, also heralding the rising clout of leading crypto financiers and the induction of crypto into the mainstream of finance.25
The New Power Brokers and the Hierarchy of Crypto Finance
The consensus-based mechanisms underlying the governance structure of crypto, where decisions are made through majority votes of crypto token holders rather than by an executive board, are upheld as a way towards democratization of finance. But the concentration of crypto tokens in only a few hands means that the automated mechanisms of handing out control and decision-making to those holding crypto tokens also grants undue power and influence to a few large investors. These large holders can and do wield their power to set terms, manipulate prices, and seize larger returns. However, there is some evidence that big players draw the line at deliberately endangering the integrity of the platforms. Thus, the aforementioned study of bitcoin found that even when a few miners held more than half the tokens and were in a position to take over and compromise the platform in what is called a 51 percent attack, they played by the rules and refrained from such attacks in the longer-term collective interest of preserving integrity and trust in the platform. The centrally orchestrated emergency plans put forward by DeFi platforms like Solend, Bancor, and Maker DAO as crypto prices crashed only served to underscore that when push comes to shove, the governance of these platforms is seized by its central executive authority.26
The lender of last resort actions of FTX can be understood as a reflection of its long-term vision of investing in building the crypto sphere. Far from being altruistic, the FTX bail-outs signal the growing ambitions of Bankman-Fried as an emerging power broker joining the upper echelons of high finance. Alameda, already FTX’s largest shareholder with an 11 percent stake in the bankrupt crypto lender Voyager, initiated a bid to acquire the platform it had just bailed out. The FTX loan to BlockFi included an option to purchase the beleaguered platform. FTX also floated an equity trading service that would allow investors to buy shares with stablecoins, bought a stake in online retail brokerage Robinhood, and purchased LedgerX, a U.S.-based futures and options exchange. All of this points to the expansion of the FTX-Alameda empire to a broader range of financial services, and its maturation as a dominant player even beyond the sphere of crypto.27
Following the tradition of earlier stalwarts of big finance, Bankman-Fried is also poised to seize the initiative in framing the regulatory rulebook for crypto finance in ways that would remain conducive to profit-making, while imparting a veneer of legitimacy to crypto finance by appearing to embrace regulation. To this end, FTX is putting its heft behind the recent legislative proposals to grant the Commodity Futures Trading Commission—rather than the Security Exchange Commission, which has been taking a more aggressive stance—greater regulatory power over the crypto sector. In another attempt to wrest leadership and control over any backlash calling for regulations, FTX recently announced that it was clamping down on leveraged trades by bringing leverage from 100 times the collateral offered down to twenty times. Binance, another large exchange, followed suit.28
Bankman-Fried has also been aggressively lobbying with the Commodity Futures Trading Commission to introduce its automated real-time, algorithm-based risk management system to the commodity futures market, in a challenge to the role of the big merchant-brokers in monitoring and enforcing margins. This system of leveraged futures trade would require investors to post only a fraction of value—the margin—as collateral. Round-the-clock monitoring of margins by automated mechanisms, would eliminate the need for brokers and trigger instantaneous liquidation when the margin falls below the requisite level, rather than calling for more collateral to be posted. Instead of the route of centralized clearing and stricter margins that has been advocated following the global financial crisis, the premise here is that real-time, automated risk management harnessing the magic of blockchain is the path forward to dealing with systemic risk. To address the fear that leveraged investors are vulnerable to these marauding liquidators searching for quick profits, FTX proposed setting up a $250 million guarantee fund as a backstop for the perils of relentless round-the-clock trading. This lobbying has set off alarm bells due its implications for agricultural and commodity markets and fears of speculative price manipulation. It also marks an opening salvo by the FTX empire in the sphere of commodity trade futures, which is currently dominated by the merchant arms of the big banks Goldman Sachs and JPMorgan Chase.29
Even beyond FTX-Alameda, the crypto finance sector has intensified its lobbying efforts. Reports indicate that the money spent on lobbying jumped from $80,000 in 2016 to $2 million in 2020 to $7.2 million in 2021. Groups such as the Blockchain Association and the Chamber of Digital Commerce have stepped up spending on organized campaigns, including efforts to influence the tax proposal embedded within the infrastructure bill passed last year, which would crack down on tax avoidance in the crypto sphere by making it mandatory for crypto platforms to report all transactions and capital gains to the tax authorities. Key to the new tax rules is the distinction between brokerages and money transmitters. The latter designates custodial rights over customer funds and is subject to lighter regulations, but the operations of crypto platforms come closer to those of broker-dealers that leverage funds borrowed from clients to garner hefty profits by entering riskier and more speculative terrain. Thus, they could come under more stringent reporting requirements under the new tax rule.30
More recently, lobbying efforts have focused on steering the passage of the Keep Innovation in America bill that seeks to determine the rules and parameters for regulation of crypto finance, with the crypto lobby spending as much as $8.9 million in the first half of 2022.31
Digital Delusions and the Doom Loop
The rise and metamorphosis of crypto finance reflects the incessant march of financial innovations within capitalism and its inherent tendency to breed instability, acting as an engine of accumulation and concentration of wealth.
The financial engineering behind securitization, the slice-and-dice alchemy that converts illiquid, long-term liabilities into more liquid, short-term securities, fueled the spread of shadow banking. When the collapse of Lehman in 2008 turned the spotlight on the dangers of the unregulated shadow mechanisms of securitization, the major central banks, led by the U.S. Federal Reserve, pulled out all the stops in unconventional policy measures to rescue and reinvigorate shadow banking. Securitization, therefore, remains entrenched in the inner workings of finance, despite its role in the global financial crisis. Meanwhile, policy discourse promoting revamped, market-based finance has given a new lease of life to shadow banking.
Now tokenization—digital representation of conventional assets enabled by blockchain technology—is being promoted as the path forward. Thus, a digital token representing conventional shares of a company can be created, stored, and traded in the crypto sphere, granting token-owners a partial claim on the underlying shares. And the field is not limited to financial assets: digital tokens can represent real estate, art, and even high-end wine and whiskey. The claim is that tokenization enhances liquidity and widens accessibility to indivisible, illiquid assets by creating tradeable, fractional claims. In this respect, tokenization goes even further than securitization.32
JPMorgan Chase recently launched a platform that tokenizes treasury bonds. Treasuries are prized collateral in repo markets, where they are lent overnight in exchange for cash with the understanding that they will be repurchased at the end of that period. Such repo transactions form the essential fuel of the contemporary financial machinery. New regulatory requirements imposed after the global financial crisis, which require banks to hold a certain level of safe and liquid treasuries as a buffer against market gyrations, circumscribe the extent to which treasury holdings can be used to pump the engines of credit. The new JPMorgan Chase platform allows crypto tokens representing treasuries to be used as collateral in repo markets by lending them out for shorter durations, even within the day, in smart contracts that preempt the regulatory requirements. While the token is deployed to borrow cash and ramp up trading throughout the day, the treasuries remain on the bank’s balance sheet at the closing bell. A new spigot of liquidity has been opened.33
The tokenization of bank deposits and other regulated liabilities is also being proposed as a way of promoting decentralized, round-the-clock automatic settlement and transfer of digital representations of these liabilities within blockchain platforms.34 This development seeks to anchor crypto tokens in conventional financial assets and buttress the role of stablecoins as a parallel private mechanism for generating liquidity alongside repos, money-market shares, and asset-backed commercial paper that function as private money within shadow banking.35
Tokenization would thus embed and integrate blockchains and crypto more pervasively within the web of conventional finance. The world of finance already rests on flimsy foundations. Tokenization adds another layer to the illusion of value that fuels financial speculation and the inexorable growth of what Marx called “fictitious capital.”36 Like securitization, tokenization is set to become enshrined in the mainstream of finance as it continually reinvents itself. Thus, the new market for carbon tokens is making hay off the rising prices of carbon offsets by buying and tokenizing cheaper carbon offsets, with questionable implications for carbon emissions. At the same time, a recently launched upgrade of the technological infrastructure underpinning Ethereum, the mainstay of the DeFi, is paving the path to further expanding the reach of crypto finance. In this upgrade, instead of mining by energy-guzzling cryptographic puzzle-solving, participants stake their crypto assets as collateral (what is called proof of stake) when verifying crypto transactions. This much-vaunted upgrade—Merge—will intensify the tendency of crypto finance to exacerbate concentration of assets.37
As crypto finance enters the mainstream, with big finance seeking to exploit the new frontier of speculation and big tech joining the fray with its own stablecoins, central banks have begun responding to this changing landscape by exploring their own digital currency projects, both for use by the broader public (retail) and by financial institutions for settlement and transfers between themselves (wholesale). The technological possibilities offered by blockchains to automate and speed up the settlement process—particularly for cross-border payments—are being probed by central banks. While these digital currency experiments seek to position the central bank as a critical player in growing crypto markets, they also imply an embrace of crypto stablecoins as a monetary substitute.38
The digital terrain is likely to be a battleground where China tests and challenges the global hegemony of the dollar. It has already made greater headway in its experiments with a digital currency, e-yuan, that is issued, regulated, and guaranteed by the Chinese state, and an ambitious state-backed, blockchain-based global platform for decentralized applications, known as the Blockchain-based Service Network. A recent executive order from the White House addresses the imperative to “reinforce American leadership in the global financial system and at the technological frontier,” underlining the urgent need to develop a centralized U.S. digital currency to consolidate and harness the global network effects that undergird dollar hegemony.39
It is clear that as crypto finance grows and permeates conventional finance more pervasively, the aftershocks of future crypto convulsions will have more widespread repercussions. Just as the global financial crisis forced the U.S. Federal Reserve to employ all of its financial firepower to rescue shadow banking, it will—when crisis inevitably strikes again due to flailing crypto markets—be compelled to extend its backstop to critical stablecoins in order to contain systemic risk from imploding the entire financial system. The doom loop that locks the state together with private finance as bigger and bigger speculative bets necessitate larger and larger rescues by the state, enabling even larger gambles, would in the process become more intractable.40
The Hidden Politics of Crypto
Far from being a means of snatching authority from the state and establishing a neo-Hayekian utopia of private currencies, crypto ends up reinforcing the pivotal role of the state in upholding the edifice of finance. There is an irony in the fact that Bitcoin was conceived with the libertarian promise of “de-politicizing” money by privatizing it and removing it from the control of both the state and big banks, yet the financial revolution it engendered consolidated both central bank authority and the power of finance. The technological breakthroughs of the crypto sphere are not enough to banish or bury the inescapably political character of money.41
Historically, money is a hybrid creature of both the state and markets, a symbol of both political authority and economic power. In the course of capitalist development, we see the tension between the state asserting its monopoly over the creation of money and private finance’s continual stretching of the mechanisms of money creation through private channels, and between the state’s dependence on financial markets to prop up public trust in its monetary liabilities and the financial markets’ reliance on the state for insurance and credibility. When bills of exchange stretched liquidity beyond the constraints of the gold reserves of the Bank of England in the nineteenth century, recurrent market volatility paved the way for the central bank to reassert its control through its market-making interventions in the bill markets. More than a century later, private, shadow money mechanisms fueled liquidity outside of the reach of central bank control—but when these mechanisms ground to a halt, the full weight of the U.S. Federal Reserve, backed by the authority of the U.S. government, was commandeered to restore the global financial markets and shadow banking system.
Submerged in the rhetoric of independence from central banks that was central to the neoliberal agenda heralding the maturation of finance capitalism was the hidden politics of money that was, in effect, a project to de-democratize money by moving it outside the scope of democratic accountability.42 The partnership between the state and private finance has been critical in paving the way for the ascendancy of finance and the extraordinary, extra-constitutional, and unaccountable command that finance enjoys in contemporary capitalism as a fourth power outside of the three pillars of the executive, legislature, and judiciary.43
The 2008 global financial crisis underscored the immense capacity of the U.S. state to conjure money at will, with a few strokes of a keyboard, and to “mark up” the accounts that banks held with it, as then-head of the Federal Reserve, Ben Bernanke, famously recounted.44 A clear revelation of the politics of money creation is seen in the Federal Reserve’s response to the global financial crisis and, later, during the COVID-19 pandemic, when the power of the Federal Reserve to turn on the money spigot was deployed asymmetrically to serve the interests of finance.45 The contradictory and contested politics of money led on the one hand to the political project of the Modern Monetary Theory, which embraces this capacity of the state and seeks to weld it to progressive agendas of employment guarantees and a Green New Deal; and on the other to the libertarian espousal of cryptocurrency as a bulwark against the unbridled despotism of the Federal Reserve, and a way to take money outside the sphere of politics (and democratic accountability) by privatizing it. If the former project is faced with the intransigent power of finance to hold the state hostage to its interests, the latter initiative founders on its ultimate dependence on the state for life support. Both statist reforms that aim to expand the discretionary power of the state to address the priorities of working people and privatist experiments that seek a democratic alternative in private currencies run up against the power of this alliance between state and private finance that lies at the heart of contemporary finance capitalism. The political authority of the state and the economic power of finance are bound, historically, in a volatile partnership that drives the engines of liquidity, further fueling accumulation. This alliance has entrenched the ascendancy of finance in contemporary capitalism.
The metamorphosis of the crypto sphere as it emerges from the recent convulsions will also reflect the tensions of this contested partnership. The power exercised by this alliance forecloses any potential of blockchains to offer ways to enforce democratic accountability and oversight of finance. Crypto technology has instead served to exacerbate concentration of wealth and expand the hegemony of finance, while access to the vast trove of data gleaned from the everyday transactions of ordinary people is being deployed not just as a new source of revenues, but also as a weapon of centralized control and surveillance in the era of finance capitalism.
As this article was going to press, the FTX-Alameda empire, after its failed bid for a rescue by its rival Binance, was left scrambling for funds to fill a $8 billion hole in its balance sheet. This spectacular unraveling testifies to the precarious foundations of crypto fortunes. The crypto convulsions are far from over.
- ↩ Karl Marx, Capital, vol. 3 (London: Penguin, 1981), 572.
- ↩ Ann Pettifor, The Production of Money (London: Verso, 2017).
- ↩ P. Koning, “Bitcoin as a Novel Financial Game,” American Institute for Economic Research, June 6, 2018.
- ↩ Breaches to the integrity of the underlying code and software and questions about the finality of transactions—for instance, when a fork emerges in the blockchain and one path gets overridden by another, wiping out transactions believed to be legitimate at the time—also undermine the wider acceptability of crypto coins as a means of payment.
- ↩ Sirio Aramonte, Weqian Huang, and Andreas Schrimpf, “DeFi Risks and the Decentralization Illusion,” BIS Quarterly Review (2021).
- ↩ “Fact Sheet: President Biden to Sign Executive Order on Ensuring Responsible Development of Digital Assets,” (Washington, DC: White House), March 29, 2022.
- ↩ Robert McCauley, “How Stablecoins Are Destabilizing Crypto,” Financial Times, May 12, 2022; Joshua Oliver, Scott Chipolina, and Kadhim Shubber, “Crypto Feels the Shockwaves From Its Own ‘Credit Crisis,’” Financial Times, June 24, 2022.
- ↩ Brendan Greeley, “The Eternal Dream of Automatic Money,” Financial Times, May 21, 2022.
- ↩ Kadhim Shubber, Joshua Oliver, and Scott Chipolina, “Celsius Bid to Rival Wall Street with Crypto Lending Scuppered by Risky Bets,” Financial Times, June 14, 2022; Kadhim Shubber and Joshua Oliver, “Inside Celsius,” Financial Times, July 13, 2022.
- ↩ Scott Chipolina and Adam Sampson, “Crypto Hedge Fund Three Arrows Files for US Bankruptcy,” Financial Times, July 2, 2022.
- ↩ Siddharth Venkataramakrishnan and Joshua Oliver, “What Is a Stablecoin and Why Is Tether Central to the Global Crypto Market?,” Financial Times, May 12, 2022; Siddharth Venkataramakrishnan and Joe Rennison, “Tether’s Commercial Paper Disclosure Places It Among Global Giants, Financial Times, June 10, 2021.
- ↩ Alex Hern and Dan Milmo, “Crypto Crisis,” Guardian, June 29, 2022); Joshua Oliver, Scott Chipolina, and Eva Szalay, “Luna Crash Sends Chill through Decentralised Finance Market,” Financial Times, June 3, 2022; Oliver, Chipolina, and Shubber, “Crypto Feels the Shockwaves From its Own ‘Credit Crisis.’”
- ↩ Paul M. Sweezy, “The Triumph of Finance Capital,” Monthly Review 46, no. 2 (June 1994) and Harry Magdoff and Paul M. Sweezy, Stagnation and the Financial Explosion (New York: Monthly Review Press, 1987) point to the role of finance in the transformations of 1980s; John Bellamy Foster, “The Financialization of Capitalism,” Monthly Review 58, no. 11 (April 2007) traces the gravitational shift towards finance with the establishment of finance capitalism. See Gérard Duménil and Dominique Lévy, Capital Resurgent (Cambridge, MA: Harvard University Press, 2004) and Gérard Duménil and Dominique Lévy, The Crisis of Neoliberalism (Cambridge, MA: Harvard University Press, 2013) for an elaboration of the neoliberal transformation unleashed in the 1980s in terms of a coup of finance.
- ↩ Shadow banking is cogently explained in Perry Mehrling, The New Lombard Street (Princeton: Princeton University Press, 2010).
- ↩ Mehrling, The New Lombard Street; Ramaa Vasudevan, Things Fall Apart (Thousand Oaks, CA: SAGE, 2013); Adam Tooze, Crashed (New York: Viking, 2018).
- ↩ Sirio Aramonte et al., “DeFi Lending,” BIS Bulletin, no. 57, June 14, 2022.
- ↩ Oliver, Chipolina, and Shubber, “Crypto Feels the Shockwaves from Its Own ‘Credit Crisis.’”
- ↩ Aramonte et al., “DeFi Lending.”
- ↩ John M. Griffin and Amin Shams, “Is Bitcoin Really Untethered?,” Journal of Finance 75, no. 4 (2020): 1913–64
- ↩ Aramonte, Huang, and Schrimpf, “DeFi Risks and the Decentralization Illusion.”
- ↩ Scott Chipolina and Joshua Oliver, “Crypto Exchange FTX Bails Out Lending Platform BlockFi,” Financial Times, June 21, 2022.
- ↩ Igor Makarov and Antoinette Schoar, “Blockchain Analysis of the Bitcoin Market,” Working Paper, no. 29396, National Bureau of Economic Research, Cambridge, MA, 2021; Alyssa Blackburn et al., “Cooperation Among an Anonymous Group Protected Bitcoin During Failures of Decentralization” (2022). While this distribution has been established in the top percentiles of the population, recent work relates this skewed distribution to property income. See Anwar Shaikh, Capitalism (Oxford: Oxford University Press, 2016).
- ↩ BIS Annual Economic Report 2018 (Basel: BIS, 2018); BIS Annual Economic Report 2022 (Basel: BIS, 2022).
- ↩ BIS Annual Economic Report 2022.
- ↩ Gillian Tett, “Crypto Enthusiasts Are Betting the House on Creative Destruction,” Financial Times, June 23, 2022.
- ↩ Blackburn et al., “Cooperation Among an Anonymous Group Protected Bitcoin”; Scott Chipolina, “Cryptocurrency Fallout Delivers Sharp Kick to Decentralized Finance Dreams,” Financial Times, June 22, 2022.
- ↩ Gary Silverman, “Cryptocurrency Platform FTX Expands into Equities Market,” Financial Times, May 19, 2022.
- ↩ Central to the debate on where regulatory authority should rest is the vexed question of whether crypto tokens are characterized as commodities (like oil and grain) or securities (like bonds and stocks).
- ↩ Gary Silverman and Philip Stafford, “Blockchains and Financial Markets,” Financial Times, April 5, 2022; Bryce Elder, “Automated Margin Calls Are Another Thing Blockchain Doesn’t Have to Fix,” Financial Times, July 20, 2022; Alexandra Heal and Philip Stafford, “How FTX Plans to Reshape the US Futures Market with Crypto Tech,” Financial Times, July 20, 2022.
- ↩ Kiran Stacey, “Meet the ‘Crypto Caucus,’” Financial Times, March 30, 2022.
- ↩ Tory Newmyer, “Crypto Finds a Bright Spot in a Stormy Summer,” Washington Post, August 7, 2022.
- ↩ Isabella Kaminsky, “What Is Tokenisation Really?,” Financial Times, October 3, 2017; Jane Croft, “Which Real-World Assets Are Being Tokenised?,” Financial Times, November 29, 2021.
- ↩ Eva Szalay, “Banks Turn to Blockchain in Search of High Quality Trading Assets,” Financial Times, May 24, 2022.
- ↩ BIS Annual Economic Report 2022.
- ↩ For an exposition of the role of repos in the shadow mechanisms of liquidity creation see Mehrling, The New Lombard Street; Daniela Gabor and Jacob Vestergaard, “Towards a Theory of Shadow Money,” (New York: Institute for New Economic Thinking, 2016). A broader analysis of liquidity in shadow banking, including the role of asset-backed commercial paper and money market fund shares, is set out in Zoltan Pozsar, Shadow Money (Washington, DC: Office of Financial Research, 2014).
- ↩ In fact, policy experts point to tokenization of real-world assets as a way of reforming DeFi and curbing its self-referential tendencies. See Aramonte et al., “DeFi Lending.”
- ↩ Camilla Hodgson, “Carbon-Linked Crypto Tokens Alarm Climate Experts,” Financial Times, April 15, 2022.
- ↩ Ramaa Vasudevan, “Libra and Facebook’s Money Illusion,” Challenge 63, no. 1 (2020): 21–39; Raphael Auer, Giulio Cornelli, and Jon Frost, “Rise of the Central Bank Digital Currencies,” BIS Working Paper, no. 880, Basel, 2020; Shaikh, Capitalism; BIS Annual Economic Report 2021 (Basel: BIS, 2021); Augustín Carstens, “Digital Currencies and the Future of the Monetary System” (speech), Hoover Institution Policy Seminar, Basel, January 27, 2021.
- ↩ James Kynge and Sun Yu, “Virtual Control,” Financial Times, February 16, 2021; “President Biden to Sign Executive Order on Ensuring Responsible Development of Digital Assets.”
- ↩ This characterization of the doom loop was made by Andrew Haldane and Piergiorgio Alessandri, “Banking on the State,” presentation at the Federal Reserve Bank of Chicago Twelfth Annual International Banking Conference, Chicago, September 25, 2009.
- ↩ For a perceptive account of the Hayekian politics of Bitcoin in the light the monetary disorder of the 1970s, see Stefan Eich, “Old Utopias, New Tax Havens” in Regulating Blockchain, ed. Philipp Hacker et al. (Oxford: Oxford University Press, 2019). The adoption of Bitcoin as legal tender by El Salvador, and more recently by the Central African Republic, is also explicable as an attempt—albeit doomed—to forge greater policy space for the central banks of these countries. Prior to this, the official currency of El Salvador was the U.S. dollar, and that of the Central African Republic was the franc of the Financial Community of Africa, and so the scope for independent monetary policy was severely curtailed in these countries.
- ↩ See Stefan Eich, The Currency of Politics (Princeton: Princeton University Press, 2022) for a historical overview of these hidden politics and of how the call to depoliticize money in fact de-democratized it.
- ↩ This argument is elaborated in Joseph Vogl, The Ascendancy of Finance (Cambridge, UK: Polity, 2017).
- ↩ This interview is cited in Pettifor, The Production of Money.
- ↩ Ramaa Vasudevan, “The Doom-Loop Redux,” Review of Radical Political Economics 54, no 2 (2022): 171–89.
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