Trust Fuels Adoption
In June of 2022, The Network Firm’s CEO, Noah Buxton, appeared on Bloomberg for an interview to discuss the chaos created by the Terra Luna collapse. He wrote this blog to expand on the topics mentioned on Bloomberg. This blog was written before the collapse of FTX.com, BlockFi, and Voyager in late 2022; the case for increased trust and transparency mechanisms in the digital assets market was true then and remains even more true today.
Putting June 2022 Crypto Market in Context of History and making the case for more trust and transparency in crypto markets.
Below are a few longer-form thoughts after my short-form appearance on Bloomberg Radio last Friday, June 17th.
Tim Stenovec asked me what impact current market conditions and news has on overall adoption in the crypto space.
My answer: Yes, black swans, project failures, and volatility of market prices means that the pre-coiners are more cautious, and many of the recent adopters take their losses and leave. This is what crypto winters look like; only those with the right gear and the right mindset weather the storm.
But there is so much more to say on this point…
What happened; where we are today (June 2022).
Yes, its chilly out there, but why? The Terra (UST) 🌍 Powered by LUNA 🌕 collapse impacted institutional players, funds, and retail-facing platforms, such as crypto lenders. The blunt force trauma to these balance sheets took some time to show the bruise. In the following weeks, Celsius was the first large player to show the contagion contusion when they announced that they would pause withdraws for their customers.
This news traveled quickly and talk of insolvency trended.
Crypto bank run conditions set in, withdraws for other platforms ticket up, and, very importantly, institutions with B2B credit or margin facilities got called. What we have is a mini credit crisis. I say mini, because the magnitude of this credit tightening is ultimately very small compared to the 2008 financial crisis. And while the market is uncertain, there is still plenty of lending and capital flowing in the crypto economy.
As of June 22, 2024, Celsius still hasn’t revealed any more information on the state of the company’s finances. They did reportedly pay back a loan taken from the Compound protocol, but otherwise, their normally vocal CEO, Alex Mashinsky has been conspicuously silent. FTX — Cryptocurrency Derivatives Exchange / Alameda Research has stepped in to provide credit facilities for at least one crypto lending platform, BlockFi, and it looks like Voyager, a prime brokerage offering and Canadian publicly-listed company got caught on their heels after Three Arrows Capital announced they may be unable to pay creditors including Voyager (to the tune of approx $600M).
Strong Markets Require Visibility and Trust
Back to that adoption question — in our industry we’ve had endless pontification on this topic… “what will trigger more adoption?” And the same ideas have been recycled at fireside chats during large industry conferences: user experience, fiat onramp access, user interfaces, education, regulatory clarity, the institutional wall of capital, and the retail FOMO that will follow. All these reasons have been popular talking points. And they each play some role in the evolution of which crypto people will buy and how they will use it.
But what’s missing in the adoption analysis? A clear and compelling explanation of the TRUST & TRANSPARENCY GAPS in our current crypto asset service providers and markets.
The Case for More Infrastructure of Trust Has Never Been More Clear
Celsius’ current state of suspended animation, suspected insolvency, public shame, are a perfect example of this trust and transparency problem. Simply put, Celsius is not a victim of the market, their fate is the natural and predictable result of management’s own failure to prove their own assets to their customers. The reason Celsius never offered proof of their reserves and their ability to satisfy customer liabilities (i.e. make good on their account balances if withdrawn) is because, in my opinion, Celsius…
(1) grew so quickly that they struggled to put the proper systems in place to track their own accounting and operations.
(2) took risks with customer assets without proper risk mitigation measures.
(3) got greedy and sought more customers and more business by reducing loan collateral requirements.
(4) didn’t care enough to prove reserves to clients; rather, management chose the ‘charismatic and trustworthy leader’ approach to creating customer trust.
Putting this Problem in Historical Context
Markets that rely on charisma and promises are (and always have been) inefficient, unfair, and bound to cause riches for some and pain for others.
Think back to the 1600s and the advent of the financial instrument called the “share.” Shares were as revolutionary then as crypto is today. In 1602, the Dutch East India Company was the world’s first publicly traded company and offered shares on the Amsterdam Stock Exchange (the first public stock exchange).
Stocks and bonds were issued to investors; each investor was entitled to a fixed percentage of East India Company’s profits. Far flung missions to search [pillage and colonize] for resources, riches, commodities, and durable goods from the East Indian Ocean region, funded by individual and royal capital investments, were a paradigm shift from the “capital markets” pre-dating this era.
Capital markets before the 1600s Dutch, English, and French East India companies were characterized by local trading of personal loan notes between lenders. Often, the trade venue was the pub.
The East India companies and the associated shitcoins of their day (blind pools) were often scams. Why? Because there was no regulation and no mechanisms of trust and transparency to hold East India or similar companies accountable. There were no fair, orderly, and transparent markets to facilitate price discovery or asses the track record of the companies in returning investor capital.
This is clearly an abridged version of the story, which leaves out the development of armies to protect company resources and the use of those powers to colonize, namely the British East India Company being the pre-cursor to British rule of India. However, the point here is that the East India companies had frequent financial woes and eventually were wound up by an act of the UK Parliament.
In 1790, the first US stock exchange was organized and named the “Board of Brokers of Philadelphia” (NASDAQ’s great, great grandfather). The London Stock Exchange was formed almost 100 years earlier in 1801, but had limited markets as the British government had restricted the issuance of company shares to public investors. In 1825, investors experienced what is thought of as the first financial crisis, dubbed the “Panic of 1825.” The post-Napoleonic war period was one of peace and prosperity in the UK, accompanied by economic growth and a glut of speculative investments. This bubble burst in 1825.
To bang the drum again — early markets lacked the mechanisms of trust and transparency that investors needed.
In fact, we don’t need to go back hundreds of years to make this point. Let’s not let it be lost on us that the term “Ponzi’s scheme” is used colloquially as the “rob Peter to pay Paul” fraud that Charles Ponzi so effectively executed in 1920 (resulting in the loss of approximately $20M in investor money over a year’s time… approximately $300M in 2022 dollars).
Even the public stock scams, and frauds since the mid-1980s show that the financial oversight by the SEC, accounting standards promulgated by the PCAOB, reporting and disclosure requirements, and information systems that distribute such information have all evolved and improved dramatically over a short period.
Bre-X Minerals, ZZZZ Best, Enron, WorldCom, Bernie Madoff, Health South, and others are all recent examples of failures in financial oversight and investor reporting. And they happened before crypto was a thing; imagine that.
This problem isn’t new, but crypto is
So, the TradFi-entrenched point the finger at the crypto markets and claim it’s all a fad, a bubble, or a Ponzi scheme. No, it’s not.
Crypto detractors do rightly point out that there is work to be done before we have fair, efficient, and orderly markets with sufficient investor transparency.
The part they are completely missing: the standards, oversight, regulation, and best practices for investor reporting are being built right now. Not only that, digital assets can and will be fundamentally more trustworthy than TradFi instruments.
Digital assets allow for auditing techniques that are possible today but not widely adopted. These techniques will allow platforms to more frequently prove to their users that they are holding adequate collateral (example: stablecoins), that they are reserving customer assets (example: proof of reserves for exchanges and lenders), or that their balance sheet is sufficiently healthy (perhaps by zero-knowledge proofs to show “solvency” without disclosure of actual balance sheet amounts). In addition, smart contracts will have reliable financial controls baked in. And almost certainly, there will be other positive tech that has yet to be developed.
The trend is still our friend
How it all takes shape I can’t say with certainty; however, I can say with conviction that the transformation of our financial system and capital markets is inevitable.
Then: Cypherpunk bitcoin wasn’t taken seriously and certainly not compared to equities markets or other institutional asset classes.
Now: Bitcoin is an institutional asset. It is part of the global macro environment and other public blockchain projects are making headway as they innovate and disrupt lending, centralized exchanges, traditional commodities markets, gaming, and more.
Tomorrow: Tokenization wins out. Faster, cheaper, more transparent platforms for digitizing “real world” assets and off-chain intangibles like equity, real estate LP interests, commodities, futures and derivatives will gain market share. Our financial lives will run on public ledgers and the trading floor of today will be a quaint memory.
Putting a pin in it
Financial markets have taken different forms over human history, but have always experienced continuous evolution. Crypto and digital assets represent the next phase of this natural and predictable evolution. As markets change, so must the methods and tech that enable the requisite level of trust and transparency.