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Cryptocalypse Now!

Originally published: The Blind Spot on May 20, 2022 by Izabella Kaminska (more by The Blind Spot) (Posted May 23, 2022)

The “A Long Time In Finance” Transcripts

Cryptocurrencies are collapsing across the etherspace. Neil and Jonathan talk to Izabella Kaminska, founder of the Blind Spot and keen cryptowatcher, about Terra, Luna and Tether, the death spiral of the stablecoins, and whether anyone in the real world should care.

Jonathan Ford: Hello, and welcome to ‘A Long Time In Finance’ with Jonathan Ford and Neil Collins, in partnership with briefcase.news, the service that brings intelligent curation and analysis to your media monitoring.

Hello, and today, our subject is the cryptopocalypse. That’s the massive declines in the value of cryptocurrencies, which if you remember was supposed to disrupt our financial system. You remember that, Neil?

Neil Collins: I do. Yes, it was going to change the world that seems to have been changed rather seriously itself?

Jonathan Ford: Yeah. Well, the question I suppose is, do cryptocurrencies really work? Or do they work only when the price is going up? On the way down nothing seems to function quite as it should–a trait common to Ponzi schemes down the ages. In the current market carnage the exchanges that are promoted digital currencies have a lot to answer for. Bitcoin is down nearly 60% over the past six months as investors dump it for boring oil real currency and… remember that? That was the stuff it was supposed to disrupt.

Neil Collins: Paper currencies, Imagine that.

Jonathan Ford: Yes, yes, a newfangled thing. Can’t trust them. Stable coins, crypto coins that’s supposed to stay the same level against the dollar have broken free from their moorings. Crypto exchanges, which made fortunes for their founders by peddling this stuff, such as by Binance and FTX been announcing temporary suspensions of trading. And all this is happening in an unregulated sandpit, where these assets are hyped, dumped without anyone really setting any rules. So I’m really pleased today–here we are in Neil’s garden, it’s a  beautiful day, sun shining down. Neil’s wearing a funny floppy hat,

Neil Collins: All is well with the world, at least the real world rather than the crypto world.

Jonathan Ford: I’m very pleased to be here in this Neil’s garden with Izzy Izabella Kaminska, who’s the founder of the Blind spot a financial news site, ex Financial Times Alphaville and a whiz on all things crypto. Hi, welcome, Izzy. Very nice to see you.

Izabella Kaminska: Thank you for having me.

Jonathan Ford: I think we should start by just talking a little bit about this crash and how serious you think it is.

Izabella Kaminska: If you look at the grand scheme of like crypto crashes, and in times gone by, it’s not unprecedented, like crypto has had a lot of these winters as they like to call them. So what makes it different this time, I think, is the perception that it’s maybe more concrete and more long lasting than the other crypto winters. And I think that is because its timing has come just as the Fed has started raising rates,

Neil Collins: Do you think it’s as a result of them raising rates?

Izabella Kaminska: Yeah, I do. Actually, personally, I think that sort of era of cheap money has come to an end. And with that the first domino to fall is going to be the most speculative part of the market, which was crypto, which depends essentially on an incredibly pro risk-on attitude. And when money gets tighter than like a CDO, I see as like the first tranche of global liquidity getting mopped up.

Neil Collins: Of course, that was the canary in the coal mine at the start of the 2008 financial crisis that these things became unmoored. Do you think something similar is taking place at the moment? Or do you think it’s just another correction that they will get past?

Izabella Kaminska: I think it’s like a cross between 2008 and.com It’s like the perfect fusion of those two crises, isn’t it? Because on the one hand, the similarities of 2008 are the financial engineering and this idea that we had created systems that were totally immune from, like conventional risks in the financial system. And then the other side of it is this sort of casino style, you know, money printing world of dot com era where everyone was basically printing their own currency as well, but in the form of stock, and using it to pay out their employees or whatever. And that came to a grinding halt, if you recall, also within the tightening cycle of the Fed. So I think there is a common sort of similarity between those two and it’s merged into the crypto crisis. The difference this time round is whether it’s more contained. And I think maybe there is a fair argument to say that it hasn’t got to the systemic stage. In fact, I would say in some ways cryptos operated like a honeypot attracting the worst of like financial speculation and taking it outside of the conventional core financial system. And it remained quite gated and now was actually the moment when the divide between crypto and core was starting to kind of…

Jonathan Ford: I mean the difference here in here I’m speaking preposition almost perfect ignorance. But it does seem to me that one of the differences here is that I always think of cryptocurrency as sort of Bitcoin or things of board apes sitting on a kind of branch or saying, sort of non fungible token. But of course, we have these things called stablecoin now and as far as I can understand it, stablecoin, unlike bitcoin is made to be stable, ie to keep its value not to shoot up and down like Bitcoin has and presumably the idea is to try and encourage people to use it as a medium for making transactions as well as just speculating on its value. And it basically means presumably, that it will be more… it’s the way in which you bring it into the mainstream finance. But what we’ve seen is sort of in this crisis, of course, that the so called stablecoins didn’t turn out to be very stable at all. You have a thing about horses. The horses,

Neil Collins: The horse has bolted, hoho. But the…

Jonathan Ford: She’s got to answer my question first.

Izabella Kaminska: I think you’re right. But I think it’s also important to understand that stable coins emerged because of a market need. Because crypto was so volatile people when they were speculating in the market, they always wanted to take profits and bank their money in somewhere relatively stable. But the market essentially created these things as a way to retain the capital within the crypto economy like a capital control exercise, because it didn’t want the fiat currency to leave the system and the on ramping and off ramping of fiat in and out of the system is where the main friction is. So Stablecoins were kind of created as a mechanism to keep the capital in the system…

Jonathan Ford: What happens then? Do stablecoins lend to each other, do they lend to people in stablecoin? Because the whole point of having my money in Bitcoin is it goes up? I mean, yes, it could go down. But if, if I have it in this thing, which just stays at $1.

Izabella Kaminska: That’s if you are a hodler, right. but if you’re like an active trader, you need… A Hodler.

Neil Collins: Eh?

Jonathan Ford: Hold on for dear life.

Neil Collins: Okay, I’ll try

Izabella Kaminska: To Hodl is like a market sort of originated Time Deposit, it’s effectively :I’m gonna keep my money in crypto I’m never going to exit no matter what.” But the trading community wants to take profit and like do trading strategies. And of course, because of the frictions between the regulated space and the unregulated space, they had to effectively synthesise a copycat of the dollar system. That’s where stablecoins emerge, they were going to be like the PayPal of crypto, and in the original incarnation, which was Tether, they were materialised, through Fiat coming into a some sort of custodial arrangement. And then issuing like a money market fund, or even an ETF tokens against that collateral.

Jonathan Ford: What do I get? So I buy $1 worth of bitcoin goes to $2. I feel relieved, and I want to hold on for dear life or Hodl. I then say I’m going to put it into an account full of stablecoin. Do I get any return on my stable coin? Or do I just hold my stable coin in a pile of stablecoins?

Izabella Kaminska: People use it for all sorts of reasons. But…

Jonathan Ford: But it’s not itself giving me a return?

Izabella Kaminska: No, no, no, no, it’s mainly as a trading mechanism. And also, sometimes if your wealth is trapped in the crypto economy, getting it out means lots of KYC and AML, proving your identity and making sure you’re not Russian…

Jonathan Ford: That’s Know Your client.

Izabella Kaminska: Or Vladimir Putin, if you want to like be able to sort of transfer value in a in a stable way, you might take your crypto gains, put them in a stablecoin, and then send that stable coin over to… because it’s trapped in that crypto, regulatory sort of light touch arena.

Neil Collins: These stable coins now have $150 billion.

Izabella Kaminska: Yeah.

Neil Collins: …And those are real dollars, because somebody somewhere has paid a real dollar for them or for the things that they bought, and they traded back into a stable coin. So in theory, your money is absolutely safe there. But in practice, I don’t think it is.

Izabella Kaminska: So they originally started as like, the market selling point was that they would every dollar invested would be kept in a depository account. But of course, the reality is, this was effectively a narrow, narrow bank, right. But those aren’t very profitable to operate, because…

Jonathan Ford: Which was a light bulb moment,

Neil Collins: So, without fraud, of course, fraud is a great way of getting the money out.

Izabella Kaminska: So the incentive for the stablecoin operators was to effectively do a bit of asset transformation. So rather than putting your money, customers’ money into a time deposit at a licenced Bank, which is how they originated, they started taking more and more risk. So we’re punting in the bond market, but most recently in commercial paper, and in Cryptos.

Jonathan Ford: So we’re talking here really about I think Tether, which is one of the big Stablecoins, where effectively they say, if you buy a dollars worth of tether, we will hold your money in a bank or in some sort of place where it’s safe as a reserve, but you’re saying that that of course is not a very profitable thing, just to put it in a pile in a bank. We don’t know really, I think

Izabella Kaminska: Not just that…

Jonathan Ford: Do we know where that where it all goes?

Izabella Kaminska: Well, one of the things whatever was that they would claim that they were hindered in this like noble endeavour because no bank wanted to bank them. And as a result, they had to get creative with where they put…

Jonathan Ford: They had a bank in Panama?

Izabella Kaminska: And then they had to take more and more risk in terms of who they were banking with. And then the community started to stress like are the dollars really there? Then they got hacked a few times, and nobody was sure whether or not the reserves really there? So they then commissioned a bunch of auditors to try and regain confidence, that the reserves were really there, nobody then trusted whether the audits were true or not.

Neil Collins: Well, they were well short of actually saying whether they were really there…

Izabella Kaminska: There was a little bit of obfuscation one might say, but obviously in the interim, there was slippage between the collateral they had been amassed, and the liabilities they’d put out into the system. As a result, they started to kind of look at investing in assets that might go up in value to compensate for the capital depreciation, which then made it a mark to market exercise.

Jonathan Ford: That means what they did was they made it risky. To use let’s use simple words here. So that’s one way of doing it is to say bit like, I don’t know, the Hong Kong dollar, every stable Hong Kong dollar or stable coin is backed by a real currency. The other way is this Tether has gone down a bit, but it hasn’t collapsed. But the other way of doing it is this algorithmic Terra Luna system, which I have to say I had to spend a few minutes reading up on but I’m still not sure I understand it. But broadly, there are two systems,

Izabella Kaminska: Basically, because the conventional and less risky way of managing these these things wasn’t very profitable. The great brains in the crypto industry, they effectively tried to engineer a proxy for doing this. So essentially, they created an arbitrage mechanism. So it’s not backed by an algorithm. It’s really backed by an arbitrage between…

Jonathan Ford: Made by a chap in South Korea, I think, Do Kwon.

Neil Collins: It’s not actually backed by anything.

Izabella Kaminska: No because it’s like an synthetic ETF. It’s essentially a promise that they will always be able to deliver on a redemption request because they have this magical arbitrage process so they can take the proceeds and do whatever they want with them, because they feel confident that in the event of any slippage in the NAV, in the net asset value to the tradable token, they can recapitalize through the Luna coin, okay, and the coin operated in my opinion, the best metaphor is like what Enron used to do with the Raptors, remember the Raptors?

Jonathan Ford: I’m gonna read out and description that I’ve got in front of me, because I think one needs to get this thing in one’s mind. So the mechanism is designed to keep there are two sister currencies, Terra Luna, the mechanism is supposed to keep Terra always at $1. So if it trades 99 cents at any point, an automatic process prints more Luna and uses them to buy Terra until it’s back to $1. And if it goes to $1 and a cent, the process reverses and you Tara and use them to buy Luna until it’s back to $1. You can look at this as a very rational clever system. But you could also look at it as what I would call the Rudolph Harvenstein School of words, Rudolph Havenstein was the man who ran that we ran the Reichsbank at the time, it decided that the way to solve all the money problems in Germany after the First World War was to print reichsmarks faster and faster. So I mean, essentially, if anyone ever loses confidence, and the whole system hinges on the Lina bit, and if anyone ever loses confidence, it is zero. There’s no amount of Luna you can print at zero, that will ever make Terra worth the dollar.

Neil Collins: I mean it is actually a confidence trick. Thank you for that explanation, which is very good. I think the interesting question is how did it get to this point in the first place? Why didn’t people say, well hang on. This is pulling itself up by its own bootstraps.

Jonathan Ford: Well how did paper currencies get to this point?

Neil Collins: I can explain that. But I think that’s beyond the scope of this volume.

Izabella Kaminska: Because look, first of all, there have been other algorithmic coins that have failed already. So the model was already being tested. But Terra Luna became a systemic issue just because–not systemic, systemic within the crypto world–because of how popular they got. And the reason they got popular is because Luna was on a positive trajectory. Effectively, the equity being absorbed into Luna was being used to subsidise any slippage or variance in the ability of Terra to match the dollar, right? That allowed for the perception of stability.

But actually, for me, the moment the confidence trick became sort of unwound was when they decided to add Bitcoin to their reserves as a sort of additional layer of trust, you know, so that the community could feel assured that it wasn’t just the algorithm that was backing the thing, but also this nice little reserve of Bitcoin. And that was like a massive failure in what I would call sort of their own central bank comms, because the moment you signal to the market, that you need a reserve at all you’re signalling that you don’t really trust the arbitrage mechanism.

Neil Collins: Yeah, I see that. So why did the market believe it in the first place when it was so transparently flawed?

Izabella Kaminska: There were many of these algorithmic coins that have already failed. So the market I think, should have known better, frankly. But there was this irrational exuberance related to the performance of Luna and when these equity values go up, they ratchet up and create, you know, FOMO.

Jonathan Ford: This is a very old concept really, isn’t it? It’s a thing called the death spiral convertible, which is, you will know all about these, you probably issue these in your days as a stockbroker.

So a death spiral convertible is basically where you have the right to convert something into a bond into a share. But then the number of shares, you get flexes with the value, so you always get the same value. So of course, if the share goes to nothing, you end up with infinite number of shares, and the whole thing is dead.

Izabella Kaminska: That’s a really interesting comparison.

Jonathan Ford: And what’s interesting about it is that it’s a financial no no, you don’t see many death spiral convertibles issued these days, because companies and investors have become sceptical that they are indeed a good deal.

Neil Collins: So I think FOMO is probably the most convincing explanation I’ve heard to the enormous gathering rushed by these things.

Izabella Kaminska: Yeah. And also, I think we shouldn’t underestimate the part that can I say the C word, corruption, has played in all this, because, you know, the crypto market has become so powerful, and there’s so much money sitting in there, they’ve managed to fund this huge lobbying machine that has just created a sort of gaslighting effect on the entire industry, which hasn’t really helped rationality, frankly.

Neil Collins: Can I just move it all a bit? Does this matter? Or is it basically consenting adults losing large amounts of money between themselves? Or is it going to impinge on the wider financial system, which the rest of us depend upon for our investments?

Izabella Kaminska: I would argue we’re still at the point where from a systemic perspective, now was the right moment for this to fall apart, crypto was still barely contained. And in a funny way, had it been more regulated than there would have been more of an expectation for regulators to bail the system out.

Neil Collins: That’s a very good point.

Izabella Kaminska: It was still a caveat emptor market. And I suspect that has allowed it to absorb a lot of the speculation that might otherwise have hit the kind of core financial system as well. So it acted like a honeypot for the all of excesses out of the QE period, and hopefully contained them in…

Jonathan Ford: That’s Quantitative Easing.

Izabella Kaminska: But hopefully, it’s contained them. This is the moment we discover how contained it really is.

Jonathan Ford: But sounds to me as if you think that we’d be better off leaving it where it is in this sort of unregulated sandpit, because at least then, even if the odd aunt Agatha, basically wades in and basically loses her shirt. By and large, most people won’t, because they’re basically going to keep it away as much as possible from the mainstream financial system. Do you think that’s really where it should stay? Because there are some people who argue actually, the lesson from all this is, we should recognise that this is going to happen, and we should start to regulate it like normal financial products.

Izabella Kaminska: So I think it’s useful to have it as a more caveat emptor kind of market because like, you know, the unintended consequence of regulation is increasing responsibility for that market. So I think the best way to regulate it is with counter advertising from the regulatory market.

Neil Collins: I think we’ve had a lot of that I think every central bank has said, don’t buy these.

Izabella Kaminska: Right, which is why I think, how do you counter Matt Damon? Advertising to the Superbowl? Whatever, right?

Jonathan Ford: But then you sort of do say it’s 150 billion, and in another 10 years, if it’s a trillion, you know, is there a point at which you say, actually, this has outgrown it sort of Wild West? Well,

Izabella Kaminska: The one thing I will say about the crypto market is that it doesn’t really call for regulation. They’re quite happy to suffer these losses. I find it a very bizarre market. It’s so resilient in the face of loss. They see it as a sort of like a rite of passage almost. Like “I’ve survived five crypto winters and I’m still here” you know, they see it, they have a different mentality and…

Jonathan Ford: They don’t have a house. My dog’s left me. But I’m still I’m still standing.

Neil Collins: Rather than being one and a half trillion in 10 years time, it looks to me like it’s more likely to be 15 million. I mean, eventually, the people who’ve made a lot of money will disappear and live in the Bahamas. And the people who have lost it will go home to like their wounds, even if they don’t have a dog left to go home to. It doesn’t seem to me to have any sort of momentum.

Izabella Kaminska: But maybe that’s the role it serves in society. Maybe it’s that sort of, you know, when you’re coming out of school, wherever we go, one goes through that. At naughty phase and they have to experience you know, smoking behind the bike sheds or whatever. So everyone gets a flirtation with the crypto market learns the lesson never does it again, maybe it’s there as a sort of incentive for like young financially engineering minded people to think they know better than the market and then always figure out that they don’t.

Jonathan Ford: Well, it’s a bit like paper currency in that way, if you ever want to be paid in paper currency? You’re right, they these kind of battle hardened veterans come through the latest nuclear winter repair go lightly irradiated, but still fired up for another round. What is the purpose of crypto in the long run? How does it fit into the system? Is it just a kind of, you know, bet 365 kind of style asset which people have a punt on from every now and then when they’re feeling lucky or wider purpose?

Izabella Kaminska: So a lot, you know, the crypto community would say, oh, it’s attracting the brightest minds, you know, people instead of becoming nuclear physcists people are going over to work in crypto, blah, blah, blah. But my take is more that it is speculation for speculation’s’ sake. It is another offshoot of a gambling market. If there is any utility to be had in crypto, now’s the moment. It’s like with the dot com bubble, like there was a lot of stuff out there. That was not wrong just too early, right. And then out of the debris of dot com. crash, Google emerged and Amazon emerged, right. So if there is any utility to be found in this market, it’s in a winter.

Jonathan Ford: Okay what is the possible application? What’s the great thing that our listeners saw it happening? They could think this is the one this is the time to get in?

Izabella Kaminska: So I’m generally quite sceptical, and that for a long time Bitcoin was seen as a solution looking for a problem, right. But the one thing I will say is that in the last year or so we have a lot more problems out there than we had, like 10 years ago.

Jonathan Ford: it’s now a problem looking for a solution, I think.

Izabella Kaminska: There’s that. But I do think it might have a role to play…  in, you know the dollar is obviously no longer a neutral currency. Right. So it has become a highly politicised sanctions-focused currency.

Jonathan Ford: So good for Russians then.

Izabella Kaminska: Yes, in some ways, you could see it as sort of anti sanctions, but there are always going to be areas of the financial system that are in some ways challenged unfairly viathe sanctions regime, whether that’s inadvertently, you know, causing starvation in certain sectors–unintended consequences of sanctions, right? That’s one area. I think it might also provide a counterbalance against CBDCs. And I’ve–Central Bank, digital currencies. And so with central banks coming in to issue their own stablecoins, digital currencies, that are going to be integrated with all sorts of datasets or identity, you know, theoretically you could end up with like, an app where your entire digital life is linked to your bank account, and then you could, and that’s great when the government is, you know, one that you can trust but not so great if suddenly Vladimir Putin invades the UK and takes over the servers.

Neil Collins: You’ve found a government you can trust?

Izabella Kaminska: Well, precisely. So there is always a risk of that. And the thing that bitcoin does is that it keeps… I compare it to like the right to bear arms, it’s best deployed as a deterrent against bad practice in the core system because the core system knows that if it behaves badly, it risks diverting capital into this more fluky crazy market. But in an ideal world, the deterrent is there but never utilised. So Bitcoin is there as a hedge, keeping the core system honest, so to speak, but never really actively utilised.

Jonathan Ford: So just before we go for the mention of the great hope for Bitcoin being or any cryptocurrency being a Russian invasion, which I think is an interesting idea in itself, I think one currency as listeners will know I take a great interest in Nibblecoin. So I went, I went to have a look at nibble coins. They were getting on in the cryptopocalypse. And I can tell you that there’s a wide spread on the websites. The less optimistic ones have it at dollar zero. But I’m going with the most optimistic price which is nought point nought, nought, nought and one cent.

Neil Collins: Ah right. Well, there’s scope for some market making.

Jonathan Ford: Which gives the whole Nibble coin universe a value of $49–enough to buy a loaf of bread if the Russians invade.

That was a long time in finance with Jonathan Ford and Neil Collins. Editing and Production is by Nick Hilton, and our sponsorship partner is briefcase.news. Join us again next week.

Neil Collins: I haven’t heard the script this time. It’s all very exciting.

Jonathan Ford: I emailed it to you. Yeah, you don’t pay any attention to anything.

Neil Collins: No, you never answer the phone if we’re trading these things.

Izabella Kaminska: Here we go, like a married couple.

Neil Collins: Oh no we’re not. Oh yes we are.