Finally, an Answer to "What is Crypto Good For?"

Dutch East India Company, aka “Tokenization”

Back in September I made an argument that – living now in the opening days of Trump 2.0 – already seems quaint and naive: I suggested that shadow banks must be either regulated or prosecuted. Of course, crypto “stablecoins” are nothing more than shadow banks dressed up in the language of decentralized techno disruption.¹ Tethers are slightly useful for gambling on crypto (because you don’t need to repeatedly pay fees to transfer dollars in and out of the cryptoverse), but they are really good for engaging in criminal activity (because the circulation of tethers is much much harder to track than the circulation of bank deposits).

If we zoom out we can observe that shadow banks are just one form of a much broader and absolutely crucial money/power phenomenon, which I described this way back near the launch of this newsletter:

Just as Foucault famously said “where there is power there is resistance,” so every trader knows that where there is regulation there is the opportunity for regulatory arbitrage. If the trader can get around the intent of the regulation without actually breaking the law, then they can make money (for their firm, for their client, perhaps for themselves).

A pure regulatory arbitrage would create a new financial instrument or strategy that truly avoided breaking the law. But there’s a much easier, and perhaps more au courant, option: break the law blatantly, but claim that the law doesn’t apply to you. This is one way of describing the back-and-forth battle that has been going on for the past five years or so between crypto players and the US Securities and Exchange Commission – a battle that likely not so much been won but ended by Trump’s election.

Here I make a more general point designed to bring the wider crypto landscape into sharp focus: the only real-world use for crypto is illicit regulatory arbitrage that takes the form of mystification.

In order to work our way back to this conclusion, let’s begin with an absolutely astounding opinion piece that Jeff Bezos’s Washington Post published last month. Penned by none other than the CEO of Robinhood Markets, Vlad Tenev, the subtitle announces boldly that “crypto technology can democratize access,” and since we know that “democracy dies in darkness,” this makes crypto out to be the bringer of light and truth. But how does crypto save democracy? What is the problem that crypto solves?

In a word, it solves the problem that not everyone can invest in SpaceX or OpenAI. These are private companies, and US law states that while anyone can buy stock in a publicly traded company, only “accredited investors” can purchase share in a private company. The main way to gain this status is by making more than $200,000 a year in income or holding over $1,000,000 in financial assets. Hence Tenev’s deeply democratic concern that “roughly 80% of US households” are ineligible to invest in the growing private markets. He calls this “the investment gap,” a term he uses to leverage the idea of a great injustice: the exclusion of millions of American households from participation in free markets.

Obviously the answer is crypto:

Crypto’s blockchain technology allows for the fast, easy and secure creation of digital tokens, which can confer ownership claims to something of value. The power of this process, called tokenization, lies in the flexibility of the technology to divide and distribute rights to almost anything so that they are tradable like a stock. Real-world assets, such as private companies, can be tokenized with only minor changes to the existing legal documents that govern ownership claims to these assets.

… Anyone with a mobile phone could trade any tokenized asset in any quantity 24/7 — a technological step-change improvement over our current stock markets.

That’s where the investing revolution begins. Tokenizing private-company stock would enable retail investors to invest in leading companies early in their life cycles, before they potentially go public…(emphasis added)

Where to begin?

1. The problem is made up.
   Tenev makes it sound like there is some ever-widening gap between “the haves” who get to invest in private companies and the “have nots” who are confined to the gruel of public markets. Both the general idea (that the inequality problem lies squarely with the suffering many who can’t buy private stock) and the claim to an empirical trend (that the gap is getting worse) are utter rubbish. First, only 21% of the American public owns any public stocks directly to begin with. So roughly the same group of Americans who buy public stock already have the right to buy private stock. Even if the gap were a problem (it’s not) there is no real gap here. Second, the $200,000 limit was set 43 years ago, and has not been adjusted for inflation, meaning the number of Americans who qualify has grown dramatically. Even if the gap were a problem (it’s not), it’s growing smaller not larger.

2. The technology is made up.
   Tenev tells us that tokenization makes it possible to “confer ownership claims to something of value” and to divide and distribute those rights. Sounds great! But that innovative breakthrough goes back at least to the invention of joint-stock companies in the 16th and 17th centuries. There is absolutely nothing new here: creating some sort of symbol or token to represent shares of ownership of some thing in the world – that’s very very old.²

3. The made-up technology is not the solution to the made-up problem.
   The entire op-ed is sleight of hand. The “problem,” if you are the CEO of Robinhood, is that your customers cannot generate fees for you by speculating on private companies. Tenev is not worried about democratic access; he’s worried about his access. His proposal would not democratize investing; it would provide him with more customers and more transactions and more profit.

The above thoroughly debunks Tenev’s position, but to conclude we need to see what is really at stake here – namely, regulatory arbitrage. I cannot come up with better words than those Matt Levine used to describe his own reaction to the above paragraphs from Tenev. Following Tenev’s call for the investing revolution, Levine needs a moment to find his words:

What. But. I mean. The reason retail investors can’t buy private company stock is not that computers are too slow, or too centralized. You do not need a blockchain to trade SpaceX stock. The reason retail investors can’t buy private company stock is:

(1) Whatever you think of other crypto tokens, securities laws make it very clear that stock of a company is a security, and to sell stock to the public you need to register it with the SEC and provide public disclosures. And SpaceX and other private companies have decided not to do that. That is the thing that makes them private companies!

(2) Separately, a lot of private companies don’t want to sell their stock to the public; they want to have control over their shareholder base and transfers of stock. If you went to Stripe and said “hey good news, because of the power of the blockchain, any retail investor can buy your stock,” Stripe would say “no that’s bad.”

Crypto simply is not a technological solution to any problem involving private companies. But just as in 2018, it is a way of obfuscating the securities law point. (bold mine; italics original)

With my bolded emphasis above I’m trying to draw out from Levine’s rightfully sarcastic tone a key conclusion about crypto. During the first crypto boom, “blockchain blockchain blockchain” was the mystical incantation that was meant to lull the reader into a false sense of revolutionary possibility. If you put it on the blockchain it would just…somehow…be better! These days, the specific terms sometimes change, but the general logic of mystification and misdirection stays the same.

Tenev says “tokenization” in the hopes that readers won’t notice that what makes the future he’s describing currently unrealizable is not the lack of a technological breakthrough, but the presence of real laws and regulations. Note that those laws protect not only public investors, who are less likely to be scammed, due to disclosure, accounting, and a whole host of other regulations, but also private companies, who want to have some control over whom their investors are.

It seems so silly to have to type this out, but laws and regulations exist for a reason. Those laws/regulations might make your life more difficult, and you might not agree with their reasons for being, but that doesn’t change the basic facts. One of the many ways we will need to work to uphold basic democratic institutions and the rule of law is by repeatedly responding to crypto proposals by exposing their basic logic, which takes the form of extreme regulatory arbitrage. By this I mean that crypto’s real purpose is not finding a way to do an illegal thing legally, but just blazing a path along which to do the illegal thing (to break the law) while saying “look over there, isn’t technology great?!”

As many crypto skeptics have been saying for a very long time: the blockchain is now very old technology (a brilliant synthesis of multiple, even older technologies) yet no one has yet found a purpose or application for it, that is, a thing it actually does. But now, finally, we have an answer to the question, “what is crypto good for?” In fancy terms, “regulatory arbitrage”; in blunt terms, helping criminals break the law.

1. When crypto isn’t just an outright scam, it’s almost always some very old tool or strategy of traditional finance that’s been hidden within a jumble of math/computer/tech terminology. Matt Levine has built up an impressive record of cataloging all these “discoveries”; here’s a recent example, explaining why the ostensibly revolutionary “infinity pools” are, at best funded collar trades (kinda fancy, but not at all new), and at worse, simple call options (boring!).

2. So is writing it down in an analog ledger or digital database. Storing the ownership of shares in a decentralized database would, in fact, be new. However, it’s not at all clear whether that is the plan here. (A) Would a private company truly float its shares on a decentralized blockchain that’s subject to a 50%+1 takeover? Or would the ledger be controlled by them while they repeat the word “blockchain” to make it sound edgy? (B) If you were an investor would you really want your stock held in a decentralized ledger that allows a majority stockholder to just rewrite the code to make the stock theirs?