Alexander Lipton via Quantitative Finance
Alexander Lipton
I vividly remember my experience in January 2020 at the World Economic Forum in Davos, which I attended as part of the MIT Connection Science contingent. Since Davos is a small town, ill-suited for hosting large international gatherings, space was at a premium. Before giving a scheduled interview, I had to wait in a small room for the previous conversation to finish. The interviewee was very hostile to cryptocurrencies and used obligatory references to the infamous tulipmania and profane language to make his points.
The longer the interview lasted, the clearer it became to me that this distinguished scholar had little, if any, understanding of the topic he was talking about. He compensated for the lack of knowledge with his strong language, which, unfortunately, is not uncommon when cryptocurrencies and distributed ledgers are discussed. I mentally called the professor a ‘sans-cluelotte’, i.e. a person without a clue.
This experience is still fresh in my memory after more than a year. Hence, when the editors of Quantitative Finance invited me to write a piece explaining my views of cryptocurrencies, blockchains, distributed ledgers, and ‘all this jazz’, I accepted their invitation with alacrity. Here are the fruits of my labor. Interested readers can find further details in a recent book written by Adrien Treccani and me.
The existing financial system is too complex for its own good. This complexity arises for several reasons. First and foremost, historically, banks commit the cardinal sin of capitalism by violating the division of labor and engaging in record keeping and credit creation at the same time.
Second, regulators rely on macroeconomic theories which are manifestly wrong and do not pass muster with thinkers raised on scientific tradition; see Lipton (2016a). As a result, they use obsolete and imprecise tools for steering economic activities in the desired direction. Reliance on negative interest rates and dogged pursuit of Quantitative Easing (QE) are just two of many examples.
Exceptionally low or negative interest rates are destroying the middle class, with little benefit for society at large. They exacerbate the inequality, which has been growing exponentially. QE is forcing central banks to alter their modus operandi dramatically and become fractional-reserve banks in all but name. One can reuse the apt phrase of Ferdinand Braudel and describe the financial system as ‘un total de faiblesses’.
Rather than shrinking, too-big-to-fail banks became even more prominent than before the crisis and massively increased their overall business share. Although undeniably better capitalized, banking institutions are so complex that regulators, depositors, investors, or even internal management do not understand their balance sheets' complexity in detail. As a result, bank conglomerates morphed into institutions, which are too-big-to-manage, and, even more, alarmingly, too-big-to-regulate. Examples abound. In 2020–2021, Citibank erroneously paid principal instead of interest and lost half-a-billion dollars as a result; Credit Suisse lost five billion dollars on an Archegos margin call; Robinhood, who received a broker-dealer license without being able to calculate initial margins correctly, was forced to raise billions of dollars overnight to deliver them to its clearinghouse. One can extend this list ad nauseam. Cato the Elder put it best: ‘Carthago delenda est’.
Money plays a vital role in modern society. It is simultaneously very concrete and abstract. There is no doubt in my mind that money is one of the greatest inventions of humankind, on a par with writing. Speaking of which, the Sumerians invented writing first and foremost to reflect economic and monetary relations; see Goetzmann (2017). While reasonable people can disagree about some attributes of money, several of its main properties are beyond dispute.
Money has to be:
Given the above, money can be viewed as a perpetual call option for acquiring goods and services and discharging one's obligations. In contrast to paying with cryptocurrencies, paying with money is not a taxable event per se. Besides, Graziani (2003) and Keen (2001) argue that in a monetary (as opposite to a barter) economy, money has to be:
Okamoto and Ohta (1991) succinctly articulate requirements for electronic money as follows.
Electronic money is:
Historically, anything acceptable for discharging tax obligations eventually became money. Wicksteed (1910) summarizes the situation best: ‘Inconvertible paper money had a positive value squarely on its being made acceptable by the government for the payment of taxes’. Since money and taxes come hand-in-hand, in a modern, legally compliant economy, money has to be linked to identity one way or the other.
Money can be object-based, such as gold coins or banknotes, or record-based, such as bank deposits. Interestingly enough, in ancient Mesopotamia, priests made progress toward using record-based money. While it was widely used in antiquity, record-based money was more or less forgotten for a thousand years. Money was predominantly object-based in the Middle Ages. However, over time, it became clear that object-based money is not commensurable with the growing complexity of the economic system, so that record-based money became prevalent again. Initially, it took hold in Venice and Genoa in Italy and then spread through Lyon to the Low Countries, specifically Belgium and the Netherlands. Then it expanded to London, Paris, Zurich, New York, Tokyo, etc.
As a result, people and their money became separated, and an intermediary handling the money became the central part of the system, rather than its auxiliary. Essentially, the financial system was modeled on the Catholic Church's organization. Since ordinary Catholics could not read the Bible themselves because it was written in Latin, a priest had to interpret the Bible for them. Similarly, unless a person pays in cash, they have to rely on a banker to make a payment. Essentially, if Alice and Bob wanted to exchange some value, it wouldn't be directly between Alice and Bob. Instead, the transaction would be between Alice and her banker, then Alice's and Bob's bankers, and Bob's banker and Bob. This chain is even more complicated when cross-border payments are involved.
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