Another guest by Martin Walker
Big Crypto leaders seem to have a lot of trouble understanding the basic concepts of traditional finance – such as balance sheets, auditing and cash flow.
Changpeng Zhao, Also known as “CZ” from the Binance cryptocurrency exchange, described recently How They Managed Over $580 Million in FTT Crypto Tokens: “We never touched it, we kind of forgot about it.” Sam Bankman-Fried expressed endless confusion about asset management by cryptocurrency exchange FTX and hedge fund Alameda.
Even before the FTX crash, Sam had some unusual ideas about the methods the crypto industry uses to generate value:
… the smart money is like, oh wow, this thing is now making 60% a year on X Tokens. Of course, I’ll take mine at 60%, right? So, they go and pour another $300 million into the fund and you get psychic and then it just goes on endlessly. And then everyone earns money.
The cynics, like most of the mainstream media and the SEC, are finally starting to weigh in on the idea that much of Big Crypto is run by recklessly incompetent and/or criminal people. Maybe some of them. But it’s worth trying to understand how billionaires (and more recently ex-billionaires) have developed their ideas about the financial world.
In 2016, I co-authored a paper that argued that cryptocurrencies like Bitcoin are an “asset without liability.” In other words, “created out of nothing that defies the laws of double entry and bookkeeping.” Financial assets are always someone else’s responsibility. If it is not the responsibility of another party, who will pay the returns on the assets that ultimately give it value? Nobody, and therefore they have no fundamental value.
The big cryptocurrency companies have been buying and selling “nothing” for so long, mostly for various combinations of “nothing,” that many really believe that taking nothing, giving it a name — and sometimes a story — along with a bit of back-and-forth trading With friends, nothing gives tremendous value.
Whether the massive valuations of “nothing” tokens come from simply jacking up the market price of old-school cryptocurrencies or creating complex DeFi (decentralized finance) structures, believing in the value of nothing makes it easy to lose sight of the underlying reality: real money flows in rather than out. It is “technology”, “society”, “network” or “freedom” that gives value to crypto assets.
Cryptocurrency enthusiasts who struggle with the idea that financial assets have matching liabilities should find the concept of a balance sheet absolutely amazing. Unfortunately, this fundamental misunderstanding of bookkeeping is reinforced by a fundamental misunderstanding about banking and economics.
Big Crypto leaders, including those who are regularly interviewed on the likes of CNBC, seem to have mostly learned about banking and finance by repeating fictional stories to each other on old and old tweets and blogs about the Austrian economy. Most of them seem to really believe that banks are “creating money out of thin air”, selfishly enriching themselves and defrauding the public by creating inflation. If they have some understanding of balance sheets, they may understand how making a loan creates an asset (the loan) for the bank and a liability (the money put into the borrower’s account) and that the bank does not create money for itself. Out of nowhere, even the amount of credit creation is controlled by the requirement of having sufficient capital.
Curiously, given the disdain for inflation that generates fiat money, Big Crypto really does create “money” out of thin air. Their preferred method of dealing with the resulting dissonance is based on further misunderstandings. They believe that having a fixed supply of any given token – not representing “nothing” – protects against inflation. Although some of the major cryptocurrencies like Ethereum and Dogecoin do not have a fixed supply.
Perhaps if they study some basic monetary economics and learn all four letters of the quantity theory of money:
In plain English, only the price level (P) remains constant – in another meaning. Do not inflate – if the speed at which money is spent (V) is constant And the There is real expenditure on goods and services (Q). Since there is no real spending for cryptocurrency on goods and services, it doesn’t really matter if the money supply is fixed.
Which brings us to the crypto industry’s struggle with the concept of auditing. cz He mentioned about audit firms that “Not many of them know how to audit cryptocurrency exchanges.” With the cryptocurrency industry largely living outside the basic laws of finance and economics, what hope do auditors have to apply their outdated ideas about assets, liabilities, and the balance sheet? Very little – but not just because the cryptocurrency industry struggles to understand the basics.
One of Crypto’s tenets of belief is that everything is transparent “because it’s on the blockchain.” Revisions aren’t really necessary, and if they do have to be done, they involve complex mathematical analysis. Unfortunately, blockchain doesn’t make things transparent the old-fashioned way that validators like. A certain amount of cryptography may be held at a specific address on the blockchain – but that does not mean that it is under the control of the party being audited. An auditor cannot simply see an asset in the accounts and reconcile it with a bank statement.
In the world of crypto, the best guarantee that you own cryptocurrency is to move some cryptocurrency from one address to another, and hopefully back again – as Craig Wright famously failed. Unfortunately, even this gives limited confirmation. Traditional auditing can check who has permission to move money out of a bank account. In the crypto world, anyone who has seen the private keys related to crypto money can take them, and there is no central party to ask if they are authorized or even to reverse the transaction.
We now hope that the reader will empathize more with the poor, confused leaders of Big Crypto. If any of them unfortunately end up in jail, the least society can do for them is to provide them with some basic courses in accounting and economics. A sure thing to help in rehabilitation. Perhaps taking the correct courses is a condition of your parole to encourage more serious study.
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