- Interview by
- Daniel Finn
For its boosters, crypto finance is a modern-day version of the nineteenth-century gold rush, with fortunes to be made. It certainly seems to have attracted as many crooks and charlatans as the original Wild West. Sam Bankman-Fried is currently on trial in one of the biggest fraud cases in US history after the ignominious collapse of FTX.
Yet in spite of the high-profile crash of 2022, which saw the value of crypto finance plunge to a third of its previous level, it looks as if crypto is here to stay — not as a way for ordinary people to escape the constraints of state-backed money, but as a vehicle for financial speculation. The growth of crypto will compound the volatility of global capitalism.
Ramaa Vasudevan is a professor of economics at Colorado State University and the author of Things Fall Apart: From the Crash of 2008 to the Great Slump. This is an edited transcript from Jacobin’s Long Reads podcast. You can listen to the interview here.
How do cryptocurrencies such as Bitcoin differ from traditional currencies such as the dollar, the euro, or the yen?
All currency or money is based on trust. That could be trust in a central authority — a state — or a financial institution. We use bank deposits to make payments, and we are sure that the bank is going to fulfill the payment. If the bank doesn’t have the cash, we know that it can borrow from other banks or go to the central bank in order to clear payments. This is the trust which is at the heart of conventional money.
Cryptocurrency upends this model. It’s not based on the guarantee of any bank or the state for its acceptability or credibility. It sets up a peer-to-peer payment system which dispenses with the need for a central authority or financial intermediary. To bring this about and literally create crypto tokens out of thin air, crypto deploys technology instead of trust.
This is a conceit of crypto — the idea that technology can bypass the need for trust in ensuring the credibility of a crypto token. They use cryptographic proof — the power of code — with an algorithm that is wielded to establish a secure, permissionless payment system.
The magic of blockchain is the bedrock of crypto’s decentralized logic. That magic lies in timestamped, immutable, cryptographically proven transactions which are recorded and shared in distributed ledgers across a network of servers. This is what distinguishes crypto from “boring” finance as it were — no backing from the state or the reputation of a financial institution, just technology.
In terms of the wider social picture, what was the promise that was associated with cryptocurrencies when Bitcoin first launched shortly after the collapse of Lehman Brothers in 2008? Has that promise been realized?
Crypto was launched through a white paper by an anonymous person who went by the name of Satoshi Nakamoto. This came right when all hell was breaking loose across the financial system. Banks had collapsed and the mortgage crisis had upended the shadow banking system. We had witnessed an extraordinary bailout of big finance by the Federal Reserve and other central banks.
This is where the allure of crypto comes from. It’s derived from a libertarian pipe dream of supplanting the tyranny of central banks and the predations of big finance with neutral, faceless arbitration through digital technology. The premise is that decentralized, trustless, anonymous, peer-to-peer, blockchain-enabled mechanisms could be wielded to challenge the stranglehold of big finance.
Belying these illusions of decentralization, the actual functioning of crypto finance remains highly dependent on centralized exchanges for buying and selling crypto assets, such as Coinbase, Binance, or the infamous FTX, or centralized lending platforms like Celsius and Block. These are third-party, private entities which coordinate, mediate, and clear transactions while maintaining records and retaining rights over the accounts off the chain.
The governance structure of crypto is also supposed to be based on consensus-based mechanisms. It’s done through the majority votes of crypto token holders and not by an executive board of big financiers. This has been held up as a way of democratizing finance.
However, crypto tokens are concentrated in a few hands, and the automatic mechanisms of handing control over decision-making to crypto holders basically grants greater power and influence to a few large investors. These large investors can (and do) wield their power to set terms, manipulate prices, and gather larger returns, while the smaller investors lose out in the process.
There are segments of the cryptoverse which are not based on centralized platforms but rather on what is called DeFi (Decentralized Finance). In this area, you have automated protocols with smart codes that run day and night on the blockchain. Yet even here, the need for governance makes some kind of centralization necessary, and there is a concentration of decision-making power in the hands of the big token holders.
In that sense, decentralization is a myth. You see that most clearly when there’s some kind of crisis and there’s a need for executive decisions. You don’t have any consensus-based mechanisms at work — someone at the top makes a decision. Decentralization is basically a nonstarter, even though it has been one of the supposed features of crypto finance that has been used to promote it very aggressively.
What have cryptocurrencies actually been used for over the last decade and a half?
Crypto tokens have been subject to volatile price swings ever since their inception. The settlement process is also painfully slow. This means that they’re not very good as a stable or efficient means of payment — as money.
The frenzy for collecting and trading digital assets has not established them as a means of payment, except in the shady world of money laundering, illegal trades, the darknet, and corporate ransomware. There has recently been a study which shows the role of cryptocurrency in opioid trafficking. It also functions as a means of payment in the evasion of international sanctions, which is becoming more and more important.
Crypto tokens really serve as a financial asset which is held and transacted in the hope of making speculative gains. Crypto finance has expanded the hunting grounds of financial speculation. It’s a place for scamster developers who talk up a new crypto token, sign up a lot of investors, and then run off with the loot. This is known as the rug pull — early-bird Ponzi schemes where those who get in early make gains but then pull out, while those who are left lose a lot of money. It’s not a zero-sum game: people lose.
As crypto has evolved and new crypto assets have been developed, the scope for speculative profits has also widened beyond simple price swings. In the unregulated world of crypto, you can make money from lending, investing, and leverage bets. This ecosystem peaked after the pandemic, crossing the threshold of $3 trillion, before it collapsed to $1 trillion last year. It’s a new frontier for financial speculation.
What is the environmental impact of cryptocurrencies?
Crypto does away with — or claims to do away with — the need for financial intermediaries or central banks, and technology is its anchor. But this means that the network of servers, which mine and validate crypto tokens, guzzles a lot of energy in order to support the computing power that is needed to solve cryptographic puzzles — the proof of work which validates a transaction.
This proof of work is highly energy intensive. One report found that in 2022, the electricity usage for crypto assets was between 120 and 240 billion kilowatt hours per year. That range exceeds the total annual electricity usage of individual countries like Argentina or Australia.
Crypto asset activity in the United States alone is estimated to have resulted in somewhere between 0.4 and 0.8 percent of total US greenhouse emissions. That may seem small, but it’s a range of emissions similar to that from the diesel fuel used in railroads in the United States. The environmental footprint of crypto is huge, with the massive amount of energy-guzzling computing power needed to support it.
People have been talking about the proof of stake: Ether, one of the big crypto coins, is moving towards that. The shift from proof of work to proof of stake means that instead of using code or algorithm to solve puzzles and validate transactions, you put up collateral, which is a crypto asset. That is what is guaranteeing the transaction.
But this means that what you might gain in terms of reducing environmental footprints, you’re going to lose in terms of exacerbating inequality, because only those who have assets can provide the collateral. Collateral-based systems don’t just fuel fragility: they also promote greater inequality because those with assets can plow them back in, earn more, put that back in, earn even more, and so on. It promotes an even more unequal distribution.
How important was the development of stablecoins for the field of crypto finance?
Stablecoins were crucial for the huge growth and transformation of crypto finance. Stablecoins such as Tether are designed to maintain a peg to conventional currencies. They’re typically managed by a centralized platform which oversees not just the creation, but also the adjustment or redemption of stablecoins.
A stablecoin has to be backed by a portfolio of assets, and you need to adjust and redeem parts of that portfolio in order to make sure that the stablecoin can be redeemed at par with conventional currency. In order to maintain the peg, you need to have assets which you can liquidate in order to pay cash.
Stablecoins are distinct from crypto tokens like Bitcoin. Their prices are fixed relative to conventional currencies, and so they provide an anchor against price fluctuations. They’re a place where you can store value within the cryptoverse.
This also means that it’s a source of liquidity within the sphere. Crypto traders can move in and out of crypto assets without using conventional currencies, but with the assurance that there’s some anchor in conventional currencies. Stablecoins have been hugely important for the surge and growth of new crypto assets and funds. They’re a kind of bridge between the volatile cryptocurrencies like Bitcoin and conventional currencies like the dollar, yen, or euro.
In the world of crypto finance, you could think of them as standing at the apex of the hierarchy. They helped crypto finance to develop as a full-fledged, complex financial ecosystem which does everything that conventional finance does.
But there’s a paradox at work here. Since stablecoins are backed by conventional safe assets such as Treasury bills, crypto is ultimately dependent on conventional currencies as a source of credibility and stability. If crypto is to grow, it has to do so on the basis of its link to conventional currencies through stablecoins.
How did the crypto crash of last year come about, and what were the main players involved in the crisis?
The pandemic gave a big impetus to crypto, with everyone in lockdown mode in front of their screens. Its value surged through the roof, reaching a peak with the Super Bowl ads of 2022. This bull run came to an ignoble end in May of that year.
It began with the collapse of paired crypto tokens called Terra Luna. You could think of this as a kind of “Minsky moment” for crypto — the moment when, after going strong for a long time, the bull run comes to an end. Terra was a stablecoin that was hitched to the Luna through algorithmic trading. This maintained its peg with the Luna, which was floating.
There was a nice little game at work where Luna holders made profit from their stakes in Terra while the demand for Terra was stoked through a new Terra lending platform called Anchor. This platform offered huge interest rates, in the vicinity of 20 percent, which were payable in Terra. This engine kept stoking its own demand in a way that seemed too good to be true.
Of course, it was too good to be true. The rates were unsustainable. Eventually, a pullout from Anchor began, which set off gyrations in Terra. Instead of maintaining its peg, Terra started falling and the whole Terra Luna system crumbled. Incidentally, Alameda, the venture arm of FTX, which was part of Sam Bankman-Fried’s empire, was a big Anchor depositor and one that pulled out early.
The ripples of Terra Luna spread. Celsius, a crypto lender which was offering huge interest rates, didn’t have the crypto cash to pay depositors when they started pulling out. You also had Three Arrows Capital, a crypto hedge fund that invested heavily in Terra. When asset prices fell, the fund didn’t have the value of the collateral it had put forward.
As the reverberation spread, one of the most important stablecoins, Tether, was faced with a fall in value — a moment which is like breaking the buck in a money-market fund. The nadir came with the spectacular tumble of FTX. After first emerging as a savior, injecting funds into crypto entities during the early stages of the crisis, Alameda was found to have siphoned off depositor funds from FTX to finance loans.
This unraveling reveals the fragile foundations of crypto finance. From $3 trillion, it fell to less than $1 trillion in a short period of time. What happened was very analogous to bank runs that have plagued the financial system since its inception. Traditional bank runs happen when depositors pull out their deposits.
In 2008, when Lehman Brothers collapsed, there was a different type of bank run. It was sparked by the collapse in the value of assets which were used as collateral. Those assets had pumped up the shadow banking system based on borrowing and lending through the market, rather than through loans and deposits, which is the traditional banking model. Falling collateral values decimated the basis for lending between banks and credit creation. Investors began pulling out money from money-market funds and the system came to a stop.
The crypto tumble was another form of bank run in the new, unregulated world of crypto finance. Again, collateral values played a big role. This is very important, because crypto transactions are pseudo-anonymous, so traditional forms of credit-risk assessment for the borrower are not possible. In place of risk assessment, collateral becomes important and plays an even bigger role.
Crypto transactions are generally overcollateralized and the liquidation of a transaction when collateral values fall is enforced automatically, which makes it very fragile. This fragility becomes even more severe because there is a rampant practice of using borrowed crypto collateral as collateral for further transactions. You borrow collateral and then use it to borrow even more. This is what is known as a collateral chain.
There are huge returns which can potentially be captured through this approach. This means that the initial collateral forms the foundation for a huge pile of debt. The pyramid of crypto lending is being erected on the shifting sands of volatile crypto collateral.
Another Achilles’ heel of traditional banking is the fact that you have a mismatch between your assets and your liabilities. A bank will borrow in the form of short-term deposits, but it will lend in the form of long-term loans. As depositors pull out, the bank doesn’t have the ready cash to pay, because the loans are long-term.
Crypto is subject to the same kind of mismatch. Stablecoins like Tether were issued against less liquid assets like commercial paper, which are used to fund the short-term transactions of corporations. The collapse of Terra showed that risky and volatile crypto tokens were the basis of its lending. When it had to pay out, it only had volatile crypto tokens, which had fallen in value.
Once again, we saw that crypto finance is not very different from traditional finance. It has the same tendency to fragility, and last year’s crash revealed that.
In the light of that crash and other episodes of turbulence, how would you say the absence of central banks as lenders of last resort affects the overall dynamics of crypto finance?
The history of finance is the history of manias, panics, and crashes, to use Charles Kindleberger’s famous expression. Convulsions in the past have set the stage for the emergence of central banking and for the evolution of the tools and techniques that central banks use to manage the financial system.
Whenever the financial system faces the threat of an implosion, central banks step in with their safety nets and bailouts as lenders or market-makers of last resort. As asset prices plunge and the credit machinery grinds to a halt, this buying and lending is what shores up the financial system. As the Wild West of finance, crypto has no such backstop.
In the past, the role of coordinating rescues has also been done through private initiatives coordinated by big financiers with clout and capital. Those big financiers will get other banks together and inject funds in order to shore up financial markets. The great example of this is the lifeboat operation by J. P. Morgan in the panic of 1907, before the Fed was established in the United States.
When the crypto markets stumbled, it was the heyday of Sam Bankman-Fried, and Alameda pumped money into flagging crypto funds, prompting comparisons to J. P. Morgan. But privately coordinated rescues are not enough. If the implosion of the crypto sphere had threatened to engulf the financial system as a whole, central banks might have needed to act more directly.
In fact, when ripples from the collapse in the crypto sphere affected firms like Silicon Valley Bank, you did have the Fed stepping in. This has been the pattern historically. Privately created liquid assets gather momentum and are used to stoke the growth of finance. However, when the going gets rough, prices tumble, and the machinery comes to a stop. In that situation, it’s the interventions of the central bank which ensure the resilience of the financial system.
As crypto finance becomes more mainstream, with big finance now seeking to exploit this new frontier of speculation and big tech firms entering with their own stablecoins, such as Meta’s Diem, central banks have also been responding to this changing landscape. They have been exploring a host of new digital currency projects and seeking to position central banks as critical players in the growing crypto markets.
If this trend continues, this implies that crypto stablecoins will be more established as a monetary substitute and central banks will be more implicated in ensuring their rescue when things go south. Again, this is the historical pattern. There is a link between private finance and central banks backed by the authority of the state. They fuel each other and are joined at the hip.
How does the rise of crypto finance fit into the wider picture of financialization and asset-price bubbles over the past few decades? Has it worsened the problem of financial instability?
Crypto finance emerged in the wake of the global financial crisis of 2008, as you mentioned earlier. This had turned the spotlight on the leveraged world of shadow finance, shadow banking, and the speculative excesses of big banks. However, the ascendency of finance and the inexorable pull of financial innovation in search of more returns did not abate in the aftermath of the crash.
In fact, the financial system became more concentrated and big banks, along with asset management funds, became more consolidated. The impetus to financialization did not abate. Crypto embodies finance’s innate impulse to continually innovate, expand, and explore new frontiers in the quest for returns and the next big thing. The birth of crypto in the aftershock of the global financial crisis reflects this search for new avenues of profits at a time when the discourse had turned to the need to curb big banks and regulate them.
Crypto also tapped into the pipe dream that crypto was a way for ordinary people to share in the rich bonanza that finance offered to the top 1 percent. All of this boosted crypto, but crypto fuels the same pathologies of finance to promote inequality and the concentration of wealth, while also continuously promoting fragility.
The financial system is a very powerful mechanism of concentration, and the distribution of financial assets is heavily skewed towards the top 1 percent and even the top 0.01 percent. We can see the same logic at work in crypto. The distribution of assets follows the same pattern of concentration.
There’s a study of Bitcoin between 2015 and 2020 which shows that 0.1 percent of miners controlled 50 percent of Bitcoin mining capacity. The distribution of ownership is also concentrated, with 0.01 individual Bitcoin holders holding more than a quarter of total assets. A few large pools and a few players dominate. This is the same pattern that you see in finance. Crypto has not leveled the playing field.
It has also not contained fragility. The early crypto boom was fueled by price movements. The evolution of crypto finance has opened the path to more returns from lending, investment, and other forms of financial transactions. In addition, it embodies finance and financialization in a more pathological form, in the sense that decentralized finance in particular is a reflexive space which feeds on itself.
You exchange one crypto asset for another — you lend in a crypto token in order to invest in more crypto assets. The transaction is itself secured by crypto assets which may have been borrowed. Rather than funding real economic transactions — trade, investment — crypto lending and borrowing is solely for speculation and making money from arbitrage. It’s rent-seeking financial speculation in its purest form — finance for finance’s sake.
Crypto finance, as it exists, does not even perform the productive functions of finance and the economy in funding real investment, for instance. Despite all this, and despite the recent crash, crypto is here to stay. It is mutating and transforming financialization.
Two things are very important here. One is that conventional financial institutions are entering the fray even as big crypto players face a regulatory backlash. This includes big asset manager funds. BlackRock is now pushing for a Bitcoin exchange-traded fund, which would trade on the stock market. Leading banks such as Goldman Sachs, Citigroup, and J. P. Morgan are all wading deeper into the crypto sphere, while institutional investors and their clients are also banging at the door.
The second thing is that just as securitization — the alchemy which transformed illiquid, long-term loans like mortgages into liquid, tradable assets — remains entrenched and continues to be promoted in the workings of finance, even though it crashed the system in 2008, the innovations at the heart of crypto, embodied in blockchains, smart contracts, and tokenization, are reshaping conventional finance.
Tokenization is a blockchain-secured digital representation of conventional assets, and it’s the next big thing. It goes even further than securitization, enhancing liquidity and widening access to indivisible, illiquid assets by creating fractional shares, whereby you get a 0.01 percent share in something. Just as mortgages are securitized, crypto has now opened the path to tokenizing assets, including deposits, Treasury bonds, and other securities. It’s turning on a spigot of financial fortune-hunting.
The world of finance already rests on flimsy foundations, and tokenization adds another layer to the illusion of value that fuels speculation. To give one example, there’s a new market for carbon tokens, which is making hay off the rising price of carbon offsets by buying and tokenizing cheaper carbon offsets. Of course, this has questionable implications for carbon emissions, but it’s a rich bonanza for the institutions trading in it. Through crypto, the processes of financialization are metamorphizing and metastasizing.
You’ve touched on this already in talking about the role of central banks as lenders of last resort, but perhaps we could go into it now in a bit more detail. What would you say the story of crypto finance tells us about the politics of money and its relationship with the state?
Bitcoin and the allure of crypto is based on the libertarian promise of depoliticizing money by privatizing it and removing it from the control of both the state and big banks. This was held out as the path towards establishing a new Hayekian utopia of permissionless private currencies. However, hidden behind this rhetoric of independence from central banks is the process which has enabled the ascendency of finance and a project which basically de-democratized money by removing it from the scope of democratic accountability.
This is very much in keeping with the thrust of the neoliberal agenda. The rhetoric of “independence” basically involves money being outside democratic accountability. To unpack this, we have to recognize that money is a hybrid offspring of state authority and market forces. Historically, there has been a tension between the state asserting its monopoly over the creation of money and private finance continually stretching the mechanisms of money creation through private channels in pursuit of profit.
There has also been a tension between the state’s dependence on financial markets to ensure the credibility of its monetary liabilities — Treasury bills, etc. — and the reliance of financial markets on the state for insurance and a guarantee against crashes and crises. Private shadow-money mechanisms flourished outside central bank control throughout the 1990s. When those mechanisms ground to a halt in 2008, the full weight of the US Federal Reserve, backed by the authority of the US government, was brought to bear in order to restore the markets.
Finance continually innovates, seeking to escape regulatory bounds, and the state is compelled to step in and rescue private finance when a crisis threatens the survival of the existing system. This partnership between the state and private finance has been critical in paving the way for the ascendancy of finance and what has been called financialized capitalism. The politics of money creation was clearly revealed in the Fed’s extraordinary interventions at the time of the global financial crash, but even more so in the response to the COVID-19 pandemic, when the power of the Fed to turn on the money spigot was deployed asymmetrically to serve the interests of finance.
This is the context in which you can see the growing influence of the political project of Modern Monetary Theory, which embraces the capacity of the state to create money and seeks to weld it to a progressive agenda of employment guarantees or the Green New Deal. On the other hand, it is also the context for the libertarian espousal of cryptocurrency as a bulwark against the despotism of the Fed — a way to take money outside the sphere of politics and thus outside the sphere of democratic accountability by privatizing it.
If the first of these projects comes up against the power of finance to hold the state hostage to its interests, the second is ultimately faced with its dependence on the state for life support. This powerful and contested alliance between state and private finance, which lies at the heart of contemporary finance capitalism, is what the politics of money in today’s world is all about.
Reforms which want to expand the discretionary power of the state to address the priorities of working people on the one hand, and private experiments that seek to decentralize money on the other, will both have to contend with this power if a progressive, democratic politics of money is going to be forged. Crypto as it exists doesn’t depoliticize money — it merely de-democratizes it.
Would you say that crypto finance is likely to be a battleground in the economic competition between the United States and China?
It’s definitely going to be a battleground, and it already is in some ways. It’s a place where China will test and challenge the hegemony of the dollar. China has already made headway in its experiments with a digital currency, the yuan. It has an ambitious state-backed, blockchain-enabled global platform for decentralized applications and finance. China is trying to get the first-mover advantage.
Even before the war in Ukraine, the White House had explicitly acknowledged the political imperatives of reinforcing American leadership in the global financial system at this technological frontier. US officials were already talking about developing a centralized US digital currency in order to ensure the future hegemony of the dollar.
The Ukraine war has sharpened the geopolitical significance of digital money, especially since it has been the prime channel for the evasion of sanctions in a context where sanctions are one form of warfare. It has also been sought as a space that provides an escape from the shackles of dollar hegemony. This area, along with artificial intelligence, is going to be critical in shaping the contours of the evolving geopolitical order, and we are already seeing rumbles.