A few months ago at a raucous tech conference in Toronto, I got chatting to some crypto evangelists who were keen to extol the joys of decentralised finance or, as they like to call it, “DeFi”.
With reverential fervour, they declared that they loved digital assets because there were no hierarchies: anyone could deal in bitcoin, for instance, without having to rely on centralised gatekeepers such as banks.
What about the exchanges, I asked, pointing out that much crypto activity was taking place on these centralised hubs. Economic sociologist Koray Çalışkan notes that more than 90 per cent of bitcoin traded in 2021 was kept in crypto exchanges.
To me, it seemed that this created more, not fewer, concentrations of power than in mainstream finance. The collapsed cryptocurrency exchange FTX, for example, was not just a broker but also issued its own currency, offered custody for customers’ assets and was linked to a trading company called Alameda.
Wasn’t this centralisation a contradiction in the DeFi creed? Not for the crypto-kids in Toronto, who brushed my question aside.
I smiled at the irony then, but the situation is no laughing matter. Since FTX imploded this month, it’s become clear that the concentration of power, coupled with a lack of oversight, has caused massive customer losses, because funds were funnelled around with no accountability.
As the British central banker Sir Jon Cunliffe noted in a speech this week: “The crypto institutions at the centre of much of the system exist in largely unregulated space and are very prone to the risks that regulation in the conventional financial sector is designed to avoid.”
Peering at the wreckage, we need to ask not just how FTX created an $8bn hole in its balance sheet but also why these dangerous contradictions were ignored for so long. Why did so many have a blind spot?
One answer is that humans, as anthropologists often point out, are wired to embrace magical thinking, or mystical explanations for things we do not understand; we need hope in a scary world. Digitisation has not changed that. The workings of cyber space are as baffling to most of us as anything we encounter in the real world.
We’re also pretty adept at ignoring things that might undermine the beliefs we use to frame our world. “It is difficult to get a man to understand something, when his salary depends on his not understanding it,” the US writer Upton Sinclair noted. The same goes for social status, religion or other parts of our identity.
Decades back, I witnessed this while working as a reporter in capital markets, where financiers had invented a new way of repackaging debts such as mortgages into complex new instruments known as collateralised debt obligations (CDOs). When I asked why bankers were doing this, they told me they were creating a more “liquid” (tradeable) free market that would make the financial system safer by spreading risk.
It sounded seductive. And they probably believed it in part. But, as in crypto land, there were some big contradictions. For one, the CDOs were so complex that they were not easily traded in a “free” (liquid) market. And the CDO sector was so opaque that it actually increased risk in the name of making finance safe. Magical thinking ruled.
So to Silicon Valley. When I first visited in 2010, I encountered an evangelism with echoes of the CDO sphere, despite the recent global financial crisis. There were those like Facebook founder Mark Zuckerberg, who insisted that making the world more connected was good because it would promote equality, democracy and freedom. Never mind that the sector seemed ripe for exploitation as only a tiny minority understood the core algorithms used by groups such as Facebook. The creation mythology of tech was riddled with contradictions, as in finance, that went widely ignored.
I am not suggesting that either tech or finance was unusually bad in this respect. Contradictory creation myths are found in most professions, including the media. Nor am I arguing that the mere existence of self-deception makes all of these innovations wrong. Far from it. The internet is an amazing invention, even with its flaws. And some forms of debt repackaging are useful, with oversight. Digital asset innovations can be valuable too: decentralised ledgers, for example, could improve real estate record keeping.
But the FTX saga shows how, when taken to extremes, doublethink can have hugely damaging repercussions.
Follow Gillian on Twitter @gilliantett and email her at gillian.tett@ft.com
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