The FTX collapse exposes broken economics
Crypto is crashing because of errors at the heart of liberalism
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Cryptocurrency took another massive blow last week as the $32 billion exchange FTX froze customer withdrawals, declared bankruptcy, and fell “victim” to a massive hack that stole as much as $473 million in remaining customer assets -- potentially a gambit by insiders to cash out before they went on the lam. At the time of writing, the contagion had continued to spread, with popular platform Crypto.com beginning a familiar death spiral pattern.
The most significant risk at hand: that crypto’s freefall stems from bad ideas also shared by our entire economic order. As history’s stupidest market unravels, it may end up being a symptom of a much more serious underlying disease.
The FTX debacle is complex and widely covered -- for a comprehensive (so far) summary, check out this post. But the basics are straightforward: FTX collapsed last week following a bank run. The exchange lacked assets to cover the withdrawal requests because it appears that FTX’s founder, Sam Bankman-Fried, siphoned customer deposits into his other business, crypto-oriented trading fund Alameda Research.
Much of that money seems to have flowed into buying up other crypto businesses, especially those that were failing in the last spate of crypto collapses earlier this year. Now at least one of those firms, crypto lender BlockFi, has frozen customer accounts in the wake of the FTX failure. The FTX insolvency not only threatens to contaminate much of the cryptosphere, it may be the largest bankruptcy in history, dwarfing even Enron.
These relentless waves of crypto failures highlight a painful fact for the sector: it relies on incorrect political and economic ideas that extend far beyond its fanbase into investment and policy decision-making at large.
Namely, both cryptocurrency and liberal economics rest on the assumption that there is no intrinsic value in any goods or services besides whatever price people are willing to pay for them, regardless of any of their objective contents.
Bankman-Fried inadvertently confessed to this on a Bloomberg podcast in April where the hosts called him out for essentially describing his business model as a Ponzi scheme. Talking about an inherently worthless crypto protocol he calls a “box,” Bankman-Fried said, “Like this is a valuable box as demonstrated by all the money that people have apparently decided should be in the box. And who are we to say that they're wrong about that?”
This is the logic that makes speculation possible, and liberal economics -- especially of the hardcore libertarian variety exemplified by the cryptosphere -- views things through the flawed lens of individualism. At the individual scale, speculation works -- a seller names a price and a buyer pays it, each got what they wanted and the system satisfies everybody.
But all human activity is collective activity, and at the societal level, speculation is a losing game. Take the Dutch 17th century tulip mania as an example.
A group of tulip owners sells its bulbs to tulip buyers.
Money goes from buyer pockets to owner pockets -- nobody creates any additional wealth.
The buyers hoard the tulips in hopes that somebody else will pay more for them later -- no new goods or services come into existence.
So while an individual seller made money and an individual buyer got a tulip bulb, in the collective no new wealth or utility was added to the system. The entire arrangement requires a steady inflow of money from outside the system to survive -- an inflow like the 14 years of ultra-loose monetary policy from central banks that has prevailed during all of cryptocurrency’s history until now.
The alternative to this viewpoint is one where commodities have intrinsic value stemming from the materials and labor that go into producing them. In this system, firms buy raw materials and hire workers to combine them into new products better able to meet some human need. Utility increases overall, and wealth grows because collectively all the buyers pay more for the value-added goods than the sellers do for the materials and labor.
The additional money comes from lenders who can create new deposits “out of thin air” in anticipation that borrowers will be able to pay them back with interest from the very economic growth we just described.
But this system too has a fatal flaw: when value growth slows down, lenders and investors get stingy and the process slows or stops, leading to economic crises. That slowing growth is exactly what led the central banks to artificially manipulate credit conditions for years, setting the stage for crypto’s takeoff.
Now the banks are throwing everything into reverse because they share yet another error with crypto believers, that inflation is “always and everywhere a monetary phenomenon.” In a model without a concept of intrinsic value, conditions of production don’t really matter. Prices go up when buyers have more money, and so we can cure inflation by pulling money out of the system with artificially high interest rates -- just like we pushed it into the system with low ones.
In reality, deglobalization and ecological crisis have made production more difficult and uncertain, with prices going up in response. Cryptocurrency has already disproven the monetarist hypothesis by “inflating” tremendously over the last year despite no changes in its supply dynamics. Now the rest of us face an intentional recession as demand fails with household credit squeezed and real businesses -- not just crypto exchanges -- forced into insolvency by rising borrowing costs.
Altogether these shared errors mean that there is no way out for crypto -- it has no value, and sooner or later the gravity of reality will pull it back to earth. But there is no way out for the system that created it in the first place either. As the knots inside our way of life get untangled, FTX and the crypto swamp it came out of could be just one of many major failures in the years to come.
Our only investment advice: Follow Molly.
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