The Götterdammerung of Play Money

Behind the crypto crash was a bad case of technological presbyopia.

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EP has paid little attention to the collapse of crypto-mania because, since it has been clear all along that it was a fraud perpetrated on the greedy and gullible by a coterie of tech-savvy young.

The so-called crypto currencies were simply unregulated banks, their accounting dubious, their lending practices opaque, their valuations in public markets jacked up to preposterous heights by leverage. As Wall Street Journal columnist Greg Ip wrote Friday,

While bankruptcy filings aren’t entirely clear, they describe many of the largest creditors as customers or other crypto-related companies. Crypto companies, in other words, operate in a closed loop, deeply interconnected within that loop but with few apparent connections of significance to traditional finance. This explains how an asset class once worth roughly $3 trillion could lose 72% of its value, and prominent intermediaries could go bust, with no discernible spillovers to the financial system.

Block chain technology, on the other hand, has interested EP ever since Bitcoin, in 2008, introduced its possibilities to the modern world. Interested, that is, but not enough to do much about it.

It is no accident that the best timeline on the inspiration behind block chain technology I could quickly find last week was published by the Institute of Charters Accountants of England and Wales. That is because the ICAEW, with its 150,000 well-compensated members, and their counterparts enrolled in similar organizations around the world, represent the profession of trusted book-keepers whose livelihoods are threatened in some degree by the new digital technology. Threatened someday, that is – not all at once, but eventually, in ten to twenty years.

Nor is it surprising that the ICAEW is pretty good on the details of the invention of the threat to the accountancy profession. (Here is a slightly more informative version.) A couple more clicks led to this highly readable digest, The little-known history of block chain, as told by its inventors, by Greg Hall, on a Bitcoin Association website.

It turns out that the inventors of the technology behind block chain were working for Bellcore, descendent of the old Bell Laboratories, owned in 1991 by the seven Baby Bells, when they began discussing how it might be possible to time-stamp a digital document.  Stuart Haber had a PhD in computer science from Columbia University, Scott Stornetta was a Stanford-trained physicist. They shared an interest in cryptography, a lively topic at the time.

Stornetta knew how easy it was to doctor a digital document without anyone noticing.  Society depends on trustworthy records – that is where the bookkeepers came in.  But if a transition to entirely digital documents was inevitable, the problem was to create immutable records.

Haber and Stornetta figured out how. Hall writes, “The solution was to use one-way hash functions, take requests for registration of documents (which mean the hash values of the documents), group them into ‘units’ (blocks), build the Merkle tree and create a linked chain of hash values.”  They presented their work to an international cryptology conference in Santa Barbara; block chain was born.  For a better feel for the inventors, and the work that they did, watch the ten-minute YouTube interview at the end of Hall’s piece.

In 1998 a reclusive Hungarian computer scientist and lawyer named Nick Szabo began experimenting with a digital currency he called Bit Gold. In 2000, German cryptologist and software engineer Stefan Konst published a theory of cryptographically secured chains of data.

But only in 2008 did developers, working under the pseudonym Satoshi Nakamoto, publish a workable model of a distributed ledger by then known as block chain. Bitcoin, the killer application, appeared the next year.  And in 2014, a block chain 2.0 version was separated from the Bitcoin asset and offered for other kinds of transactions-reporting applications. By then cloud computing was a fact. The human block chain – the accounting profession with their ledgers and books – had been put on notice. Audit robots? Not so fast!

The Bitcoin world, though a reality, is still thronged with crypto-market evangelicals. To get out of it, I turned to Distributed Ledgers: Design and Regulation of Financial Infrastructure and Payment Systems (MIT, 2020), by Robert Townsend, professor of economics at the Massachusetts Institute of Technology.  Townsend is a remarkable scholar.  A general equilibrium theorist, trained at the University of Minnesota, he taught at the Carnegie Mellon University and the University of Chicago for thirty years.

In 1993, he published The Medieval Village Economy: A Study of the Pareto Mapping in General Equilibrium Models (Princeton.) and, in 1997, began his continuing Thailand Project (sample paper: The Village Money Market Revealed: Credit Chains and Shadow Banking).  By 2021, he spent a year as the senior research fellow at the Bank for International Settlements, the central bankers’ central bank,” in Basel, Switzerland.  And when disparate central bank digital currencies, with their distributed ledgers, are eventually stitched together, that is where the reconciliation will take place.

The cryptocurrency craze, a fraud of memorable proportions, was based on an acute case of what the legendary economic historian Paul David thirty years ago labeled technological presbyopia – the tendency to see clearly events as they will be, far ahead in time, while overlooking all the necessary steps to get there. For a sense of how long it takes for a new discovery to realize its full technological potential, read Chip War: The Fight for the World’s Most Crucial Technology (Scribner, 2022), by Chris Miller.  Look for a similarly highly readable a book about distributed ledgers to appear in, say, another thirty years.