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Systemic Risks From The Rise of Crypto


Parsad
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With more and more people jumping on the crypto bandwagon, and some institutions/countries partaking in some form of participation in cryptocurrencies, is there a possible underlying systemic risk from potential losses that regulators aren't noticing? 

 

It's starting to feel like deja vu...we've seen new tools, instruments rise and create systemic risks as participants clamor for the new thing.   Junk bonds, CDS, ARM mortgages, etc...is crypto the new financial nuclear bomb?!  Cheers!

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This whole crypto thing reminds me of the dot com bubble. Just have a look at Axie Infinity, it's a tulip bubble and easy to predict that it will end badly but almost impossible to know when. Depending on how big this crypto shit becomes there is a chance to become a serious systematic risk.

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After reading Devil Take The Hindmost, I came to the conclusion that the current Bitcoin\cypto phenomenon is similar to bubbles of the past.  It is certainly similar in sentiment to the internet bubble of the 1990's, but it is also eerily similar to the railroad boom in the 1800's.  In all three periods there were similar sentiments and statements made about how the technology would change the world.  Statements like the world economies will be connected and (in the case of the railroads) will bring world peace (Jack Dorsey?).

 

Crazy how similar all of these bubbles are in hindsight.

Edited by JRM
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I don't have a dime in crypto and no plans to. But I have wondered if this is a risk to currencies as we know them. With the printing presses running at full steam is the foolish person the one who still believes in a dollar/euro/etc.? When the tech bubble happened, it didn't mean that all the tech was bad. Same could hold that we are in a bubble, but not everything within the bubble is wrong. 

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2 hours ago, maxthetrade said:

This whole crypto thing reminds me of the dot com bubble. Just have a look at Axie Infinity, it's a tulip bubble and easy to predict that it will end badly but almost impossible to know when. Depending on how big this crypto shit becomes there is a chance to become a serious systematic risk.

Yes its feels like policy makers have their heads in the sand https://www.reuters.com/breakingviews/crypto-poses-systemic-risks-that-need-swift-remedy-2021-09-07/

 

I often think what would the world be like if we could only invest in crypto & not in any other asset class?  Well we would be massively capital starved & that would affect everything - the pace of innovation & the quality of all our lives would be considerably reduced. Like Bill Gates I think said said, better to invest in things that actually create goods & services that people need and want - thats creating real value for society. Yes the blockchain is incredible technology but the crypto currencies themselves have this primary utility as trading toys.

 

 

 

 

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Crypto is The Emperor's New clothes.  

 

Why?

Currencies are always rising and falling and hold no intrinsic value.

It's ability to generate cash flow is 0.

It's a medium of exchange, not an asset.

It's 'marketed' by early proponents to late adopters, who take on more risk.

It's shares much in common with the Ponzi scheme.

Its not 'legal tender'

It's not limited in number since it's infinitely divisible. 

 

To summarize, I'm not a fan. 

 

 

 

 

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The systemic risk is generational shift, that older folks just do not get.

 

Simply look around you. Most folks < 35 look to apps (ie: a Wealth Simple) for their financial and investment advice (ie: a Robin Hood) - not an investment advisor. To them, doing anything without tech is wierd, this is most of the demographic buying crypto ETF's, and most wealth apps are quite adequate for the everyday transaction. Sure, young investors can still make stupid investments, and there is risk to being on the bleeding edge - but against the remaining runway? it's just not a big deal. 

 

You and I might rant that we'd never trust an app (ie: algo), or hold a token -  but we're the dinosours. As long as we see lots of other dinosours around us, we are positive that things will never change! - yet totally miss that the glacier we are standing on is rapidly melting.  Every chunk of glacier breaking off, a black swan event.

 

SD

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10 minutes ago, SharperDingaan said:

The systemic risk is generational shift, that older folks just do not get.

 

Simply look around you. Most folks < 35 look to apps (ie: a Wealth Simple) for their financial and investment advice (ie: a Robin Hood) - not an investment advisor. To them, doing anything without tech is wierd, this is most of the demographic buying crypto ETF's, and most wealth apps are quite adequate for the everyday transaction. Sure, young investors can still make stupid investments, and there is risk to being on the bleeding edge - but against the remaining runway? it's just not a big deal. 

 

You and I might rant that we'd never trust an app (ie: algo), or hold a token -  but we're the dinosours. As long as we see lots of other dinosours around us, we are positive that things will never change! - yet totally miss that the glacier we are standing on is rapidly melting.  Every chunk of glacier breaking off, a black swan event.

 

SD

 

This explains the short-run: Why so many young people feel comfortable buying crypto.

 

But it doesn't address the long-term question of where this is going. Crypto and NFTs don't generate cash flows. Isn't that a meaningful distinction (compared to other asset classes)? If we follow the crypto boom to its logical end point, we get a bunch of tokens that are changing hands at astronomical prices and accounting for a large percentage of global paper wealth. (They still don't generate any cash flows, right?) So... maybe this would allow actual cash-flowing assets to continue generating decent returns, since their prices have not been bid up as much in that world?

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2 hours ago, SharperDingaan said:

The systemic risk is generational shift, that older folks just do not get.

 

Simply look around you. Most folks < 35 look to apps (ie: a Wealth Simple) for their financial and investment advice (ie: a Robin Hood) - not an investment advisor. To them, doing anything without tech is wierd, this is most of the demographic buying crypto ETF's, and most wealth apps are quite adequate for the everyday transaction. Sure, young investors can still make stupid investments, and there is risk to being on the bleeding edge - but against the remaining runway? it's just not a big deal. 

 

You and I might rant that we'd never trust an app (ie: algo), or hold a token -  but we're the dinosours. As long as we see lots of other dinosours around us, we are positive that things will never change! - yet totally miss that the glacier we are standing on is rapidly melting.  Every chunk of glacier breaking off, a black swan event.

 

SD

 

Isn't this the refrain of every bubble?  It's a new era, generational change, game-changing, the future! 

 

I'm a huge proponent of blockchain technology...have been following it longer than 99% of crypto investors...so I'm certainly not blind to the technological change.  But the functionality, utility and volatility of the current crop of crypto leave me bewildered regarding how confident people are that these are investable. 

 

Combine that with the fact that there is nothing backing the current batch of crypto...no tax revenues, no assets, no cash flow generation, absolutely nothing.  If ever there was a fiat currency, I would imagine crypto is it!  Even tulips could be planted and new bulbs sold for pennies.  What the hell will people do with wallets full of crypto when the bubble explodes? 

 

And it's this explosion that concerns me.  How much capital will be destroyed (I would imagine at least $2.7T - 99%).  Are certain companies, institutions and national balance sheets holding some of this potential risk that could create a systemic issue? 

 

The internet bubble destroyed about $6T in capital...the housing bubble of 2008 destroyed roughly the same.  Maybe we have some ways to go before we see the crypto craze collapse based on the damage done during those bubbles!  Cheers! 

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I suspect social media has allowed greater numbers of 'fringe' ideology, such as crypto to proliferate.  

 

One can essentially come up with a crazy idea, garner support for it, and monetize it.  Some examples that come to mind include: certain go fund me campaigns, nfts, Reddit GameStop group, old car and watch collectors,  and yes, even antivax groups etc. 

 

All of these groups have in common an element of distrust in the conventional ideology.  

 

What causes any of them to burst?  That's the million dollar question...  Higher interest rates and the cost of money probably. Intrinsic value of any of these? 0.

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Amongst other things I teach a course in 'Introductory Fintech' at both the Master and Undergraduate level :classic_wink:

The mechanics of blockchain and smart  contacts, the IT vs Busines view, the business integration of the new technology. 'Wealth Management' is one of the classes, and all students are routinely surveyed on if/when they would use de-fi apps, invest in crypto EFT's, and why. Similar classes in the apllication of NFT, cash/CBDC, etc. Popular course, most are in the 20-35 demographic, student mix is roughly 50/50 domestic/international, 60/40 male/female. Baba, Tencent, etc. are routine case studies.

 

The 'trust' thing is largely irrelevant, whether that be the de-fi platform itself or the token bought on it. Most treat future crypto investment as a given, know the hack and volatility risk, and invest only small amounts to see how it works out; the objective is experience at both the platform and investment level. De-fi platforms complement traditional wealth management, and serve the vast bulk of everyday routine need. There is a great willingness to pay up for good financial advice, but not for simply order-taking or replicating what an app could do better. Wipes out the 'value add' of a great many financial advisors!

 

'This time it's different', because this time it really is different.

The reality is that this technology did not exist a decade ago. Almost all with knowledge of the subject, unanamously recognize that going forward - the technology will fundamentally and materially change the plumbing of how most things will be done. Older folks just hear the platitude and mock, 'been there, and done that !!!!'. Dinosaurs, with zero recognition of the widespread generational shift taking place under their feet. 

 

Sure, if you are 'old' and your clients are 'old', you can probably ignore this. 

But you are a dying demographic, and there are fewer of you every year.

 

Just a different POV.

 

SD

 

 

 

 

Edited by SharperDingaan
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@SharperDingaan - Appreciate the commentary, but as someone who is from the "next generation" most of the people I know also dont understand the crypto space beyond it being cool and its going up so buy it.

 

I can still understand utility NFTs - I can understand why someone is willing to pay 500 USD (or whatever ETH that is today) for the next generation machine gun on COD (I dont think I would do it but sure there is a business proposition here). Someone has added value to you/your experience, and you have paid them for that added value. The fact that it is rare probably adds a little more juice to value. But why an Ape is worth 500K will never make sense to me. I similarly dont understand why a Picasso is worth x million USD. But again, granted there is a business proposition of sorts here as well there are only so many of these items, if you have one that means that there are less on the market, and so people have to pay more for it.

 

And yet someone has to explain to me why a dogecoin is worth what its worth beyond the greater fool theory. Even in the businesses that do accept crypto (not the illegal ones but the legit ones) they pay their employees in USD in the most part, they pay their vendors in USD or fiat on the most part. All they are doing is accepting huge currency risk for the marketing of being "tech friendly". Again just an average (or below average) investor, but doesnt seem to make sense to me. Additionally, there have been numerous reports about the risk of a 51% attack on BTC with a very small number of miners and wallet holders owning/controlling the coin. While I am not the biggest fan of national governments, I usually know who they are and who makes the calls, and I can put that into a risk calculation. In this case I have no idea who they are and no idea what their game plan is.

 

Full disclosure, I bought some BTC and ETH earlier this year, up nearly 80% on both of them, but I wrote off that part of my portfolio the minute I did. The refrain from the crypto-bulls of "this time it is different" is pretty similar to the geniuses who came up with the MBSs of early 2000s or the dot-com guys in the late 1990s or any other such bubble. Not denying that there is a great utility for the product (just like there is a use-case for MBSs and obviously for internet businesses) - and specifically the NFTs which I am sure will be a large part of future business infrastructures and way to market - but that doesnt mean that the market is not in a bubble and that this bubble popping will not lead to a financial squeeze amongst other asset classes.

 

Just following on with @Parsad's point, when the 2.7T reduces in value, even by say 50%, the repercussions are not going to be just the 1.35T that disappears, because people are loaning on crypto and staking crypto. And the fact that we have large financial institutions like mutual funds and payment processing companies having crypto on their books is a dereliction of fiduciary duty by those managers, because there are no risk management tools invented yet for crypto. No one knows the true volatility in a down market, no one knows the liquidity when the market starts to cascade, there is no historical evidence, there are no options traded by large scale banks that the Fed will bail out.

 

So again, yes, by all means I think it should be 100% legal to invest in crypto, just like it is legal to go to vegas and put money on the roulette table, but just like that roulette table, lets not make it a "business model" or something with intrinsic value, it is a gamble (a fun one and one thats going well for me at the moment). And lets not say that having it permeate our financial infrastructure is not dangerous.

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A certain economy is starting to show signs of weakness, households are moving from fiat and other assets into crypto such as Bitcoin, just in case. Perhaps the country itself encourages this transformation. A couple of years pass and the country is now on the brink of default; in order to stop a bank run and foreign currency outflows, it tries to enforce it via regulation. Alas, as by now most households have significant amount of their money in crypto this feeble attempt by the government has little impact the entire financial system is now gone beyond repair and with it the political system.  Without crypto, it might have been possible to buy some time to save the whole system.

 

That's the main systemic risk. It's of course also one of the main arguments why individuals should hold Bitcoin.

 

Edited by meiroy
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On 10/30/2021 at 8:10 AM, SharperDingaan said:

'This time it's different', because this time it really is different.

The reality is that this technology did not exist a decade ago. Almost all with knowledge of the subject, unanamously recognize that going forward - the technology will fundamentally and materially change the plumbing of how most things will be done. Older folks just hear the platitude and mock, 'been there, and done that !!!!'. Dinosaurs, with zero recognition of the widespread generational shift taking place under their feet. 

 

Is the technology reflected in the prices of assets being traded? With the .com bubble the technology changed the world arguably more than even originally envisioned, but the early companies mostly did not. 

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8 hours ago, ANP301191 said:

@SharperDingaan 

yet someone has to explain to me why a dogecoin is worth what its worth beyond the greater fool theory. 

 

Additionally, there have been numerous reports about the risk of a 51% attack on BTC with a very small number of miners and wallet holders owning/controlling the coin. While I am not the biggest fan of national governments, I usually know who they are and who makes the calls, and I can put that into a risk calculation. In this case I have no idea who they are and no idea what their game plan is.

 

Just following on with @Parsad's point, when the 2.7T reduces in value, even by say 50%, the repercussions are not going to be just the 1.35T that disappears, because people are loaning on crypto and staking crypto. And the fact that we have large financial institutions like mutual funds and payment processing companies having crypto on their books is a dereliction of fiduciary duty by those managers, because there are no risk management tools invented yet for crypto. No one knows the true volatility in a down market, no one knows the liquidity when the market starts to cascade, there is no historical evidence, there are no options traded by large scale banks that the Fed will bail out.

 

 

1. I think most people who are in the crypto world acknowledge that there is little, if any, utility to Doge or Shiba or whatever hot shitcoin has taken the market that week. Doge in particular has all of the makings of a hyperinflationary currency seeing as ~14 million are produced daily with no cap on total supply. 

 

2. I think the likelihood of a 51% attack is very remote and becomes less likely as the market cap of BTC moves higher. Also, with as many eyes are on the network, it'd hard for me to imagine anyone would benefit even if they were successful. Why spend all of that money/time acquiring hash rate to attempt to make fraudulent transactions that could be immediately be detected and result in BTC dropping to a small fraction of its current value likely resulting in a loss of investment versus the cost of the hash power.  

 

3. We just witnessed a 50% drop in the crypto market cap in May. Nothing catastrophic occurred. Same could be said for the 80+% correction back in 2018. At some point I agree this will become systemically important and regulation is welcomed. But crypto industry/players/companies have proven themselves to be WAY more resilient to drops in the underlying asset prices than say traditional banks proved themselves to be in 2008. The reason? The vast bulk of the crypto industry isn't levered and the vast bulk of loans/lending are over-collateralized. There is no guarantee that will always work, but it's worked pretty well for the last several 50+% corrections that we've witnessed in recent years. I trust this form of risk management over VaR models that seem to regularly blow-up when something previously unforeseen occurs. 

 

 

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Couple of add-on's to this.

 

Outside of BTC and ETH, most of the 20-35 demographic have zero confidence in crypto coin. They are primarily in it to learn how they could use this, how de-fi platforms work; which are better for what, size/type of commissions paid, what volaltility actually means, how a CBDC (eKrona) is actually used, how a stable coin works, what a crowd fund actually is, how it works, why anyone would contribute, etc.. A few hunderd bucks in 'tuition', not much different to how most people 'learnt' how to use smart 'phones when they first came out. Time/money well invested.

 

Very much a utility view, most see ETH as the 'operating' coin that you are going to run your NFT on, and BTC as the practical store of value in 2nd-3rd world apllications. Helps being able to talk directly with peers from these countries around store of value vs volatility. Stable coin viewed primarily as a mutual fund backed by 'whatever', and not as a currency peg. Most existing apps seen as 'OK, or utter sh1te', and in need of a lot of work - same as the early smart 'phones.

 

Stong selection bias in the sample, this is the top 5-20% of the demographic, and they come at it entirely from the business side.

There are very few if any coders.

  • All students produce a white paper from scratch; either as a 'green field', or as an assessment of someone else's whitepaper under standardized criteria. Both require a solid understanding of blockchain mechanics, strong familiarity with the tech stack, and the bones of a strong business plan. Where possible, industry management makes guest appearances, and some of the 'green fields' are expected to potentially grow up into startups post graduation, via grants/incubators.
  • 15-25%+ of undergrads go on to do a Master in Fintech at prominent business schools across Asia, India, and South America - against competitive entry. A good portion of the Masters students go on to become involved in policy &/or impementation work at prominent Canadian institutions.

 

SD

Edited by SharperDingaan
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3 hours ago, TwoCitiesCapital said:

I think most people who are in the crypto world acknowledge that there is little, if any, utility to Doge or Shiba or whatever hot shitcoin has taken the market that week. Doge in particular has all of the makings of a hyperinflationary currency seeing as ~14 million are produced daily with no cap on total supply. 

 

Exactly.  The fact that the people most enthused and/or knowledgeable about crypto refer to them as "shitcoins" should give this away.  No where during the techbubble did the most enthused internet investors commonly refer to toys.com, et al as  shitstocks, not until after the crash anyway.  No one really thinks Shiba or any dog-meme coin is going to change the world.

 

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Let's see what happens once governments outlaw them, regulate them, tax them (capital gains) or make their own digital currency to compete with them.  

 

At a certain point sling the same course, I think crypto could become a destabilizing force economically, so escaping the above restrictions will become an impossibility.

 

The rules surrounding crypto haven't yet been written.

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There's a reason podcast on 'We Study Billionaires' and there was a crypto guru talking up bitcoin/crypto, and he sounded like classical person who is caught up in the euphoria / market sentiment, and not about the fundamentals. I think this is a good example of the market sentiment on this topic. 

 

I think crypto needs to get further entrenched in the economy, and it's probably more like 1995 rather than 1999 / 2000. And even then, if crypto gets widespread adoption, it will turn out it won't be a bubble after all.  

 

I predict another 4-5 years of this, and IMO, you need to see some really really really stupid shit over the coming years. I don't think were there yet. 

 

I want to see books called "Bitcoin $1M"

 

I want to see more Crypto ETFs

 

I want to see more corporations buying Crypto

 

I want to see more derivatives of Shibu's and Doges 

 

I want to see CME sell Shibu Inu Futures 

 

etc...

Edited by Simba
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IMHO, The bottom line is that cash is still the defacto intermediary. Not gold and not crypto. These need to ultimately be converted to cash. This allows banks to track you and the government to tax you.  

 

Interestingly, crypto is creating a whole economy from mining, businesses, trading etc.  This is beneficial for productivity and taxation.

 

Sure, trade in crypto for now.  But try to escape the tax system, that's when things will get interesting.  That's why I don't think a crypto to crypto bank/ trading system outside of government control has any long term prospect. 

 

That's not to say Governments won't start their own crypto or digital currency.

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The tax thing is evolving.

 

CBDC use grows at the expense of paper bills, which cut-out ability to track the money trail. Hence, the more an economy has to use CBDC, the more visble the entire  underground economy becomes, and the ability to tax it - both domestically and internationally. The recent minimum global tax of 15% as recent evidence of future magnitude and direction.

 

The downside is greater use of tax evasion via the physical goods route, vs the digital payments route.

Supply chain can 'obscure' a great many things, and physical co-mingling is very difficult to seperate. It's pretty hard to seperate the blood gold out of your 1oz wafer, and there are a great many smugglers very good at both bribing and co-mingling.

 

SD

Edited by SharperDingaan
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1 hour ago, ICUMD said:

IMHO, The bottom line is that cash is still the defacto intermediary. Not gold and not crypto. These need to ultimately be converted to cash. This allows banks to track you and the government to tax you.  

 

Interestingly, crypto is creating a whole economy from mining, businesses, trading etc.  This is beneficial for productivity and taxation.

 

Sure, trade in crypto for now.  But try to escape the tax system, that's when things will get interesting.  That's why I don't think a crypto to crypto bank/ trading system outside of government control has any long term prospect. 

 

That's not to say Governments won't start their own crypto or digital currency.

The goal of bitcoin is exactly to escape the tax system. The sovereign individual docet.

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12 hours ago, Simba said:

There's a reason podcast on 'We Study Billionaires' and there was a crypto guru talking up bitcoin/crypto, and he sounded like classical person who is caught up in the euphoria / market sentiment, and not about the fundamentals. I think this is a good example of the market sentiment on this topic. 

 

I think crypto needs to get further entrenched in the economy, and it's probably more like 1995 rather than 1999 / 2000. And even then, if crypto gets widespread adoption, it will turn out it won't be a bubble after all.  

 

I predict another 4-5 years of this, and IMO, you need to see some really really really stupid shit over the coming years. I don't think were there yet. 

 

I want to see books called "Bitcoin $1M"

 

I want to see more Crypto ETFs

 

I want to see more corporations buying Crypto

 

I want to see more derivatives of Shibu's and Doges 

 

I want to see CME sell Shibu Inu Futures 

 

etc...

 

Just go on any crypto related subreddit and you'll see a lot of what you're referencing 😂

 

I think the boom/bust psychology is still in play in crypto, though to a lesser extent than in prior booms. My guess is we'll never see sub-40k BTC again, though we may get close at the bottom of the next bear market. 

 

1 hour ago, ICUMD said:

IMHO, The bottom line is that cash is still the defacto intermediary. Not gold and not crypto. These need to ultimately be converted to cash. This allows banks to track you and the government to tax you.  

 

 

 

Once KYC protocols are in place at on-ramps and off-ramps crypto becomes way easier to track than the USD. 

 

As far as cash being the intermediary, of course! USD is still the unit of account. Before crypto can become a unit of account it needs to be the medium of exchange. And before it's a medium of exchange, it needs to be a trusted store of value. We're still working on trusted store of value step, but I think it's pretty much won out there. Places like El Salvador are pushing it forward as a medium of exchange. 

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