First, there was a series of disclosures about monetary policymakers’ stock trading activity, a controversy that contributed to the resignation of the presidents of the Federal Reserve banks of Boston and Dallas and has put Fed Chairman Jerome Powell’s renomination in jeopardy.
Then, last weekend, the International Consortium of Independent Journalists dropped the Pandora Papers. That trove of 11.9 million confidential documents revealed how “35 current and former world leaders, more than 330 politicians and public officials in 91 countries and territories, and a global lineup of fugitives, con artists and murderers” have shifted assets into offshore havens, shell companies and trusts to hide their business dealings and evade trillions in taxes.
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You might be tempted to dismiss these revelations as nothing new, as mere confirmation of what you’ve already known. Others might be inclined to take the – in my opinion, naive – view that “well, all these actions aren’t technically illegal, so what’s the problem?”
But it’s important to take stock of these new developments. They force us to confront the harsh reality that there are two sets of rules for society: one for a narrow group of people with access to the levers of power, the other for the rest of us. Given the challenging economic and social backdrop of 2021, the reminder of this unfair dichotomy can do nothing but hurt public confidence in the centralized institutions that control our economy.
It also raises questions about what this kind of institutional confidence blow means for crypto and for the prospects of an alternative, decentralized financial system that its proponents are seeking to build. We’ll address that lower down.
Trust under threat
These revelations come amid a global health and economic crisis in which the poor have suffered enormously while the wealthy, at least in financial terms, are markedly better off. They sit alongside the image of politicians too gripped by partisan divisions to enact regulations that enable productive innovation and sustainable growth. And they put more than a decade of central banks’ “quantitative easing” measures into a more cynical context, implying that a monetary policy of questionable efficacy is being administered in the narrow interests of those institutions’ officials rather than those of the wider economy.
What matters here is the core question of trust.
Money, as we’ve discussed in past Money Reimagined newsletters and podcasts, is a collectively imagined concept. A currency only works if there’s shared belief among its users that the system it’s built upon is serving the common interest. It requires faith in the rules, protocols and institutions that run that system.
We’ve seen what happens when the bedrock of trust breaks down: the hyperinflation of Weimar Germany, of Zimbabwe and of many Latin American countries; the ingrained, self-reinforcing disdain for government that makes it impossible for failed monetary systems like Argentina’s to break a cycle of repeated crises.
Until now, we have seen no such breakdown in the dollar-centric global financial system. Despite domestic and geopolitical challenges to U.S. leadership, most of us still trust that system sufficiently to not abandon it.
But that trust is not infinite. At some point, if people see enough evidence that the system is working against them, that faith will evaporate. If an appealing, alternative model starts to arise, people may gravitate toward it.
That, of course, leads us to the aspirations of the crypto community, which wants a system that employs a decentralized protocol to set rules and execute transactions rather than relying on a corruptible centralized intermediary such as a bank or a government. Given that it’s impossible to create an infallible human institution, the idea is to defer our trust to infallible math.
Crypto’s promises and challenges
I say “aspirations” because there aren’t many concrete signs that the wider general public – as angry as people might be – is willing to make the leap to bitcoin, to stablecoins or to some other token as their primary mechanism for sending and saving money. Some of that is about misperception and education. But it’s also because the crypto industry writ large continues to integrate many of the centralized vulnerabilities that confront the legacy financial system.
Crypto advocates are right to complain that the mainstream press overly focuses on hacks, losses and failures without sufficiently covering the industry’s incredible innovation and progress over the past decade. But the reality is those problems occur because of a similar structure to that which enabled the Fed stock trading controversy and the Pandora Papers transactions. Crypto is full of centralized entities entrusted with people’s funds, each posing a prospect for abuse or failure. Think QuadrigaX or Mt. Gox.
Those centralized entities have been somewhat unavoidable because this industry’s evolving technology is not sufficiently developed and because the network of users is insufficiently large or robust to allow for true decentralized governance. It’s also because developers have tried to build applications that interface with the traditional financial system, which leaves them subject to traditional regulatory demands that imply centralized custody and user data collection.
Blockchain developers have made tremendous progress building cryptographic solutions to these problems and in incentivizing rapid adoption so services can be provided in a decentralized manner. The growth of decentralized autonomous organizations (DAOs) within decentralized finance (DeFi) reflects that effort. But it’s far from a finished process.
Read More: The Pandora Papers Show Why People Love Crypto: You Can’t Trust the Powerful
Meanwhile, the regulatory framework, at least in the U.S., is currently not conducive to this decentralization push, especially the hardline position of Securities and Exchange Commission Chairman Gary Gensler who is arguing that most tokens are securities and is suspicious of industry claims that decentralized finance (DeFi) is sufficiently decentralized to avoid that treatment.
Finally, the quality of public discourse around cryptocurrencies remains poor. Instead of focusing on how removing trusted intermediaries could address corruption, the discussion is framed by the rules of the old, centralized paradigm, where intermediating institutions such as banks are expected to identify and catch bad guys. I fully expect many people to use the Pandora Papers as an argument against crypto and wrongly conclude that it makes it easier for crooks to launder money.
The reality is that blockchain analytics, combined with privacy-protecting tools such as zero-knowledge proofs can provide valuable tools for law enforcement while preserving privacy and decentralization. It’s just that people aren’t talking about them in the mainstream, which means they aren’t on regulators’ radars.
The upshot: We still have a ways to go before there’s a viable decentralized solution to the failures of the centralized financial system. Let’s hope that mistrust in the latter doesn’t throw us into chaos before then.
