Where Agustin Carsten, Jon Frost, Hyun Song Shin got it wrong on Crypto

Refuting Crypto pretenses which incumbents are holding on to from imperilled HQs

Disclaimer: opinions are my own

The International Monetary Fund has published a new article entitled: A Foundation of Trust. Authors are financial heavy weights Agustin Carstens, Jon Frost and Hyun Song Shin.

I would like to debunk some of their thesis which underpin their conclusions (or their premises, I am tempted to say). I will do it by pasting here in bold italic key statements taken from the article and discussing them right after.

Recent developments have underscored crypto’s failure to fulfill the requirements of a monetary system that fully serves society. Its shortcomings are not just bugs but structural flaws. This is why we argue that the monetary system of the future should harness the new technical capabilities demonstrated by crypto but be grounded in the trust central banks provide (BIS 2022).

Do people trust central banks?

One doesn't need to google that far to find an infinite number of articles about the dramatic plunge in trust affecting both politicians and central bankers. A reflection of this trend being the recent results of the Italian elections.

One of many, an article from the revered FT: Markets lose trust in central banks.

Adding on, the timing of IMF's article couldn't be worse, with UK becoming a global laughing stock:

Or Japan's following the failed Terra/Luna playbook:

In other words, any legitimate transaction that can be carried out with crypto can be accomplished better with central bank money.?

Is this why Jerome Powell speaking on CBDC on Sept 8th stated that “We haven’t made any decisions at all”?

Is this why central banks have developed new blockchain, trustless technology, ahead of everybody else, and have taken the financial system by storm? [Irony Alert].

I am yet to see solid evidence of the IMF's thesis. So far I have not encountered any. Indeed the opposite seems to be true and was one of the main reasons why crypto was invented in the first place: the current monetary system and form of money are inefficient.

Let’s start by looking at the requirements of a monetary system that can fully serve society. It must be safe and stable, with participants (public and private) who are accountable to the public. It must be efficient and inclusive. Users must have control over their data, and fraud and abuse must be prevented. The system must also adapt to changing demands. And it must be open across borders, to support international economic integration.?

While definitely not mirroring the current traditional financial system, the above-described monetary system looks eerily similar to Ethereum, although ETH is clearly not (yet) stable enough in dollar terms.

Let me propose an alternative, realistic vision of the future:

• The current world allows institutions to make promises that they too often can't or don’t keep. We need to minimize the need for trust by adopting trustless smart code in our future monetary system, code which in contrast allows for efficiency, inclusivity, affordability, transparency, ownership and seamless borderless transactions. Code that indeed does not depend on people's accountability, which always implies a degree of failure or corruption, big or small depending on the specific reality, culture and legal system where people operate.
• The ideal world is mathematically and cryptographically guaranteed. No space for discrimination, intended errors, surveillance. No space for empty promises, no space for disastrous, generational wealth-destroying mistakes.

The U.S. stock market wiped out $3.3 trillion in September. Trillions with a T.

The bond market wiped out $12.2 trillion from ATH. Trillions with a T.

Cryptocurrencies and DeFi aim to replicate money, payments, and a range of financial services.

Missing the forest for the tree is one of the root causes of the misunderstandings between the disruptors and the incumbents.

First of all, Crypto does not aim to replicate stuff. It aims to create a new system altogether. It does not aim to replicate a range of financial services, it aims to open the door to a new, much broader approach to designing tools every person can and will use in the future.

Web3 is developing twice as fast as Web2, but it's still in its very infancy. It's only now that we start to see hints to applications that will create a new world, a new "operating system".

Crypto is proposing a new vision of the future.

First, crypto lacks a sound nominal anchor. The system relies on volatile cryptocurrencies and so-called stablecoins that seek such an anchor by maintaining a fixed value to a sovereign currency, such as the US dollar. But cryptocurrencies are not currencies, and stablecoins are not stable. This was underscored by the implosion of TerraUSD in May 2022 and persistent doubts about the actual assets that back the largest stablecoin, Tether. In other words, stablecoins seek to “borrow” credibility from real money issued by central banks. This shows that if central bank money did not exist, it would be necessary to invent it.

As I mentioned, the timing of this IMF's article could not be worse for their authors:

Let's break down a few points highlighted in Italic:

• "Crypto lacks a sound nominal anchor. The system relies on volatile cryptocurrencies". This can officially be turned into a meme, given the current total chaos of the traditional markets.
• "Stablecoins are not stable. This was underscored by the implosion of TerraUSD in May 2022 and persistent doubts about the actual assets that back the largest stablecoin, Tether." TerraUSD will be overused by (some) regulators for centuries to come. Although anybody having studied the crypto space knew that every single algo stablecoin before UST had failed and therefore knew very well that the UST was a high risk bet (a risk in fact rewarded by a 20% yield!), now every other day we get the overcooked beef that UST would demonstrate that all stables are potentially a scam. USDC is not a scam. USDC is real, solid, life-saving. It is regulated, as all stables should be. As UST should also have been, since it was a centralized (yes, centralized!) stable. While on Tether, regulators only need to knock on their door and ask them to open their books; Or regulate them out of existence. It's that simple.
• In other words, stablecoins seek to “borrow” credibility from real money issued by central banks. This shows that if central bank money did not exist, it would be necessary to invent it. Let's be clear: everything in human life is a convention. An invention. A consensus play. Gold is backed by demand, because people have liked gold for millennia, for many reasons. That's it. Be prepared though: We probably wouldn't be able to buy a space ship from Aliens with gold. So let's be intellectually honest and admit that the king is naked and we must move on together to a new paradigm.

Crypto induces fragmentation. Money is a social convention, characterized by network effects—the more people use a given type of money, the more attractive it becomes to others. These network effects are anchored in a trusted institution—the central bank—that guarantees the stability of the currency as well as the safety and finality (settlement and irreversibility) of transactions.

Yes. That's the world we live in. At least in a few, not all, developed countries. Which are not the majority of the nations.

And that's also the world that Ethereum and its monetary system can easily challenge. In the Ethreum world there is no need for a trusted institution to guarantee the stability of the currency. Nor its safety. Nor its finality. Transactions on Ethereum are irreversible, unlike in the traditional banking system.

Welcome to Christie's 3.0 - Where the only accepted currency is ETH.

(Yes, - that - Christie's) (Yes, it's not me calling ETH a currency).

Crypto’s decentralized nature means that it relies on incentives to anonymous validators to confirm transactions, in the form of fees and rents. This causes congestion and prevents scalability. For example, when the Ethereum network (a blockchain widely used for DeFi applications) nears its transaction limit, fees rise exponentially. As a result, over the past two years, users have moved to other blockchains, resulting in growing fragmentation of the DeFi landscape (see Chart 1). This inherent feature prevents widespread use (Boissay and others 2022).

I'm having a tea and debating whether this passage is disillusional, hopeful, naive, uninformed or simply deceiving for those who are not familiar with Crypto.

Let's do a quick homework and check how much a transaction costs on Ethereum right now, shall we? Let's go to https://ultrasound.money/

Right now, it is 3 Gwei (you see it on the top left, small number). One Gwei equals 0.000000001 ETH. At current prices in USD, the cost of a basic transaction is 0.000000001 x 1,300 USD. I will let you find out how crazy (in)expensive that is.

You might say "fine, it must indicate that the network is not congested".

Sure it is not. Why though, besides the fact that we are in a bear market, you might wonder?

Because "the builders" have built L2s on top of the Ethereum L1. King and Queen of them, Arbitrum and Optimism. L2s are the solution to the scaling problem. Which is not a problem anymore. More to it, they are now working on L3s, i.e. chains built on Ethereum L2s which are going to run just for one specific dApp. We will soon have an L3 for - say - a Web3 game, or for Uniswap, or for DYDX.

Similarly, Alt-L1s like Avalanche and Cosmos have launched SDKs for users that want to build their own dApp specific chains. For instance DeFi Kingdoms, which runs on an Avalanche subnet called DFK.

In short, we don't have any scaling problem any longer.

Also, the future is multi-chain. Fragmentation is not an issue. Multiple chains will be developed, will grow and focus on specific uses. And specific users will congregate around those specific chains as a result. Greater efficiency, concentrated liquidity driven by use cases, way cheaper fees, instant transactions.

Polygon and Cosmos are also pioneering this new multi-chain world, with Cosmos - in my view - some lengths ahead in materializing a ground breaking innovative system, which financial institutions could actually benefit from!

(PS: Binance Smart Chain is on Cosmos)

Because of these flaws, crypto is neither stable nor efficient. It is a largely unregulated sector, and its participants are not accountable to society. Frequent fraud, theft, and scams have raised serious concerns about market integrity.

Crypto is in fact a largely unregulated sector and indeed it should be regulated - see my previous deep dive on the topic. But not by the terms envisioned in the IMF's article.

It is also a place full of scams, similarly to the real world. It is not for all, and I have some tips for new entrants that do not want to be burned. To begin with, I would steer very clear from any coin and protocol that it's not proven and battle-tested.

But this is what always happens when new technologies erupt. They often create an immense value but also bring with it negative externalities. The original sin would be to kill these magmatic efforts in the name of preserving the highly inefficient, costly, non-inclusive, opaque, innovation-starving status quo.

By adopting new technical capabilities but building on a core of trust, central bank money can provide the foundation for a rich and diverse monetary ecosystem that is scalable and designed with the public interest in mind.

Central banks are uniquely placed to provide this core of trust, given the key roles they play in the monetary system. First is their role as the issuers of sovereign currency. Second is their duty to provide the means for the ultimate finality of payments. Central banks are also responsible for the smooth functioning of payment systems and for safeguarding their integrity through regulation and supervision of private services.

The central point is, the current high degree of trust and its logical frictions are not needed in this new vision, thus potentially liberating an immense amount of energy, human capital and productivity which can be dedicated to other valuable human activities.

First, wholesale CBDCs—a superior representation of central bank money for use exclusively by banks and other trusted institutions—can offer new technical capabilities. These include the programmability, composability, and tokenization previously mentioned. Wholesale CBDCs could unlock significant innovation that benefits end users. For instance, the buyer and seller of a house could agree up-front that the tokenized payment and the tokenized title transfer must be simultaneous. In the background, wholesale CBDCs would settle these transfers as a single transaction. Hands-on work by central banks is showcasing this and many other applications (see “Making Sense of Crypto” in this issue of F&D).

Second, at the retail level, CBDCs have great potential, together with their first cousins, fast payment systems. Retail CBDCs would work as digital cash available to households and businesses, with services provided by private companies. Central-bank-operated retail fast payment systems are similar to retail CBDCs in that they provide this common platform while ensuring that services are fully connected. Both promise to lower payment costs and enable financial inclusion. Brazil’s Pix system was adopted by two-thirds of Brazilian adults in only one year. Merchants pay a fee of just 0.2 percent of a transaction’s value on average, one-tenth the cost of a credit card payment. Many central banks are currently working on inclusive designs for retail CBDCs to better serve the unbanked (Carstens and Queen Máxima 2022).

Let me flip one of the IMF's initial statements: any legitimate transaction that can be carried out with central bank money can be accomplished better with crypto.?

There is nothing in the above paragraphs that cannot be done with crypto, but better. Which is logical, since CBDCs would use a subset of crypto technology developed open source in the Web3 space. CBDCs would not be open-source though, thus being condemned to always lag behind; and would not be permissionless, thus implicating censorship and surveillance.

This can help migrants pay less for their remittances, allow greater cross-border e-commerce, and support complex global value chains.

Again, migrants do not need CBDCs to achieve that. They already do, with crypto.

Vietnam and the Philippines are massive remittance markets, with?remittance inflows?accounting for 5% and 9.6% of their respective country-wide gross domestic products. Cryptocurrencies – especially stablecoins – help bridge the gap.

Concluding, digital technologies promise a bright future for the monetary system. By embracing the core of trust provided by central bank money, the private sector can adopt the best new technologies to foster a rich and diverse monetary ecosystem.

It is the exact opposite. Let me flip this statement too: By embracing the trustless core provided by the private sector, central bank money can adopt the best new technologies to foster a rich and diverse monetary ecosystem. Let's keep in mind that it's the "private sector" which invented crypto, not central banks. Or more precisely, it is "retailers" who invented Web3.

Anyway. Reading this IMF article has been a great ride. I did enjoy it, as it helped me pause and put things in perspective. Thank you Agustin Carstens, Jon Frost and Hyun Song Shin.

Appendix - Source Chainalysis