• Rasheed Saleuddin

Who controls the crypto plumbing?

There is a very old saying that the stores that sold the picks and shovels were the only ones to get rich during the Gold Rush. Indeed, it's how Levi Strauss began.

The financial plumbing that evolved over the past 100 years or so rewards those that facilitate the transaction, often more and with less risk than the actual participants. Banks, clearing houses, foreign exchange services, investment bankers taking companies public, etc all take fees in exchange for access to the plumbing.

VISA is perhaps the quintessential example of near-monopolies of plumbing. BTC was designed to disrupt these oligopolies, as was Alipay and Paypal. DTCC (stock clearing) was recently in the news, and talk had turned to how tech can disrupt this as well.

Surely, crypto, blockchain and DeFi should wrench power away from the aging yet powerful financial plumbers?

Well, not so far.

New players have indeed entered, but they are functioning in the same way as the old plumbers. Exchanges. Miners. Liquidity providers. DEXs actually require “arbitrageurs” (the very definition of risk free profiteers) to function properly. Blockchains that reference real assets need trusts to hold the actual underlying, auditors to verify they are there. Such so-called disruptors are often replacing traditional plumbing with new plumbing, and charge a toll. They all make money no matter what happens to the “users” of the system, who are the retail traders and holders of crypto assets and products linked to them.

At the same time, the old school is far from dead. So-called crypto firms are relying on VISA and MC to back their cards. Fund behemoth Fidelity has been pivoting to provide crypto custody. New “banks” have come in. However, make no mistake, they are the “same as the old banks” (with apologies to the Who). Experienced hedge funds, such as Fortress, have populated the new school trading companies. They make money by exploiting retail trading on exchanges and in the new crypto financial products markets (eg the GBTC arbitrage). Finally, exchanges and fintech often have extremely high charges for access to cryptoasset purchases.

In the current state of crypto, the only use of BTC is as a speculative asset. This is not in itself a bad thing. Speculation often precedes and perhaps even drives major innovation: the dot-com boom of 1998-9 is but one example. Speculate away. Only time will tell exactly how BTC evolves.

At the same time, the nascent crypto finance industry wants your money, and is well-placed to get it. One example is crypto-lending.

The high rates of interest on crypto have two main drivers:

1. The arbitrageurs taking advantage of inefficiencies in the system; and

2. Unknowable and often undisclosed risks (I’ll explain this in another blog).

Yet of course not all financial assets are poor risk-reward and/or have egregious (often hidden) fees. Index ETFs, for one product, do much more good than harm.

Nevertheless, serious due diligence is necessary. If you don’t know who the sucker is…