2023 Banking Crisis: Old World vs New World

The recent banking meltdown exposed the dysfunction of centralized, trust-based systems. Bitcoin and Web3 are an antithesis to that. Here's what's going on.

“The root problem with conventional currency is all the trust that’s required to make it work. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.”

– Satoshi Nakamoto

Yesterday, just after the news that Credit Suisse will be swallowed by UBS, the markets rejoiced.

“Aren’t markets closed on weekends?” No! It’s crypto, stupid! In a realm where trust was frayed, and the old guard held sway, crypto rejoiced, Bitcoin rejoiced!

Enough. Serious times deserve serious thoughts.

Given the current macro conditions, I’ll take the freedom zoom out for a second from Web3 and brands. I think it’s important to get the macro context right, as it helps to understand Web3 too. If you missed my previous crypto pieces, here they are:

• Rebels With a Cause: A Case for Crypto

• Crypto's Identity Crisis

So, what’s happening?

(Spoiler: I included a lot of footnotes. It’s worth checking them out.)

Centralization of power

“Those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety.” – Benjamin Franklin

After the biggest financial crisis since 1929 in 2008, after UBS had been bailed out by the state with tax money, after almost 15 years of quantitative easing (aka free money)¹, after a new wave of financial regulation and supervision (cf. Basel III²), after years of zero or negative interest rates that led to record high debt levels, record high inflation, zombie companies who financed themselves with cheap debt, record high gains for investors and the financial elite while the middle class has suffered from inflation³, the old financial system is again dysfunctional and on the brink of a collapse. Silvergate, Silicon Valley Bank, Signature. And now Credit Suisse.

This is historic.

Fyi: Credit Suisse was founded in 1856 by Alfred Escher as Schweizerische Kreditanstalt and is (or was) and played a crucial role in the development of the Swiss economy. It was also among the 30 global systemically important banks.

So, what happened?

In short: Silvergate couldn’t handle asset outflows after it had been hit by the FTX scandal. Silicon Valley Bank bought too many long term treasuries that got substantially devalued with rising rates.⁴ Together with asset outflows and improper public comms, it fell victim to a bank run. Credit Suisse experienced a loss of trust and the risk of a bank run after years of scandals, mismanagement and miscommunication.⁵

All those banks were regulated, audited and followed the major accounting standards.

What went wrong?

• Exogenous factors: Quantitative easing, Covid stimulus, inflation, inflated asset prices, overleverage, rising interest rates to tame inflation, fragility, increased volatility. All originating from central banks’ policy decisions.

• Endogenous factors: Failed risk management, failed communication, loss of trust, bank run.

• Catalyst: The media. Social networks. Speculators.

• The saviour: The US and Swiss governments. What should they do? Let them fail and risk an economic collapse? Or step in with short-term liquidity and thereby promote even more risk taking in the future?

Meanwhile, the “bigger” banks are buying them up (Bank of America is said to buy Signature bank; UBS is buying Credit Suisse) – and become even bigger, and more “systemic” as a result. The assets of UBS/CS combined are now more than 2x the size of Swiss GDP.

The result?

• More centralization

• Higher dependence on governments

• More risk

• A more fragile system

• No accountability

• Likely more regulation

• Likely more inequality

Isn’t there something wrong here? Isn’t that a f** freak-show?

Fragility, Complexity, Volatility

The dilemma of modern times: Reducing risk in the short-term vs. increasing risk in the long-term. The nature of our political systems, election and news cycles, frequency of crisis, craving for novelty result in a natural bias for the short-term.

In fact, volatility has become more polarised, leading to lower periods of low volatility and a fatter tail of very high volatility.

Source: Beware the fragility of the global economy, World Economic Forum

Nassim Taleb called this “sailing too close to the wind”:

“Black Swan effects are necessarily increasing, as a result of complexity, interdependence between parts, globalization, and the beastly thing called “efficiency” that makes people now sail too close to the wind.

It seems as that the financial system, the markets, the institutions have become more dependent on trust, more dependent on central banks, more fragile.⁶

We find ourselves in truly unparalleled times.

Meanwhile, with new regulation and centralization, the financial system has become more complex.

A corollary to the preceding point is that complex systems run as broken systems. The system continues to function because it contains so many redundancies and because people can make it function, despite the presence of many flaws. […] The potential for catastrophic outcome is a hallmark of complex systems. It is impossible to eliminate the potential for such catastrophic failure; the potential for such failure is always present by the system’s own nature.

– Richard I. Cook, MD, Cognitive Technologies Labratory, University of Chicago

A lot of what happened in recent months in traditional finance and in crypto (cf. FTX, 3AC, Celsius) goes back to failures of systems based on centralized trust and human inviolability.

And increased centralized intervention won’t help. Risk cannot be destroyed, it can only be shifted through time and redistributed in form.

Christopher notes:

Global Capitalism is trapped in its own Prisoner's Dilemma; forty four years after the end of the Bretton Woods System global central banks have manipulated the cost of risk in a competition of devaluation leading to a dangerous build up in debt and leverage, lower risk premiums, income disparity, and greater probability of tail events on both sides of the return distribution. Truth is being suppressed by the tools of money. Market behavior has now fully adapted to the expectation of pre-emptive central bank action to crisis creating a dangerous self-reflexivity and moral hazard.

He adds:

Central banks have taken asset returns from the future and brought them to the present... they have taken tail risk from the present and shifted it into the future...

Where do we go from here?

What about… the scam money, called Bitcoin?

Here comes a technology that tries to replace these failed, centralized foundations of trust with something trustless, decentralized, and independent.

Maybe – just maybe – it is worth a thought?

Decentralization of power