By Walt Hickey

Welcome to the Numlock Sunday edition!

This week, I spoke to Bloomberg columnist Matt Levine, who wrote “The Crypto Story” takeover of Bloomberg Businessweek.

Levine writes Money Stuff, a newsletter and column at Bloomberg, one of the most illuminating and engaging reads about money and finance.

When you’re informed that Matt Levine has written a massive single-issue spanning treatise on crypto, you drop what you’re doing, read it, and then try to get him to talk to you for your newsletter about it. “The Crypto Story” is great; it’s an evenhanded look at the premise and the promise of this tech. I spoke to Matt just ahead of publication this past Tuesday.

This interview has been condensed and edited. If you enjoy interviews like this one, consider subscribing.

All right, Matt, thank you so much for coming on. This is a real pleasure.

Thanks for having me.

Before we dive in, do you want to just maybe talk a little bit about Money Stuff, what drives you to tackle this kind of topic and what drew you to crypto in this kind of format?

Money Stuff is my daily newsletter. I write about finance broadly and I'm interested in finance as a set of aesthetic puzzles. I'm interested in it as a way to understand what goes on in the world. And so, I'm drawn to stories about structures and about just weird financial stories that give you insight into economics and how people are thinking. Crypto, I've been writing for eight years now and it has always been very fun because for one thing it just lends itself to silly stories; there are a lot of people losing their hard drives in garbage dumps and stuff like that.

But for another thing, and particularly in recent years, it's really just a laboratory to rediscover a lot of finance. Some of what happens there is crypto does things that repeat past mistakes of traditional finance systems and you get to make fun of them, but other times they discover new ways to do things that are really interesting, and they always are interesting as a little laboratory in their own right, but they're also usually interesting as throwing light back onto the traditional financial system.

Often you can understand better what happens in banking by saying, "Oh this is this crypto thing, that actually looks like the banking thing" — you can read back to understand banking a bit better.

Then the second question is why I wanted to write about crypto in this format. I have this very long takeover of a Businessweek issue about crypto from first principles. The thinking there was that crypto is a big enough topic to be big and on a lot of people's minds and complicated and sprawling, but it's also a small enough topic — it was invented, basically goes back 15 years to the invention of bitcoin — it's a small enough topic that it almost feels like you could get your head around the whole thing. It almost feels like you can start from the beginning, and work through all the ramifications to where it is today and all of the complicated stuff today.

And that's not quite true. I think that even after you read my very long thing about crypto, you won't know everything about crypto, but that seems like a really fun ambition to start with the most basic ideas behind crypto and go step by step from those basic ideas into a lot of the very different complicated things that it does today. And it felt like that was almost achievable. So I figured I'd try to do it.

Yes, it's really wonderful. It's called “The Crypto Story.” It's the takeover in Bloomberg Businessweek, which is an excellent magazine.

One thing that I really enjoyed about this is that typically discourse about crypto on the internet for better and for worse is broken down into pro-crypto and anti-crypto groups. Everybody's somewhere on that spectrum, whether it's skeptical or whole hog into it. But at the same time, I really just appreciated your perspective on this, which wasn't that crypto is good or bad, let's ignore if it's good or bad, let's look at it if it's interesting. Do you want to talk a little bit about how you frame this one up?

Obviously my biggest worry in writing this thing is that all the people who think crypto is good are going to hate this thing, and all the people who think crypto's bad are going to hate this thing. I'm somewhere neutral and just amused, and so everyone's going to wish that I was more in their camp.

I think that, as I said, crypto is a really interesting laboratory for financial experiments, and I think that where we are — and we are almost 15 years into the rise of crypto as a financial world thing — I think that there's still a lot of skepticism about real-world use for crypto. A lot of the eye-popping valuations of cryptocurrencies a year ago, if not so much today, came from a belief that people's practical lives were going to be revolutionized by crypto concepts like Web3 and the blockchain. And I am skeptical that a lot of that has happened and I think I also share some of the critics' skepticism that a lot of that stuff is either realistic or desirable.

But I also think that the stuff that is being done is really interesting. I think that one critique that I have had of crypto, and I think a lot of people have had of crypto, is that crypto has built a financial system for trading crypto. When you ask people what is a real business that's built on crypto? They say, well, look at this derivatives exchange.

There's an objection to that which is that it's all self-contained. You've built the system for trading crypto, but what are you doing for the real world? What are you doing to help people get mortgages to buy houses? What are you doing to build businesses that exist in physical reality as opposed to on the internet? And I think that in writing this, I have become more sympathetic to crypto on that question in two ways.

One is that I have to take seriously the idea that businesses that exist only on the internet are just a bigger and bigger part of life. So it's not a really good critique to say, "Well, all you're doing is finding ways to monetize internet communities," because finding ways to monetize internet communities is a big part of traditional business right now. So that's a potentially valuable thing to do.

Then the other place where I've become more sympathetic to crypto is that even if all you're doing is building a system to trade crypto claims, it's a system that the people who use it find really appealing, in ways that I think are compelling. I think people who trade crypto think this is cool because it is decentralized. There are caveats, but you're not relying on the goodwill of some exchange operator or some consortium with big banks to allow you to trade. There's the possibility of decentralized finance where everyone can trade in a permissionless way.

Then the other thing that people find very appealing is the permissionless innovation aspect of crypto where everything can run on public blockchains and there's just not a big legacy infrastructure, and also regulation is the wild west. So what that means is that if you want to start a hedge fund and start trading crypto, or if you want to start an exchange and start being a platform for trading crypto or if you want to start a business no one's ever heard of to do something financial with crypto, the barriers to doing that are a lot lower than they are in the traditional financial system. So you get a lot of really smart 25-year-olds getting into crypto because it's where they can make a lot of money and also where they can just write on a blank slate.

That might all be nothing. That just they trade crypto with each other until the bubble bursts and then they all go back to real jobs. But I have to think that if you had a lot smart people building a financial system, even if it's one that is sort of self-referential, then there's a real possibility of eventually turning that financial system to real stuff. You see some of that, you see some people in crypto doing some thinking about, "Well can we do unsecured lending? Can we do something that finances the real economy?"

But also just I think that a lot of the action in crypto is people who run crypto exchanges saying, "We'd really like to be able to trade stocks." And I think if you run a crypto exchange and it's not clear yet, but if you have a good proposition that the way your exchange works is better than the way the stock exchange works, that it allows individuals and hedge funds to compete on a level playing field or it's simpler and more transparent, or it's more trustworthy or something like that, or settlement is faster, then you can make the case that maybe you should be trading more financial products on your exchange.

And again, we're early in that, but I think that that's a real possibility where I think that a lot of people in crypto, their vision is not so much crypto transforming the world in itself, but the crypto financial system taking over from the traditional financial system and just being better at the job.

I detected throughout the piece a lot of admiration from you at people who were basically just up and inventing a financial system from first principles.

Yeah, and that's just something I personally admire. I think it's fun. It just seems like something I would enjoy doing too. My experience with finance is that there are a lot of people who are in it for the puzzles and the aesthetic and intellectual satisfaction, and you don't want to overstate that, because they also like the money. They don't turn down the money for the most part. Although a lot of crypto people are effective altruists and claim to turn down the money.

I think there is a genuine aesthetic attraction to building stuff in finance that is separate from the money. I think that a lot of those people go into crypto not only because for a while you could make just stupid flying amounts of money very quickly, but also because the velocity of aesthetic appreciation is higher. You get to just build stuff instead of going and doing what's always been done.

I really enjoyed the story and one thing that I liked about it was because I think it really tied together what the current financial system and the crypto financial systems really have in common. In some cases you'll see business models directly ripped off from the traditional financial system and others you'll see things that could never happen.

A lot of this comes down to 2008 and I would just want to ask you straight up, how much of crypto do you think is a reaction to the global financial crisis in 2008?

I think that when you read the bitcoin white paper, and also when you think back to the early days of crypto, there is a really intense sense of reaction to 2008.

One thing that 2008 did was just undermine trust in banks and then to some extent governments and central banks where the idea that you trust the bank to keep your money was a little bit less palatable than it was five years earlier. So when Satoshi Nakamoto publishes a white paper about how you can send money without a trusted central intermediary, there was some receptivity to that because people didn't trust the banks as much as they used to.

The other specific thing is that people didn't trust what they would usually call fractional reserve banking, but what I might just call leverage. The thing at the heart of traditional banking is borrowing, and in particular a dollar in a bank account ultimately represents a loan to the bank, which consists mostly of loans to companies and mortgage holders. So the whole system is really built on leverage. And in 2008 that worked out really poorly. Not that people's bank accounts were vaporized, because they weren't in 2008, banks didn't not return your money.

There was a real sense in which the dollars in your bank account were connected to this sort of teetering overleveraged system. A real innovation of bitcoin was that there would only ever be 21 million bitcoin and a bitcoin didn't represent anyone's debt. A bitcoin was just a bitcoin, it existed on the blockchain. It didn't represent effectively a loan to a bank. That concept was deeply appealing to people who were burned by the banking system of 2008.

But then crypto became very lucrative and people developed a really fun financial system in crypto, and those two facts attracted a lot of people to crypto, and some of them were not as philosophically committed to this libertarian anti-leverage philosophy that Satoshi Nakamoto laid out in the white paper.

But also, a lot of them came from hedge funds or came from high frequency trading firms. So the first thing they asked was like, "Okay, well how do I get more leverage on my bitcoins?" So you had an explosion of basically traditional financial business models, where someone who worked in traditional finance would come into crypto and say, "Well the problem here is that we don't have margin lending, so let's build margin lending." And then that would do really well, because people wanted margin lending.

Then you had people who came in and said, "Look, this is great, but what we really need are safe 18 percent yields." The real lesson of 2008 was if you package risky products into a safe product, that's when the really bad stuff happens. That's in fact what happened in the crypto meltdown, where the price of bitcoin and ether and stuff went down, and that's fine, but what was really bad was when people who were not speculating on risky assets, they thought they were getting a safe 18 percent yield on a stable coin?

When those people lost all their money, because those things were built on top of risky assets, that felt very much like 2008. It felt very much like repeating the mistakes of the traditional financial system without even the guardrails of that traditional financial system.

You had this line in there that was “the real systemic risk is in the safest assets,” which was phenomenally insightful I think. I really love this idea that you got at, which is just that the current state of business in decentralized finance is not particularly decentralized, and they often resemble banks, and many are taking a free ride on the inherent trust that people have in banks.

A lot of the stuff that went wrong was really in what people would call centralized finance, places like Celsius and Voyager that are companies that do that intermediate crypto trades rather than decentralized platforms.

I think the conventionalism is actually that true DeFi did well in the crisis because it had automatic features to end trades before they got too bad. The traditional financial approach when markets crash is to not pick up the phone when you get a margin call. To try to wait a week and see if it gets better. You saw some of that at the more centralized platforms where they would say, "No, no, no, everything is fine, everything's fine." And then they would go back the next day.

In decentralized finance, everything was kind formulaic, and for the most part that actually worked out really well, where they would formulaically liquidate things and people who were expected to get their money back got their money back. But prices went down, so it wasn't great.

I think that my impression, and I write about this, is that a lot of the more centralized intermediaries in crypto do free ride off the trust that people naturally are used to giving to banks. Despite the backlash of 2008, most people go along assuming that the money in their bank account is safe, and that someone is checking. I think a lot of people couldn't articulate the exact functions of the Fed and the Office of the Comptroller of the Currency and the FDIC and bank capital requirements, but are pretty confident that someone is in charge of making sure that the money that's supposed to be in the bank, is in the bank.

When a crypto entity comes along that looks like a bank and has a website and advertises? They're like, "Well I'm sure someone is making sure that's okay." And in many cases no one was. And those things had bad outcomes for customers. But the customers live in a society, and are used to a lot of stuff just being regulated and working. So it is a surprise when something's unregulated and doesn't work.

You were talking a little bit about the 2022 crypto crash and how it was different than the 2008 crypto crash and that both of them started with a bunch of weird synthetic assets being particularly odd and crashing. But that the difference between the two is that the 2022 crypto crash didn't really have any real-world impacts. You cite that because they haven't really had any real-world applications yet. You don't think that's going to be the case forever though. Where do you stand on that?

Just one very simple thing is that the crypto financial system is in the fairly early stages of being integrated with the traditional financial system in the sense of big institutions holding some crypto. I don't know that that will be the case forever.

There's a longstanding push for institutional adoption of crypto. There seems to be a lot of interests from institutions and I think sociologically, Jamie Dimon has always gone around saying that crypto is a scam, and part of that just feels generational. If you're a CEO of a bank now, you grew up maybe trading stocks or something, but if you're a 25-year-old at a bank, now there's a decent chance that you were trading crypto in your dorm room. If you were trading crypto in your dorm room, you're more open to it.

I think that over time there's a decent chance that the people coming into power in financial institutions will be people who are more interested in crypto because it's fun or because it's an interesting asset class or because they believe some of those claims that crypto advocates make.

So then you have institutional adoption, and then if you have the price of bitcoin going down 50 percent, then a bank has trouble because the bank holds crypto or something like that. So that's one avenue for contagion that you could imagine in the future where a crypto crash does bad things to Main Street, to the real world. It didn't happen in 2022 largely because there just isn't that much institutional adoption yet.

But then the other thing is just what is crypto actually doing? There's a financial system, and there are these stacks of leverage, but the stacks of leverage that unwound in 2022 are largely about leverage so you can speculate more on crypto. So it's all self-contained.

It's people who are crypto millionaires are now crypto thousandaires. But they didn't lose their house because they didn't buy their house with a crypto mortgage. There are exceptions to that and the exceptions are interesting.

The exceptions are people who were ordinary savers who put their money into things like Celsius or Voyager, or particularly Terra and Luna, the South Korean blockchain platform that had a stablecoin and a lending protocol that went to zero. A lot of those people were not like, "Oh, I'm going to gamble on crypto," a lot of those people thought at some level that they were saving and when their savings got frozen, that was tough for them financially. I think that the more crypto gets mainstream adoption, the more that risk grows, where if there is a contagion event in crypto, it impacts money that people are not setting aside for gambling, but money that they need to pay the rent. The more you have of that, the more possible contagion there is.

The third thing is just if crypto is a financial system that provides financing for real-world activities and then that system freezes up, then that's bad. Right now there's not a ton of financing for real-world activities that are part of crypto. There's not a ton of crypto that is being used to build homes or build non-crypto businesses. People are working on that, people would like there to be more crypto financing of real-world activities. And the more there is of that, the more danger there is of a crypto crash.

Just to wrap it up, you've covered a lot of stuff in the crypto space, particularly talking about the preponderance of scams and how easy it is for this stuff to happen. In this story you took the perspective of you didn't want to talk about "exciting people," which I think is oftentimes the principle that people start from. How was that, writing a crypto story without talking about a fascinating individual who may have absconded with a bunch of money to the Cayman Islands, or talking about somebody who drives Lambos?

It was easy in the simple practical sense that I'm not really a reporter, I'm a columnist and I'm interested in the financial structures and I'm not going out and interviewing a guy speeding in this Lambo. I feel like I was writing to what I can do and avoiding what I can't do.

As I said, the thing that I wanted to do was start at the beginning and try to figure out, just try to explain it all. To try to go from the first principles through where we are today and what the intellectual currents are that run through crypto. In anything there are scams, and crypto is very fertile for scams, I think probably for reasons that I get into about decentralization and about free riding and about the regulation. In my day job I write a lot about crypto regulation and it's just uncoordinated and early on.

There are a lot of opportunities to slip through regulatory cracks. So there are certainly a lot of scams, but I don't know, at a high level, that's not what's interesting about crypto. At a high level, what's interesting about crypto is that there’s some number of idealistic people who believe that they're doing something cool. They believe what they're doing is interesting and novel, because selling worthless stuff to retail investors is not all that interesting or novel.

That said, I do write a little bit about how crypto has found interesting new ways to do that. I think one thing that's really truly interesting about crypto is that Satoshi just invented bitcoin and then it became worth thousands and tens of thousands of dollars. That is not exactly something that's never happened before in human history, but it's kind of like that!

It's usually when you have a scam, you're like, "Well I've got this company that found oil in my basement and I'm going to sell you shares of it." You have some reference to external economic activity where you can say, "I'm making money and I'm going to give you a share." But in crypto, in the invention of bitcoin, there was none of that. It was just like, "If you buy this thing, it'll go up." And it was sort not even advertised that way, it was just like this is a thing that has some sort of technical properties and then people started buying it.

The fact that that worked, created the impression that it could work over and over again, and to some extent that's true. So you could say, "I've got a cryptocurrency that's just like bitcoin, except it has a picture of Doge on it and people would buy it." And that's not even a scam, because the dogecoin guys hate it and backed away from it and it continues to be worth money today, now it's Elon Musk's thing.

So there's a magic to crypto where you can create value out of thin air with less effort than you needed in a prior world of stock scams. And so there is an interesting opportunity for scamming, but again, that's a structural explanation that's not like, "And then a really charismatic guy came up with a scam!"

The story's called “The Crypto Story.” It's in Bloomberg Businessweek. Folks can pick it up on newsstands, they can find you on bloomberg.com. Where can folks find you on a daily basis and all that?

Probably the easiest is my Twitter, @Matt_Levine, and if you go to bloomberg.com/opinion, you can probably find my daily column, which is called Money Stuff, and you can sign up to get it in your email.

If you have anything you’d like to see in this Sunday special, shoot me an email. Comment below! Thanks for reading, and thanks so much for supporting Numlock.

Send links to me on Twitter at @WaltHickey or email me with numbers, tips or feedback at walt@numlock.news.