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The paradoxes of cryptoeconomics: one more lesson from the SVB crash

April 20, 2023

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Eduardo Valpuesta Gastaminza

Full Professor of Commercial Law and director of Master's Degree of Digital Law of the University of Navarra.

The first sentence of the document in which the famous (and unknown) Satoshi Nakamoto launched his project to create the cryptocurrency and the bitcoin payment network was: "Internet commerce has come to rely almost exclusively on financial institutions as trusted third parties in the electronic payment process". And so Nakamoto advocated creating a payment system that would make it possible to dispense with banks. From this point on, and of course with an infinite number of nuances, the "crypto world" has boasted of being an "alternative economic system" to the traditional one, which allows direct financing and payments "between individuals", dispensing with traditional banks. 

In spite of this, the truth is that in its real development the cryptoeconomy is mimicking many of the patterns of classic financial institutions, and is also showing some important contradictions. Firstly, it is paradoxical that the bitcoin system and the rest of cryptocurrencies were born to dispense with intermediaries, and now it is almost impossible to acquire cryptocurrencies if not through exchanges, custodians, trading platforms, etc., created to allow the functioning of this market. This also gives rise to enormous fraud problems, because the "private" investor who acquires cryptocurrencies through an exchange has no effective guarantee that the intermediary is actually using the money paid by the investor to acquire that cryptocurrency. 

Secondly, the system is contradictory, because what really interests the acquirer of "crypto securities" is that these assets are worth more and more... dollars. The vast majority of cryptocurrency acquirers do not want the cryptocurrency itself, but its possible revaluation in fiat money, the one to which the cryptocurrency wanted to be an alternative. Not only do bitcoins not want to displace dollars, they want "to be able to be sold for more dollars". 

These paradoxes can be seen in the recent intervention of Silicon Valley Bank. As already highlighted, the fall of this entity has been nothing but one more step in the dangerous downward staircase of the Economics crypto. For almost a year we have been witnessing continuous financial collapses of entities in this sector: fall of the cryptocurrency Luna and the Terra platform (May 2022); collapse of the FTX exchange, and of the business aligned with it, Alameda Research (October 2022); escalation in the control by the SEC of entities that issue or trade crypto securities (Ripple cases, Kraken's staking system, etc.); "orderly" closure of the cryptobank Silvergate (March 2023); and now intervention of Silicon Valley Bank. It is true that this was not a specific entity operating in the world of cryptoassets, but a good part of its clients were companies in this sector (it was not a cryptobank, but a bank for cryptocompanies). The aforementioned fall of FTX dragged Silvergate bank (there have already been lawsuits that consider that Silvergate acted as an accomplice of the possible swindle FTX is accused of), and has been having a contagious effect in this area. 

It seems that the main problem of the Californian bank has been related to the excessive acquisition of public debt, whose value has fallen sharply in the face of rising interest rates. But the trigger for the fall has been that many entities in the crypto sector that had their funds deposited in the bank have withdrawn their deposits, largely advised by financial advisors and investment funds. And as is well known, it is very difficult for a bank to resist a disproportionate withdrawal of funds (even more so if there has not really been a prudent risk management , as seems to be the case).

Backing of financial assets 

Thus, the bank's crisis has had a huge impact on companies in the crypto sector. Because many of them were depositors in the bank, and there were some of the most relevant exchanges and issuers of stablecoins. These stablecoin issuers ensure that the cryptocurrencies they create are backed by financial assets outside the crypto world, assets that they normally deposit with banks and traditional intermediaries. If these exchanges and issuers were unable to recover the billions of dollars deposited, the ripple effect and loss of confidence in the stability of the financial system would be deadly

On that framework, there are already those who point out that the US authorities, by supporting the bank's depositors and guaranteeing that "everyone" will get their money back, were actually protecting companies in the crypto sector. The small investor already had the guarantee of recovery of US$250,000 per customer. Therefore, the added guarantee promised by Joe Biden was aimed at the other customers, those big companies in the crypto world, because their fall could have a contagion effect on the traditional financial world huge. That is why, it is claimed, cryptocurrencies are rising in value, because cryptocurrency investors feel protected by such a move. 

Again, too many dangerous connections between both worlds. And a manifestation of the paradox we were talking about: the cryptoeconomy pretended to be an alternative to the capitalist Economics , but in reality it is mixed with it; and its stability depends on the classical central financial authorities it wanted to supplant .