Bitcoin Financialization: Wall Street, Digital Scarcity And A Financial Crisis


Should We Be Concerned About the Financialization of Bitcoin?

Bitcoin is becoming increasingly financialized. Some people are worried, but a new report suggests that we shouldn’t worry about the financialization of the world’s largest cryptocurrency.

“Concerns over the financialization of bitcoin are being greatly exaggerated,” writes Crypto Calzo in a recent blog post.

Crypto Calzo wrote the blog post in response to a critique from Caitlin Long, who suggested that we should fear – not embrace – Wall Street’s growing interest in bitcoin.

Long takes issue with two specific Wall Street terms: rehypothecation and commingling. Long, a 22-year old Wall Street veteran, recommends cryptocurrency users familiarize themselves with these terms immediately.

“These two words are entering the vocabulary of bitcoin enthusiasts. Soon, they will roll off tongues as freely as the term “fiat currency” does today, thanks to the entry of Wall Street incumbents into bitcoin, because rehypothecation and commingling are pervasive Wall Street practices that enable the financial system to create more claims to an underlying asset than there are underlying assets.”

Long goes on to cite the financial crisis of 2008 when many banks needed bailouts. Today, the financial ecosystem is more centralized than it was during the leadup to that financial crisis. This was done deliberately: regulators centralized credit and felt that it was easier to regulate a small number of large institutions.

“In short, much of the financial system’s credit risk is now located in the CCPs [central derivatives counterparties]. ICE is one of the largest operators of CCPs in the world. And ICE is now entering bitcoin.”

Basically, major Wall Street firms have products that are based on derivatives. Instead of trading an ounce of gold with every USD, for example, we trust that the USD has value. Bitcoin was created to counter this idea of non-gold-linked fiat currencies. Every bitcoin is a real bitcoin as verified on the bitcoin blockchain. Wall Street and modern banking runs counter to the core ethos of bitcoin.

We Shouldn’t Be Worried About Wall Street’s Interest in Bitcoin

Nevertheless, Crypto Calzo suggests we shouldn’t be worried even as Wall Street seeks to enter the world of bitcoin.

Crypto Calzo discusses how and why banks lend out customer funds. Banks need to provide customers with access to their funds when requested, but not all customers will need access to their funds at the same time. This allows the bank to find short-term, low-risk uses for its pile of assets. That’s how modern banking works.

If banks hold bitcoin, the concern is that they would use bitcoin in a similar way. Suddenly, you’d have bitcoin in your account that isn’t actually connected to a bitcoin. The bitcoin in your account is being loaned to 10 different people.

Without regulation – as we saw in the early 2000s – the financial system becomes over-leveraged and interconnected. Does this mean we’re doomed for another financial crisis – with bitcoin going down with the banks? Not so, according to Crypto Calzo.

There Are Three Major Changes Between Today’s Financial Ecosystem And The Ecosystem In 2008

Crypto Calzo cites three major changes between today’s financial ecosystem and the ecosystem of 2008, including:

  • Disclosure: According to SEC rules, funds have to disclose position-level information on what assets they lend out and the fees they generate from those assets. This transparency allows market participants to better understand their exposure to counterparty and liquidity risk in the event conditions deteriorate.
  • Consent: All established jurisdictions have legal mechanisms that either require a client to expressly consent to use of their assets. These legal mechanisms also allow a client to revoke this consent. “It is wrong to presume that custodians can do what they want with client assets without recourse,” writes Crypto Calzo.
  • Contractual Scrutiny: “There is increased awareness among market participants that the devil is in the detail when it comes to holding assets with a third party…Even if a party agrees to have its assets lent out, the circumstances, limits and right to revoke consent in the future will be well provisioned for.”

Because of these three key legal changes, the landscape isn’t comparable to where it was a decade ago. The advantage is held by those who deposit funds into institutions – like anyone who deposits bitcoin or USD into a bank.

Furthermore, investors can perform “basic due diligence” to ensure coins held on their behalf are safe and static with appropriate parties. With a check, you can verify that your bitcoins are being used – or not used – as requested.

Meanwhile, the free market will do the rest:

“In the long run the free market will ensure that only those institutions who comply with transparency measures will generate any meaningful amount of business. Crypto twitter is a viral behemoth and it will not take long for the bad actors to be outed if detriment is posed.”

Interestingly, Crypto Calzo feels that

“the greed and complacency which led to the collapse of the financial system has been weeded out and no longer persists (in the context of securities lending).”

Due to fundamental behavioral shifts by market participants, there’s a greatly reduced risk of a collapse.

Of course, nobody can predict the future. Crypto Calzo could be right, and concerns about the financialization of bitcoin could be overblown. Or, Long could be foreshadowing the collapse of bitcoin caused by rehypothecation and commingling.

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