The tradeoffs in chasing the decentralized dream

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Hello and welcome to the FT Cryptofinance newsletter. This week we look back at our annual May conference, held in London.

A recurring theme in the digital asset market is the mantra that the future of cryptocurrencies lies in decentralization. Pursuing it sometimes feels like chasing the pot of gold at the end of the rainbow.

Like cryptocurrency itself, decentralization relies heavily on the computer industry’s language and ideas about the most efficient way to organize networks, but is applied to financial services.

Ethereum, the largest blockchain for decentralized finance, was conceived not as a currency but as a new basis for trust in financial markets, said Joseph Lubin, one of its co-founders.

“Ethereum represents a profound disintermediation of financial systems as it matures.”

It aims to eliminate the services of a centralized intermediary, such as a bank or stock exchange, to carry out entrusted tasks such as decision making and record keeping, and transfer the tasks to a larger network of actors, operating on the basis of open networks source that are not controlled by any entity.

This should mean that these actors do not have to place as much trust in each other, because their more limited power means there is less incentive to try to corrupt the network.

The collapse of exchanges like FTX and Mt Gox have shown the pitfalls of concentrating so many cryptocurrency trading and custody businesses into a single entity, and these serve as ironic examples of the kind of risks and frauds that cryptocurrencies seek to remove.

But if one party potentially gains power, someone else loses it. This calculation was the basis for the Securities and Exchange Commission’s warning last week that Lubin’s blockchain software group Consensys could be next to face enforcement action.

The regulator believes the cryptocurrency storage company’s Metamask wallet could fall under its definition of a broker-dealer, a label Lubin called “absurd.”

Lubin, co-founder of the Ethereum blockchain, said the US government likes to assert its authority around the world by using banks as intermediaries.

“Our technology will allow us to build better systems that don’t rely on intermediaries, that allow people to have direct access and control over their resources, [and] enable people and communities to have direct access to financial innovation and other forms of innovation.

“The SEC is concerned that so much attention and capital will flow into our ecosystem. . . The SEC probably doesn’t want to see a wave of innovation that will truly transform the landscape.”

But this clash of broad approaches only goes so far. Human systems can be fooled; fraud, money laundering and criminal payments are endemic throughout financial history.

Candace Kelly, chief legal officer of the Stellar Development Foundation, pointed out that a decentralized world is made up of many layers, with many actors holding different levels of responsibility. SDF promotes Stellar, a blockchain network for payments and tokenized assets.

Some actors were responsible for ensuring the underlying protocol worked, others oversaw wallets that stored assets, and still others issued financial assets on a blockchain, he noted.

“It’s very similar to the Internet. No one owns or controls the Internet and that’s OK,” he said. “One of the things people miss is the power of decentralized, underlying permissionless networks and the value that that brings . . . in terms of safety, security, transparency and which is open and public and therefore is constantly ‘curated’, as opposed to an authorized private chain where you still have a centralized actor.”

But the more we delve into the practical aspects, the greater the obstacles to achieving decentralization appear. As Yuval Rooz, CEO of tokenization platform Digital Asset, noted: “I don’t think regulators would feel comfortable if JPMorgan put their website on the Internet and everyone on the Internet could access their services and see all the information about their clients’ accounts.” .”

He added: “The Internet is a good analogy because it has technical standards that allow information to interact with each other, assuming you want them to interact.

“The chain of tomorrow will have to have a public infrastructure that everyone can access, but the creators of the applications must be given the sovereignty to respect existing regulation and have control over what they want to offer to the world.”

The exchange of views and other conversations highlighted a broader consensus that is emerging: decentralization is more of an escalator than an end state. Some things may end up being more centralized than others.

But with this approach, the market structure bears more than a passing resemblance to global OTC financial markets, many of which specialize in trading bonds, swaps or hard-to-move or bespoke assets.

They don’t go through exchanges; the agreements are instead negotiated privately but still respect common regulatory standards. Furthermore, they have operated for decades without using distributed ledgers or blockchain.

It is often said that the cryptocurrency market is relearning all the lessons that traditional finance had to learn. If there’s one lesson to be learned, it’s that you can’t apply the decentralized label to everything.

It is much more problematic to decentralize governance than to decentralize technology. To build the most efficient system that works for everyone, trade-offs are necessary. Putting something on a blockchain doesn’t make it decentralized; Likewise, as demonstrated by the existence of the Internet, services can be decentralized without blockchain.

What is your opinion? Email me at philip.stafford@ft.com

Weekly highlights

• Some better news for account holders at the bankrupt FTX cryptocurrency exchange. Most of them are in line to receive cash worth more than 100% of their official credits, administrators say said Tuesday. The likely total was about that of my colleague Ellesheva Kissin revealed at the end of March. The extra cash comes mostly from the sale of venture capital investments in AI and cryptocurrencies, the value of which has risen sharply since FTX went bankrupt in November 2022.

• Consensys isn’t the only company to receive junk mail from the SEC. Robin Hood his crypto unit said a so-called Wells Alert had been sent, warning a company that it faces legal action and potential civil litigation, fines and restrictions on doing business. Robinhood said the regulator is evaluating whether some assets on its platform are securities. “We look forward to working with the SEC to clarify how weak any case against Robinhood Crypto would be on both the facts and the law,” she said.

Bite of the week: Existential threat

Joseph Lubin called the SEC’s search of Consensys’ MetaMask portfolio “absurd.” The head of Consensys had explained why it was important to him.

“If we have to register our wallet as a broker-dealer, pretty much every application on Ethereum that does similar things with tokens will have to register as a broker-dealer. And so an entire tech industry would be severely killed in the United States.”

Data Mining: Fair Value

Coinbase Global reported stronger numbers in the first quarter, with revenue rising from $773 million to $1.6 billion year over year. There’s one oddity, though: Net income rose to $1.2 billion from a loss of $79 million a year ago. Most of the gains were driven by a new accounting standard introduced late last year, which requires companies to measure cryptocurrencies at fair value in each reporting period, with changes in fair value recognized in net profit, he said. decreed the FASB. Result: a $650 million boost to Coinbase’s net profit. Cute! However, its shares have not performed badly this year, although not as well as investing your money in bitcoin or ether.

Cryptofinance is edited by Laurence Fletcher. To view previous editions of the newsletter click Here. Your comments are welcome

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