Izabella Kaminska on DeFi, ReFi & Trust

For more than a decade now, Izabella Kaminska and the rest of the Alphaville crew at the Financial Times have kept a critical eye on the development of all things crypto. (And not only that: Izabella herself made some provocative interventions in what she dubbed the Gosplan 2.0 debate, which added some fodder to discussions about reviving socialist calculation in the age of Big Data.)

I've checked in with Izabella to see what has changed in crypto coverage but also in how the more mainstream community – the one you read about in FT – perceives crypto. It turns out that the bastion of skepticism that is Alphaville could not resist all the charms of crypto; as you will find out below, even Izabella has had some second thoughts about the subject.

~ Evgeny Morozov

Keywords: web3, Bitcoin, El Salvador, CBDCs, Sovereign Individual, DeFi

For the last decade, you – and Alphaville in general – have been the bastion of crypto-skepticism. Yet, in your more recent columns and posts before departure, your tone is far less critical, with some tacit and occasionally explicit acknowledgements that, for all the criticism waged at it, the main object at the heart of the crypto-universe – Bitcoin – has not only survived unscathed but even prospered. What were the reasons for your change of heart?

While I remain incredibly cynical of most blockchain ventures and crypto projects – from ICOs to NFTs – and stand by everything I’ve ever written about crypto, I think it would be negligent to ignore bitcoin’s profound longevity. Whether rightly or wrongly, bitcoin has captured the popular imagination. Arguing that it is not sustainable, efficient or easy to use is all fair comment — bitcoin is none of those things. Nor is bitcoin necessarily censorship resistant due to its dependence on intermediaries, who must engage in censorship to be deemed eligible to formally interact with fiat economies. Nonetheless, where my position has changed is that I have come to realise that bitcoin’s raison d’être has little to do with engineering a more efficient, user friendly or sustainable financial system.

I see it now as more of a backup of last resort for an increasingly digitalised and polarised global financial system, that has – due to political reasons – been exposed to a splintering risk (whether through embargoes, wars or technological breakdowns). I have also come to realise that while a censorship resistant financial system is scary to those who consider themselves compliant and law-abiding, because it can be used to fund and render great harm upon society, it may also be an essential component of a free system.

A censorship resistant backup financial system offers the ultimate check on potentially global authoritarian power due to the way political opposition is funded.

So begrudgingly, I admit, I would rather live in a world where bitcoin remains on the table as an option (even if not popularly used, hopefully because we can continue to trust our own governments and money-issuing authorities) than one where there is no such digital alternative. At least for as long as the world remains digitised.

You’ve written about the way in which institutional investors – who may have previously shied away from crypto – are now flocking to it. How do you see El Salvador’s announcement of the “volcano bonds” in this regard? It seems designed to let institutions who may not be allowed to invest into crypto as such get a piece of action (i.e. exposure) by buying into what looks like a government bond but is, in fact, deeply linked to Bitcoin. Do you think we’ll see more El Salvador-like offerings? From where would this pushback against “hyper-Bitcoinization,” as advocates call it, come from?

I haven’t looked too closely at volcano bonds, but in general I am not a fan of the approach El Salvador is taking. The beauty of bitcoin is that it is an opt-in system. It should never be mandated. I think El Salvador made a big mistake in mandating that bitcoin become the official currency of the realm – not least because even in established economies like Britain there is no mandate on legal tender.

The fiat in fiat is usually rendered onto the system via the tax relationship, which is supported by the military power of the state. However, in a liberal and free system, the state is only free to dictate what currency its own tax collection must be paid in. A merchant must have the right to exchange goods or services against whatever he so wishes. Barter, coupons, tokens, foreign exchange. Mandating that the merchant MUST accept bitcoin or fiat, or whatever, is and always has been suboptimal.

The economic issue facing countries like El Salvador is a mismatch between their fiat-denominated liabilities and their capacity to generate the necessary fiat-denominated revenue. Bitcoinisation only solves that problem if it also associated with value added investment and productivity. Investing in volcano bonds might be a great way to do that, but I think it has little to do with the denomination of the investment.

What El Salvador is engaging in, therefore, is a speculative trade no different to when MF Global decided to take sovereign bond risk onto its portfolio. It is essentially betting that dollars raised from the bond offering will help the country develop some element of energy independence that can generate a permanent bitcoin yield. It is hoping that bitcoin yield will be greater than the relative dollar yield they owe on the bonds after conversion — and just to make sure the price of bitcoin remains supported it plans to use some remainder of the dollar funding it raises as an FX reserve cushion to support the price of bitcoin (also known as FX intervention) when the yield differential threatens to go the wrong way.

In many ways, this is not dissimilar to what China has done to get ahead in the global economy — except that China raised its dollar excess reserves from selling underpriced goods and services, rather than investment products. Either way the end objective seems the same: attract dollars for investment purposes (ideally those that stand to liberate your country) in a way that allows you to retain some control/leverage over the FX exposure on the coupon payments.

How can the institutional push into crypto be reconciled with another push – towards more ESG-compatible investments? Crypto being a rather dirty industry, with a very spotty record when it comes to emissions, how could the likes of BlackRock – which already are taken to task for faking compliance with ESG rules – ever justify their dabbling in crypto?

I think the whole concept of ESG investing is badly thought out, and equivalent to a very subjectively crafted embargo system. There are contradictions within the ESG umbrella itself. Investing in the solar panel industry satisfies the E but it doesn’t satisfy the S, if, for example, you believe that China is exploiting Uighur populations unfairly to produce such panels in slave-like conditions. Crypto may be highly energy intensive, but it is also highly innovative — most famously in finding and extracting redundant sources of energy that currently go wasted.

If humanity is ever to make a giant technological leap in terms of finding a new source of clean and plentiful energy, it is more like to emerge from a highly competitive space like crypto than it is from the ESG space. The former encourages innovation. The latter actually encourages stasis and investment in imperfect technologies.

I’m not sure if you have followed this but Vitalik Buterin, the founder of Ethereum, came out against El Salvador’s plans, calling them antithetical to the broader spirit of crypto. Is it just some tactical position by Ethereum or is there more at stake here? Broadly speaking, are there good reasons to expect the splintering of the crypto-community – there are already plenty of mutual accusations that the competitors’ coin is, in reality, just a “shitcoin” – especially as its members make different arrangements in their dealings with governments and other institutions?

I think the crypto community’s greatest weakness is its propensity to eat its own, and to continuously splinter and divide, rather than unite. And I worry these divisions are happening increasingly quickly, so that the periods of relative harmony and stability within the community are growing ever shorter. That said, as I recounted above, I agree that El Salvador’s approach is extremely blunt-headed and far too authoritative for my liking. I caveat that with the counterpoint that I remain a critic of the crypto community’s obsessive commitment to headless organisations.

I do think that the crypto community would be better off reviving trust than disrupting it, meaning accountability and personal responsibility must continue to be factored into the models of these systems. But in some measured way.

For me, Vitalik is a funny and contradictory phenomenon in his own right. He operates as the spiritual leader of a de facto headless system, while holding incredible sway and influence over the headless system he created and oversees. Who is acting more authoritatively? El Salvador’s democratically appointed president or Vitalik, who rules by a sort of divine right of founder creators? (Like an Arthurian character who just happened to pull the sword from a mystic stone.)

Vitalik may be a benign and wise philosopher king for now, but — unless he forms some sort of genetic dynasty of his own — succession will become an issue eventually. Even possibly within his own lifetime. Vitalik is not beyond corruption in his own right.

One common interpretation of bitcoin history is that, by and large, the broader utopian vision of this becoming a unit of account has failed. Save for the beaches of El Salvador and parts of the dark web, it’s not really widely accepted for payment; it has become an attractive speculative asset but not much more than that. Moreover, the rapid experiments with CBDCs around the globe might also close off many spaces where crypto-enthusiasts hoped to move into. Do you think the crypto community is going to acknowledge this failure of the bigger vision or are they going to simply twist their earlier talking points and pretend they never actually meant to offer anything beyond just another (and still highly volatile) asset class?

I think there is already plenty of evidence that the crypto community is moving the goal posts on that front. That said, I don’t think bitcoin needs to become a unit of account to make an impact though. I think its greatest potential is in creating a common unit of account between competing centralised CBDC/fiat systems – and servicing the international and offshore eurocurrency (as in eurodollar not “euro”) markets in a way that regulates them and keeps them in check. These are territories that have proven time and time again that they cannot regulate themselves effectively otherwise. At least not without becoming parasitical entities that draw stability and support from the fiat systems they challenge. They need an honour among thieves type system, and bitcoin in some ways provides and enforces that. It’s a good solution for that sector of the market.

Is it a good solution for the system at large? Not if it’s functional and honourable, and to be trusted. But as stated before, it makes sense to me that something like bitcoin exists just in case the trusted institutional structure does collapse.

Do you anticipate governments around the world to follow China’s example and impose strict regulations – if not outright bans – on crypto-mining? Or are we going to see the race to the bottom, especially with poor and failed states going out of their way to welcome miners banned from the more prosperous regions? From the geopolitical perspective, is the future of crypto-mining looking more like China or El Salvador?

I suspect authoritarian states who are not energy independent will seek to ban crypto mining. Energy rich ones (like Russia) will seek to do the opposite. Democracies will be motivated by their own natural resources and propensity to manage their own economies effectively. The more unstable and energy deprived economies are, the more likely authorities are to try and ban these crypto systems.

You have celebrated the potential of crypto as a potentially useful alternative to the traditional monetary system, especially when it comes to eluding government surveillance in a pandemic like the one we are living through right now. Yet you have also cited former CIA officials who said that “the blockchain analysis is a highly effective crime fighting and intelligence gathering tool.” How do you reconcile the two positions? Given the speed and degree of re-intermediation – by formal, legally bound institutions – in this space, what are the grounds to assume that the cryptographic utopia of full anonymity, associated with the early bitcoin culture, would survive?

I agree that this is an utter paradox. I think there is a huge chasm between the censorship resistance that crypto (especially bitcoin) promoters claim bitcoin offers to the system and the reality on the ground which is potentially the exact opposite.

In fact, I worry, bitcoin may have been used as a very useful bait and switch in terms of luring people into surveillance inclined digital monetary systems.

That said, I suspect the surveillance vulnerabilities are a function of crypto still having to lure dollar-denominated capital into its system as it establishes itself. During this initial phase crypto will need to co-exist with the fiat system and play in line with the fiat system’s rules, so that it can interact and allow ongoing inflows and outflows. It essentially needs to pretend to pay ball and compromise on some of its core values. Compliance on this level undermines anonymity, as crypto institutions that provide bridges between the two systems are obliged to inform on their users. But that obliging relationship doesn’t have to exist forever.

The power structure can change quite quickly, especially if and when crypto pushes into the physical domain, carving out effective autonomous zones or special economic zones which are not beholden to the rules of the wider realm (much how the City of London came to be many centuries before). In some respects this is what is happening in El Salvador.

There’s a lot of excitement about web3 and decentralised, crypto-based technologies among technologists, even in some of the activist circles. Yet, if one takes a more holistic picture of what is happening, it seems that many of the established players, including the mega-banks, have adapted quite well to the new environment, with JP Morgan, through its JP Morgan Coin, for example, carving out a niche that has only reinforced its global leadership. Is all this talk of “decentralisation” merely a distraction that prevents us from seeing the simultaneously unfolding processes of re-centralisation?

Yes I would agree with that. There is mock decentralisation going on all over the place. Decentralisation by name, but not by substance. I think web3 will not succeed unless it deals with its own contradictions. As it stands web3 is anathema because it isn’t focused at solving real problems or empowering the greater population. It represents, instead, a somewhat arrogant and preachy push from the technology space into the realms of real people. I see it as technologists creating communities of likeminded, technologically minded people pushing their solutionist mindset onto sectors and industries they know little to nothing about, and getting basic foundational issues wrong (or structuring themselves wittingly or unwittingly as frauds), thus quickly losing the trust of actual practitioners.

Until web3 solutions are grown bottom up by practitioners of the trades themselves, they will not lift off. In the interim, banks and incumbent intermediaries who know how to package solutions to the broader population (in alluringly basic rather than arrogant ways) will continue to crash the party with decentralisation theatre. Users will then side with the adage of better the devil you know. Also, I’m not entirely convinced that web3 is dependent on crypto to succeed. I see it as its own phenomenon.

Back in 2016, you’ve warned about the proliferating “blockchain fetishism” in the financial world, with many people assuming that, somehow, by restricting data proliferation to opt-in rule-based systems, one would create network-wide productivity booms that might compensate for the lack of innovation and productivity increases in the real economy (you’ve also intriguingly described this effort to squeeze everything into a single blockchain as a “Plaza Accord for data.”) Elsewhere, you have also compared, rather critically, such efforts to the Soviet-era Gosbank, even coining the terms “gosbankification.” Have the last five years proven you right or wrong? Has the blockchain fetishism abated?

I think blockchain fetishism has abated a bit. To some degree people have finally figured out that blockchain is not some magic solution to all sorts of data-based problems. Just adding a blockchain into an offering is no longer guaranteed to have a positive effect on marketing or fund-raising.

The attractiveness of the term has been debased by overuse, even if it is still appearing on a mass scale in official publications and academic papers. I also think there’s been enough time for practitioners to realise that more often than not they don’t actually need a blockchain in their services. They’ve figured out via trial and error that blockchain is a needless complexity/luxury that doesn’t add enough benefit to justify its costs and inefficiencies.

A good example of that is the fact that CBDCs are powering ahead with very little blockchain in them at all. Where they do feature blockchain, it’s on a sprinkled-in basis as if to justify the huge amounts of money spent on these systems — rather than because they actually enhance the offering itself. If you’re a centralised issuer, there’s no real advantage to adding a blockchain. But as is often the way, nobody is interested in writing about the down-hype.

In one of your posts from earlier this year, you have made a very striking connection between the populist appeal of “tokenisation” – including that of people and human relationships – and the critiques of state power advanced by the Sovereign Citizenship movement, which draws on the cultish 1997 book co-authored by William Rees Mogg. Could you briefly explain why you think we have to read the two together? What common ground do the two ideologies share?

While I definitely don’t endorse the narrative of the Sovereign Individual, I view it in a similar way to how I now view bitcoin. That being: I have to begrudgingly admit they got a lot right. The tokenisation of people seems the next step in the proposed decentralised paradigm shift. In the first instance, I found this proposition absurd and equivalent to a regression to an era where slavery was acceptable.

I also found the idea of deeming sovereign individuals as somehow optimal for society hugely naive because — as lockdown has shown — nobody can opt out of society. We all have a social responsibility. Being totally free to do whatever you want is suboptimal due to the negative/positive liberty paradox. Your freedom to do something harmful shouldn’t impose on somebody else’s freedom to defend themselves from that thing.

Nonetheless, I have recently become more philosophical about what our best chance of achieving freedom is. I am starting to view the world from a freedom maximising perspective. If freedom is illusory in most circumstances (because we are all beholden to all sorts of social and familial responsibilities), perhaps the best way to maximise freedom is to ensure that subservient relationships are at a minimum always entered into wittingly, with consent and as fully informed as possible, and with alternative choices (where possible) on the table.

Alternatively, they should be entered into while always retaining a majority stake in your own self-determination. Is selling a de facto minority equity stake in yourself to raise funding for a creative venture that can catapult you into creative success you excel in really worse than indebting yourself to a third party for a lifetime of mortgage payments? I don’t know. Perhaps it’s not as simple as I thought it was. I’m open to debate.

One area where you and your colleagues at Alphaville have done an incredible job in the past few years has been piercing through the rhetoric and the buzzwords of the crypto-enthusiasts. In an exceptionally punchy post from 2017, you complained of “the mass deployment of technological buzzwords to disguise what are in fact well-established financial mechanisms and processes as something cutting edge and new.” Thus, “basic spread-betting platforms and OTC derivatives systems can be reimagined as ‘tokenised investments,’ offering value-creating opportunities as opposed to zero-sum gambling traps to the financially illiterate.” We have barely gotten used to “DeFi” and now all the buzz is already about “ReFi,” “regenerative finance” (which is a lot like “DeFi” but with more useful idiots, if you were to ask me). Is there any hope of countering it? How?

I am highly suspicious of VCs entering into web3 developments, because by definition (to my mind) backing web3 models is self sabotaging to their own business models. A true web3 community based enterprise is able to bypass the need to satisfy early stage founders or strategic investors. It allows for a new type of neutrality. The VCs can still invest in it as part of a larger community, in visions or applications they prefer. But by definition their role in bootstrapping these companies and then cashing out of them at a premium has to be diluted if it’s to achieve a true web3 effect. Web3 is about ensuring the sort of profits that usually flow to VCs via exits, are redistributed to a much wider community of early adopters and investors. So I think there may be a fundamental paradox in any VC backing a web3 development.

You have been quite critical of the notion that the project of “decentralisation” – as it is touted by the crypto-crowd – is somehow inherently new to the world of finance. You’ve argued, on the contrary, that the whole recent history of some of the most toxic financial innovations is driven by the same drive to decentralise that underpins “DeFi,” even if without the advantage of using populist talking points. In that vein – and building off some academic research – you have written of the “paradox of DeFi.” How would you describe it to the uninitiated and why is it likely to persist?

I think the easiest way to explain this is in the context of why advanced societies always organise around division of labour principles and how this leads them to grow ever more complex. Alternatively just watch the South Park episode "Cartmanland," where Cartman discovers that buying an uneconomic theme park and running it on an exclusive basis just to avoid queues is not a long-term sustainable business model.

The queues re-emerge because Cartman cannot single-handedly operate and maintain the theme park while simultaneously drawing joy from using it exclusively. He has to hire personnel to manage and operate it, so that he can spend more time riding the rides. But he then has to fund that personnel by letting customers into the theme park. But the more customers he lets in, the more personnel he needs to cater to their broader needs. And on and on, until queues re-emerge and the costs of operating the theme park begin to outweigh the revenues — shutting the business down again.

DeFi, ReFi — whatever you call it — is a bit like that. It disrupts the middleman not because they’ve found a more efficient alternative but because they’ve merely rebooted the system from scratch.

Unless Cartman invests in a technological innovation that can reduce personnel cost, he won’t be able to manage the theme park any more efficiently or in any way that can reduce queues or improve the experience.

DeFi and ReFi cannot ever make a long term difference in cutting the cost of financial intermediation unless they actually synthesise trust. But trust is inherently entangled with the human condition and human agency — you cannot synthesise or commoditise it without effectively undermining human agency, and the right of people to operate freely.

Making things more complex, more expensive and more bureaucratic is the closest substitute but this is not the same as synthesising trust. In a trust based system there is always a vulnerability at the human initiation point of any bureaucracy or system. A trusted relationship with an intermediary (which is in its own right a manifestation of a trust in a specific human agency) will always reduce the costs of the checks and balances and complexities (bureaucracies) you need to synthesise trust. Therefore the more complex the “trustless” bureaucracy gets, the greater the windfall (or cost saving) in resorting to a trusted intermediary in its stead.

Izabella Kaminska is the outgoing editor of FT Alphaville, the Financial Times' award-winning finance and markets blog. Izabella is best known for her early coverage of the emerging fintech and cryptocurrency space, where she developed a reputation as a harsh but fair critic. Her other areas of focus at the FT, both as a reporter and a columnist, include central banking, money markets, market structure and platform economies. She has also written extensively about commodities, economics and finance. Izabella cut her teeth as a reporter working at little-known English language publications such as the Warsaw Business Journal, in Warsaw Poland and the Caspian Business News in Baku, Azerbaijan, and later as a Reuters trainee in London. Past roles have also included a three-year stint as a senior producer at CNBC.

Izabella is now embarking on an independent media project focused on reconfiguring how independent journalistic content is organised on the internet. It's a ridiculously ambitious project, but there's only so much moaning you can do without trying to do something about it.