April 19, 2021


Blockchain and Distributed Ledgers w/ Alexander LIPTON

METACO TALKS with Alexander Lipton, Co-founder and Chief Information Officer at Sila (an innovative fintech company working on making money programmable), Visiting Professor and Dean’s Fellow at the Hebrew University of Jerusalem, and Connection Science Fellow at MIT. In addition, Alexander is an Advisory Board Member at numerous Fintech companies worldwide. In 2021, Alex was awarded the Buy-side Quant of the Year Award by Risk Magazine. He published ten books and more than a hundred scientific papers to date.
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Welcome to METACO TALKS – Live conversations with the people operating at the frontier of crypto innovation: entrepreneurs, bankers, investors, fund administrators, traders, analysts and other crypto and digital asset market participants. Our objective is to help the broader ecosystem navigate this complex environment and unlock the market opportunity.

This podcast is hosted by METACO – the leading provider of security-critical infrastructure enabling financial institutions to enter the digital asset ecosystem.

Our guest is Alexander Lipton, Co-founder and Chief Information Officer at Sila (an innovative fintech company working on making money programmable), Visiting Professor and Dean’s Fellow at the Hebrew University of Jerusalem, and Connection Science Fellow at MIT. In addition, Alexander is an Advisory Board Member at numerous Fintech companies worldwide. In 2021, Alex was awarded the Buy-side Quant of the Year Award by Risk Magazine. He published ten books and more than a hundred scientific papers to date.

For this episode, among others, we discussed: Coinbase IPO; deep-Dive into bitcoin; cryptocurrencies management; DeFi vs. CeFi; central bank issued digital currencies and stable coins; NFTs; DAOs; the future of DLTs and cryptocurrencies and more.

Topics covered:

[00:05:37] The evolution of money and currency interactions over time

[00:09:21] Deep-dive into Bitcoin

[00:12:12] Coinbase IPO vs. the shift towards decentralized, peer-to-peer  exchanges 

[00:15:15] Banks’ role as vaults for assets

[00:28:29] Central bank issued digital currencies and stable coins

[00:33:37] Future of DLTs and cyrptocurrencies

[00:37:33] DeFi vs. CeFi

[00:46:28] What’s behind the growth of non-fungible tokens (NFTs)

Disclaimer: This is not investment advice.

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Full transcript

Adrien: [00:00:00] Hello everyone. Thank you for joining Metaco Talks, our live series of conversations with the people shaping and making the future of digital assets. I’m very happy to welcome Alex Lipton today. Alex and I have been working together, and know each other for more than four years today. We started teaching together at a university class at the Swiss technology university EPFL, on the field of blockchain and distributed ledgers.

Since then we have found many opportunities to collaborate. Obviously, Alex did not wait for me to work on many other related topics, whether on financial technologies, banking, physics, and one of these fancy topics that he loves so much and that I hope we have the opportunity to discuss today.

Alex, your curriculum details is so long, I don’t have the ambition to cover it exhaustively today. But I will just mention that you are today a Chief Information Officer at SilaMoney, which is very closely related to stable coin. I think this is going to be one of the topics we cover today. You are also a connection science fellow at MIT, and a visiting professor and Dean’s fellow at HUJI. But it’s not just about academia and industry, you’re also are now an entrepreneur with strong ties to multiple companies in FinTech and outside of Ziliqa and Clearmatics, are just two examples. I know you’re also an advisor to a Swiss bank, Sygnum.

What unites us today in this conversation is the fact that we are obviously very happy to announce this book that we have worked on, co-authored on blockchain and distributed ledgers, which is called Blockchain and Distributed Ledgers: Mathematics, Technology, And Economics. It’s now out and ready for pre-sale.

I would like to discuss this topic with you. Thank you very much for being here today.  Please feel free to jump in now and tell me a few words about your backgrounds and how you got involved into cryptocurrencies and into distributed ledgers technology. Was it a natural step for you after your experience in banking, in particular Bank of America? Or was it something that you ended up doing by chance or out of curiosity.

Alex: [00:02:34] Thank you very much, Adrien. Indeed, it’s a pleasure to be with you today, and as you said to present a little bit of our forthcoming book, which took us so long to write. But I hope the final product is of interest to the general public.

To answer your question, as you said, my background is varied. I did many different things in my life stretching from terminal nuclear fusion, to astrophysics; and from fluid dynamics to some other topics which I am not at liberty to discuss. But eventually I gravitated towards banking and worked at all kinds of leading investment banks of the world, starting with the fabled Bankers Trust.

I also worked a little bit at the famous hedge fund called Citadel here in Chicago, where I am now. Then when I moved to London to run the quant organization for Bank of America, I became interested (that was early 2010s, that is, 2013-2014) in    blockchain and Bitcoin and things like that. Then my company, Bank of America, moved me to New York to be a quantitative solutions executive for the firm as a whole. Part of my remit was the technical aspects of blockchains and investments and all kinds of ecosystem of growing companies. Metaco would be a private example if it were to exist at that time, but I think you founded it a year or two later.

I looked at it and was fascinated. I will be honest with you, my first inclination was more towards application of blockchain than the currencies themselves. I was somewhat skeptical for a little while, which I no longer am. I’m still not an enthusiastic zealot, but I certainly do see much more what people were telling me then, which I didn’t see.

I also feel that right now, honestly, we’re at the cusp which will move the system from the state in which it has been for a few hundred years, into something new. What it’s going to be and how it’s going to operate and all that remains to be seen. But we certainly live in a very, very interesting time.

Adrien: [00:05:37] You say that the system has been in some form over the last 200 years. What was it before? I know you’re an expert in understanding how money and currency interactions have evolved through time. Can you say a bit more about how this evolution is so special and potentially how it relates to previous evolutions, which have already occurred naturally?

Alex: [00:06:01] It’s an excellent question, and it’s something which I’m very keen on talking and writing about. We covered it a little bit in the book as well, naturally. But the point which I want to make, that money has existed through human history, and in fact, progress in money transmission and transactions is actually one of the underlying foundational blocks of the progress of the society as a whole.

Interestingly enough, in the ancient Sunna and in the Mesopotamia, the progress was made, which was then forgotten for millennia, literally. Money as records were known 2000 or 3000 years before the common era, and then more or less thoroughly forgotten for a couple of thousands of years. Money was predominantly in the form of objects.

But then, it became clear that it is not really commensurable with the requirements of the more complex growing economic system. Money as records became prevalent again. It initially occurred in the form of modern banking, in Venice and Genoa in  Italy, and then spread us through Lyon, the way with borders all the way up North to the low countries, and from the low countries after the 80 years of war between the Netherlands, which didn’t exist. They occurred as a result of the war. Then Spain, then it spread around to London, Paris, Zurich et cetera.

The idea became that there is a person and money, and there is an organization which handles this money. Essentially what we observed without any prejudice or anything, is a system aligned with the organization of the Catholic church, so to speak. You cannot read the Bible yourself, the priest has to interpret the Bible for you because it’s written in Latin and not that many people knew Latin. Of course, educated classes did to a degree, but many others didn’t.  There is a concept and interpreter, same as money. Unless you do a cash payment, you have to rely on a banker to do payment for you.

Essentially, if you and I wanted to exchange some value, it wouldn’t be directly between you and I. It would be between me and my banker, then your banker, and then you. This is the simplest possible connection.

Adrien: [00:09:15] The current system is based on the Catholic style of methodology.

Alex: [00:09:21] If you wish. Again, I don’t want to go into this aspect, but what I try to say is that maybe a better analogy would be like people using manuscripts to disseminate their ideas, and then comes to the printing press. It feels that the knowledge gap which existed in the 15th century, things changed dramatically. One of the consequences of that was the reformation. Reformation and the Protestant streak where you are no longer relying on the priest to interpret the Bible, you can read it in vernacular and understand what it means.

Now, I view these cryptocurrencies potentially as something along similar lines. In the ideal world, the way it was envisioned by Satoshi Nakamoto, not the world which actually materialized as of now, but I still have high hopes; in the ideal world I should just have some Bitcoin and if I need to send you a certain monetary value, I just send it from my address to your address and we’re done. Essentially there are no more bankers in between, provided that we’re consenting adults and we do know how to handle our security keys, private keys, secret keys, et cetera – which is by no means a trade to an individual level or even more so at the level of an organization. Again, in the book we do cover this topic of key security, which is in fact of paramount importance for the success of the whole thing.

This is the ideal picture. What we see right now is that direct usage of the money is not still quite possible. In reality, for an ordinary person to get Bitcoin, they have to become a member of a centralized organization, an exchange. Coinbase, Kraken, a myriad of others. That is an issue, to be perfectly honest. That’s something to think about and to work towards the ability of earning Bitcoins or other cryptocurrencies in a decentralized fashion and spending them in a decentralized fashion. That has not been resolved, yet the underlying layer which allows you to do this in principle is there.

Adrien: [00:12:12] That’s super interesting. You pointed out that exchanges are still very centralized, but we see protocols not clearing in the markets, facilitating peer-to-peer trading. Obviously, this works in conjunction with stable coins. Do you see a future where we don’t have to go to Coinbase, speaking of their massive success of this week, we don’t have to go through Coinbase potentially? We can directly access some form of value when distributed currency to P2P internet exchanges.

Alex: [00:12:46] That is what I would very much like to see, because that would be the actual implementation of this dream, if you wish. So the way it is, it all was reminds me of an aphorism from a former Russian prime minister, Viktor Chernomyrdin, who was a man of the people and a simple rustic individual. He liked to say: we wanted to do it as best as we could and it turns out to be as usual. That’s in a sense what we observe right now. To get a Bitcoin, you have to do it in a centralized fashion. Unless in fairness, you start selling some of your services for Bitcoins; then that is in principle possible to start doing things.

Adrien [00:13:38] Or if you mine.

Alex: [00:13:42] Exactly, you’re absolutely right. The reason why I said selling services for Bitcoin, I’m thinking in terms of an individual, because mining now is also in fact highly centralized. It’s not as it used to be. In Russia, they have this strange saying: you should mine while you’re young. But it’s too late right now to view mining as a real possibility of doing it. Decentralize investments and mining rigs are very, very substantial. If you really do it as an individual, having a few mining rigs in your garage, then of course you might probably get something out of it, but it’s so infrequent and so unpredictable that people pretty much prefer to join gigantic mining pools, of which of course the heart is in China. But there are many others. Chinese mining pools are particularly big.

My take on it is that we absolutely should develop further decentralized finance. It’s the most exciting things happening right now. If and when it reaches maturity, we will see fantastic things.

Adrien: [00:15:15] Alex, you’ve been in banking. I tend to believe, and sometimes I clash with bankers on this topic, that banks started as being essentially vaults. In the center of the village you had this place with a highly secure vault securing different kinds of assets. Then banks started adding different value-added services, like loans and things like that. Do you think that it is possible that with the advance of DeFi, banks actually have to get back to being simple vaults because everything else becomes decentralized?

Alex: [00:15:49] This is a super interesting question. I struggle with it myself and have been writing about it. Well, we wrote about it in the book. Also, I haven’t been writing before and after. In a few weeks’ time, I hope an opinion piece which I wrote at the invitation of Barron’s business newspaper in the US, will appear where I discussed that very issue.

The answer to your question is, I envision the separation of the entire banking industry into narrow banks (I will explain in a moment what it is) and investment pools. Narrow bank is a bank which, as you say, is just a vault. Of course for somebody like the CEO of Metaco, which is a really interesting company, the meaning of the vault has changed compared to what it was. Even though, make no mistake, people still keep vaults for their valuables. In fact, I just heard about a project by some people in New York who want to have a stable coin anchored in gold. According to the prospectus, they secured $6 billion worth of gold bars, which they plan to store somewhere in Switzerland, of course. That is one type of vault.

The other type of vault is electronic. A narrow bank is a bank which cannot fail due to market forces, but potentially can fail because of technological failures and the vault not being strong enough. That certainly is a struggle between the robbers and cops. Like people who try to break the electronic security and the people who try to protect it. In my mind, a pure, cryptographically oriented security is necessary, absolutely. But it has to be strengthened with hardware, which is also hardened.

Essentially, a narrow bank is just a bank with sole assets in a Fiat bank. The electronic money is held at the central bank, and depending on the definition and the broadness of your vision, similar financial instruments like very short dated bonds and stuff like that. That’s one thing.

The other thing is credit creation. Right now, the two are commingled, which in fact in my mind is a major affliction of the banking system. When people are talking about banks, they are talking about banks as too big to fail. That is certainly an issue, definitely. Especially in countries like the United States, or Switzerland for that matter – where two of your banks dominate the landscape and one of them had its fair share of Blinders, shall we say? To be polite. I am not going to go any further, but I’m sure everybody knows what I’m talking about.

But the problem is not so much that they’re too big to fail. They’re too big to manage and too big to regulate. These are the aspects which I would like to emphasize. The reason why is that they violate the division of labor theory, which was articulated by the French encyclopedias and also by Adam Smith and everything else. He was describing this pin factory; somebody else pulls the wire, somebody else cuts the wire, somebody else sharpens the pin, et cetera. This why they were able to produce such marvelous things at very low prices. Banks commingle keeping records and making loans. If you think about it, do you really want to be a customer at the bank where you have your money, and again, I will explain what I really mean by money, because if you think that you have money in the bank, you’re actually mistaken. At least in the Anglo-Saxon law, you’re just a junior unsecure creditor. It’s not like you really have the money.  If something were to happen, God forbid.

Then banks do loans for which you are not being compensated at all. This really is not the right business model anymore. It might have been when interest rates were kept at the natural level. By natural level, again reasonable people can disagree, but I would say 3-5% is where we need to aim at interest rate. This is not what we see at all. In America, it’s hovering around zero, in Switzerland it’s negative, Denmark negative, Europe I’m not 100% sure but it’s probably negative to zero. There is no longer compensation.

The first thing to do is to separate. Banks keep records. If you are feeling that the blockchain is not good enough for you or you are not good enough for blockchain in the sense that it’s too hard to maintain all the keys, et cetera, then there are investment pools. Investment pool, you put your money in and it’s being loaned. The fractional reserve model will switch to something else. It will just change the velocity of money, so to speak.

If I were to lend you, for example, a pen, the way it works is that I have a pen and I give it to you. I don’t have a pen anymore. With money, it’s not like that. When a bank lends you money, it’s not like it has money somewhere which it gives to you. It creates money out of thin air. Right now, this tendency is a little slowed more for lack of demand and lack of will, if you wish, from the commercial banks. By the principle of substitution, by the fact that central bank became a fractional reserve bank, at least in America and to some degree in Switzerland, where the Swiss national bank actively purchases at least foreign currencies, if nothing else. In America, the balance sheet of the federal reserve grew by a factor of 10 over that many years, over 12 years. Right now it’s about 7 trillion. It used to be 700-800 billion before the financial crisis of 2008.  We see complete, complete separation and changes. The banking industry is not in a state of equilibrium right now, let me put it this way.

Adrien: [00:23:09] Has it ever been? Let me ask you a question: when Bitcoin was launched in 2008, Satoshi included this famous sentence in the first block that’s obviously critical of the way is managed today, the way banks have been saved by the taxpayers. Do you see this as being saved by the central banks today? Do you think we are improving or do you think that potentially the situation has worsened, and we may be facing what Satoshi kind of predicted, which I wouldn’t say collapsed but at least a significant degradation of the economic environments, which may lead to alternative assets becoming dominant such as cryptocurrencies, where the supply is algorithmically tapped?

Alex: [00:23:55] That is a very interesting question. Algorithmically tapped supply for money per se might not necessarily be such a great idea, because it’s tantamount to central planning. You did not mention that when you were describing my life trajectory, but I was born and bred in Moscow, Soviet Union. I left a long time ago, but I still remember the results of central planning, which were far from being perfect.

I would say, an asset which has algorithmic supply or fixed supply, it has a great advantage potentially as a store of value. Whether it has significant advantages as a medium of exchange remains to be seen. In a sense, what we see if we were to measure everything in Bitcoin, an enormous deflation of assets. If you’re lucky enough to have a Bitcoin and you want to go on vacation, will you really cough out a 10th of your Bitcoin or 20% of your Bitcoin to go somewhere nice, but then you paid. In six months’ time, of course, it’s like you’re paid twice as much. That stops people from using it for this purpose.

Adrien: [00:25:30] Sorry to interrupt. Is it bad, though? This is always a debate. Some would argue that you need a discretionary currency to anchorage consumption. But others would say having discretionary assets actually encourage people to save, which potentially is a much better equilibrium. Even though people may buy less iPhones per year or less consumables, potentially that’s actually something which is healthier. What do you think?

Alex: [00:26:00] That is possible. In fact, definitely with the current inflationary model, as it is implemented by central banks throughout the world, there is a substantial hollowing of the middle class for the simple reason that there are no more vehicles for saving. John Maynard Keynes pointed out that money is the only link between the past and the future. It was traditional that you work for say 40 years and then you enjoy your retirement, and your money works for you when you enjoy your life. This is no longer the case in the traditional economies.

If you saved a million dollars say 30, 40 years ago, you could live on the interest for the rest of your life. Maybe not a luxurious life, but certainly a very decent life. Now, of course it gives you nothing. The bank for a million dollars, first of all it might not even want your deposit of a million dollars. But if it does, instead of interest you would receive a coffeemaker from your bank, or a toaster.

You see what I’m saying? That’s certainly a possibility of thinking of a highly deflationary environment as advantageous to savers. I would say, very sharp appreciation of the main medium of exchange probably is bad. It all has to grow and shrink with the economy itself.

Bitcoin, for example, grew by a factor of at least 5. In fact, more than that, maybe even 10. It depends. With Bitcoin it always depends on where take the starting point and current.  But say 5, 10 times over this period of one year. For economic activity, it seems to be a little too brisk. I would prefer from that perspective, to see an appreciation of say 10-15%, if one were to think about it seriously, from an economic perspective.

Adrien: [00:28:29] Could we say, Alex, that in the past the central bank currencies, the national currencies, have been protected to some degree by the fact that they were the only ones to be really liquid, in the sense you could use them to buy a piece of bread, to buy anything anywhere, essentially. But now this equilibrium is changing because Bitcoin or some cryptocurrencies are becoming extremely liquid. You can use them in more and more shops, sometimes it can be converted on the fly to national currencies.

Would it be fair to say that in such an environment, even if potentially some economists would argue with that national currency with a little bit of inflation is better than a deflationary Bitcoin, but intimately both are now liquid. The markets will decide and savers will ultimately decide if they prefer storing 95% of their assets in Bitcoin, and potentially just moving it into an inflationary currency last minute, when they are forced to do so.

Alex: [00:29:29] That is entirely possible. There is a very big nuance which we need to appreciate, which is that if Bitcoin were to become a medium of exchange on par with Fiat currencies, an interesting phenomenon will occur. That is, there would be initially a huge inflation. Think about it in very simple terms. If Bitcoin is used as a store of value, that’s fine. Bitcoin, all was bought and sold or mined. But mining right now, I would say is already secondary in importance, because now they mine about a thousand Bitcoins a day. Given that there is already 18 million Bitcoins, that’s not a lot. Then it will be decreasing with a predicted schedule.

If it’s used as a store of value, that’s fine. You paid your 50,000 and received the Bitcoin, and somebody sold it to you and received 50,000. For buying goods, there is only 50,000 right now because Bitcoin sucked it out of the system as being used as storage.

Now imagine that, as you say, more and more you can actually buy Bitcoin, and willing to use it. For example, to buy a Tesla. To be perfectly honest, I don’t anticipate Bitcoin being used to pay for coffee and that sort of thing anytime soon or ever, because it’s not designed along these lines. I would say that other currencies can certainly be used, be it being stable coins or be it something else. But for bigger pieces, like a car, which cost $80,000 or maybe $100,000, maybe one or two Bitcoins, you do it. Then there are two ways of paying for the same good: Bitcoin and the dollar.

Essentially, twice as many tokens of value are chasing the same goods. That creates a big inflation. That was the major problem with Libra, for example. Libra, or Diem as it is called right now, they were saying that it will help underdeveloped countries and emerging economies, et cetera. The truth of the matter is that it would actually create a normal inflation. To use an example of Switzerland, it’s like attracting euros becoming also on par with the  Swiss Franc. Not just marginally being used here and there, and then border areas or ski resorts; but really if it were to become then there would be too much, so to speak. That is something to think about.

I would prefer for the time being to see Bitcoin as a store of value more than a medium of exchange. I think it’s in a sense what we really see. As I said, It’s also quite interesting. Some people think that Bitcoin can be used, for example, in the corporate treasury, and we know some examples. Some others don’t. It’s very interesting that the number of Bitcoins, which for example, the mighty Coinbase has, is much less than one would expect. They only have, what? 4,000 or 5,000 Bitcoins. It’s not a lot.

It’s a complicated struggle between prudence on one sense, and a few of the others on the other hand. It’s all very interesting to see and participate a little bit.

Adrien: [00:33:37] Alex, what would you say then is the right payment protocol? Bitcoin may determine the more efficient payment protocol, for instance, for more scalable, less extensive transactions. But one can still argue that it has some properties which make it great for savings, but less great for payments.

We have seen out there many initiatives for stable coins. Some of them are algorithmic, some of them rely on the distributed ledgers. You are obviously very close to your own initiatives, SilaMoney.  How does it aim to solve these considerations?  How is it potentially avoiding this inflationary crisis?

Alex: [00:34:20] This is a very interesting question. Thank you for asking, it gives me an opportunity to plug in www.silamoney.com, which I don’t want to spend too much time. People can go to the website and see for themselves. But what we are trying to do, we’re trying to merge the cryptos, stable coins and stuff, with real economy demands for payments for startups and in particular for FinTech startups, or any other startups who need regulated payments. Make no mistake, as you were saying, the various mechanisms States protect the Fiat, they have an advantageous position in the food chain by being the sole issuers of Fiat and stuff like that.

One of the very important ones is that you have to do KYC, know your client, and anti-money laundering. That’s something which is baked in our Sila protocol and general offering from the very beginning. That is very important. I think, putting aside the discussion which we had earlier, there is a burning desire to be able to transact on the internet the same way as people transact in ordinary cash.  What we’re trying to do is to make it all regulatory compliant, to the best of our ability. That is what we feel differentiates us from others.

Also, the aim is to really use it in a real economy, as opposed to many stable coins like Tether, for example, and others, which are predominantly oriented towards exchanges. There is an old saying: if a man needs some wood, he will grow a forest. Exchanges really could not rely on banking services to allow getting in and out of cryptocurrencies like Bitcoin and Ethereum. Because of that, they had to invent stable coins, because then you can have a closed ecosystem which is being egressed infrequently and everything else is happening at a decent timescale. Otherwise, if you were to use bank transfers and so on to sell your Bitcoin, get your money and then go back, it would not be workable.

But our heart’s desire is to cover some of it as well as possible. But mostly, we want to squarely direct our activities on real economy – people really do payments and that sort of thing. That’s how I would describe it.

Adrien: [00:37:33] Understood. Alex, the DeFi (decentralized finance) has obviously grown substantially over the last few years. I find it interesting to see how issues that we face with stable coins in the past, where some of the initiatives that dates way before Bitcoin was invented, where a company would just have a bit of gold in vaults and then would create some form of a digital accounting system to transact. Well, they all faced the same weakness, which was that they were so centralized that the government would end up knocking at the door, and saying, “You’re favoring money-laundering and facilitating activities, we’re going to shut you down.”

To this, you can have two reactions, in my opinion. One is to do exactly what you’re doing, which is to say, we’re going to start from scratch, being fully compliant, and supporting the current regulations. Then there is another way, which is what DeFi has engaged with, which is to say, we’re going to try to avoid having a connection whatsoever, we’re going to have a stable coin which is based on inputs coming from Oracles that you find exchange rates. Yes, there is collateral, but this collateral is not something in the real world, it’s something like easer or some form of a decentralized token.

Do you think that, first of all, this is a sustainable system? In the context where you’ve lived through the 2008 crisis, you were in banking at these periods, you’ve seen how CDOs, collateralized debt obligations, have been one of the weak points of the crisis; do you feel that what is now a digital CDO on chain, is this something that’s sustainable? Or are we in the early days of a massive collapse.

Alex: [00:39:16] It’s a brilliant question, Adrien. I could not help but notice that indeed, I was in charge of modeling a lot of this collateral obligations. I was vehemently opposed, in fact, to the main copula model, which subsequently was blamed for that.

There were too many other problems. But it’s a matter of fact to that in 2006, Andrew Rennie and I held a conference at Merrill Lynch and published a book. I am not advertising, it’s no longer that interesting. But it’s a proof that some people, myself included, saw that coming. The book is called: Credit Derivatives: The Life After Copulas. That was done right at the height of the copula craze.

Anyway, as you said, one of those things which were characteristic to that was pooling resources, something which we also see in decentralized finance, and then slicing them into tranches where the lower tranches would absorb losses, protecting their higher tranches. Then of course the cash flows coming to the pool as a whole would be distributed appropriately. There might have been small mispricing of these cash flows coming from the topmost tranches, and that was supposed to be great ideal for getting something out of nothing.

For example, that was the undoing of AIG, the fabled insurance company. It was founded in China 100+ years ago, and then became omnipresent. What they were doing, they were saying: for a good measure we’ll sell you an insurance to these topmost tranches, because they will never be affected and so it’s free money for us. That’s not how it turned out to be. It is entirely possible that something like that might happen with decentralized finance as well. Make no mistake, a lot depends on the perception of the investors as much as on the reality. Even many of those AAA rated trenches, which blew up, in reality they didn’t blow up. They eventually, if held to maturity they paid everything they promised, and so on and so forth. But they had to be liquidated by banks in the interim because people thought that they had lost all their value.

It’s a very nuanced question which relates to a large degree, to what extent the price of the underlying, which is used as a collateral to create something stable, actually behaves in a reasonable way. The fact that financial prices are stochastic Is understood by all. The fact that they are predictable and non-stationary is understood by much fewer people. The fact that they can have tremendous jumps, appreciated by even a fewer number of people. That is something which can be the undoing of this super senior tranches. In particular, which I used as you say, to dynamically collateralized stable tranches in say Dow maker and stuff like that.

The other problem is that in the best of time, when everything is quiet and so on, this thing operates in the order reverse to how the conventional finance operates. In finance, they allow people to make purchases on margins, and we have seen something like that happening was our handlers. They were allowed to purchase, I don’t know exactly, but say a hundred billion for the sake of the argument, worth of various stocks, then some of the banks managed to liquidate them and some others have not. Those who managed to liquidate, they did not cover themselves in glory, but they didn’t lose any money. Others not only covered themselves in glory, but they also lost, like $5 billion here, $2 billion there. That is the danger, that if the underline starts to jump down very quickly, there might not be enough time to liquidate.

Nevertheless, I would say that it’s a very interesting development we see. Decentralized finance is really something new. Say what you want, but Bitcoin is something new, Ethereum is definitely something new, but it might actually be too new for its own good. I view Ethereum as a consensus, as a service provider, and that’s what we wrote about in the book. But there is a problem when it becomes too expensive. The service has also become too expensive, and it becomes very hard to use it.

The same story with decentralized finance, when you start using it in earnest it becomes too expensive. You have to pay so much for gas that small players cannot really do this. It’s only if you do 100,000 or whatever, 10,000 transaction, you say: I’ll pay 200 in fees. If you want to do 500 and pay 200 in fees, it’s kind of a much less attractive proposition. Still from a conceptual perspective, it is very interesting, I can say.

We cover it in the book a little bit. We talk about automated market-makers. That is really an attractive idea. The only thing to bear in mind is that when they talk about the impermanent loss, it’s actually a figure of speech. If the underlying exchange rate has been reverting, then of course the loss is impermanent. However, if something happens and then moves one way or the other, then it can very easily become permanent.

Still, as I said, conceptually it’s something new. It’s nice to live in this time and see new things developing all the time.

Adrien: [00:46:28] In times of this massive growth of NFTs, non-fungible tokens, are you Alex the proud owner of a crypto kitty, or a different kind of picture that us more to your taste?

Alex: [00:46:38] No. To be perfectly honest, I’m not. I was never able to understand the attraction of the modern art. I just couldn’t. It’s me, it’s not the art, I suppose. Similar with NFTs. But at least from a conceptual standpoint, NFTs is an electronic version of a print, for example. Some artists have been known to create enormous numbers of prints of their work. Dali is the prime example. As we all know, the idea of a signed print, it’s supposed that the artist looks at it against in the sharp light to see if there are any imperfections, then only sign it if it meets his or her exacting standards. If it’s bad, then it is destroyed.

As we all know, Dali was signing blank sheets of paper and then prints were created afterwards. Nevertheless, the idea is that you have something which many other people have as well, but yours is signed. There is a value in the signed one compared to the aesthetic value. Aesthetic value is probably the same. If you put in your living room a Dali print which is signed versus a print which is produced by the same publisher, which is unsigned, the difference is diminished. But in sales price, the price of ownership and whatnot, this is a very, very different. Same with NFTs.

The way I think about NFT is this, I’ll show you. Imagine that this is a baseball. Baseballs are what? $10 a piece or something like that, that’s what they go for. But if somebody great signs that for you, and it happens when you caught this on the stands and everybody saw it, and it’s on tape and everything, then it becomes suddenly a hundred times or a thousand times more expensive. Same with NFTs. You can have an electronic file, you can download like these 5,000 days. You’ll have it, probably. I’m not sure if you’re really able to have it in super fine resolution. I just don’t know, but suppose. Then, the one which is signed, it’s a very different one. That’s how I think about it. The idea is old, the implementation definitely is completely new. Definitely, the medium which is being used, et cetera.

How sustainable it is remains to be seen. In my mind, there are still some gaps. Again, the same way as I was saying that with security, you cannot just go for cryptography, but you have to go for a combination. Same there. I don’t really know what has to be done, but something along these lines.

One thing which is good is that, if this a baseball and it is signed and I gave it to you, and then you gave it to Jessica, et cetera, now it’s all recorded on a blockchain. The provenance is very easy to prove. As we all know, the vast majority of paintings in leading museums of the world – but I don’t want to name them because of legal problems – but any leading museum in the world I am sure that 50% of all paintings are fake. They themselves know it as well. The provenance is also a very hard to establish. Of course there were all this events during the war, when the chains of ownership were brutally broken. With this, at least if there are legitimate transfers from one party to the other, they’re all recorded. From the origin of this digital masterpiece to its current ownership, you can trace it all, and at least you can sleep well by knowing that you have a signed copy of a particular file rather than anyone else.

Adrien: [00:51:34] It’s a philosophical point. But does it mean that one can create value out of this air? We used to be able to use these pictures online, that they would be free or rights for most of them, and they would have almost zero value. Suddenly, just created some proof of origin has created millions, if not billions, of value out there, which didn’t exist. Let me push this to the extreme: does it mean that if everybody in this world starts tokenizing everything (your right arm, your left arm, your desk, your jar, your keys), does it mean that you end up actually creating wealth?

Alex: [00:52:16] No, I don’t think so. Everything is good in moderation. Bitcoin created this moment when the Bible was translated from Latin to vernacular, unfortunately immediately there is a crowd of people which separate you from your Bitcoin. Effective to Metaco to some degree, by providing services, which in principle self-sovereign people should be able to do themselves. But in practice, of course they can’t, just because it’s too complicated. It’s not so easy to be your own keeper of value and so on and so forth. Make no mistake, banks as vaults do play an important role. There are many things to say about a trusted keeper of value.

I think that with NFTs, time will tell to what extent it will stand. As they say, in principle you can sell anything provided that somebody buys it. What it really shows, without any shadow of doubt, is that existing macro-economic theory is not even wrong. They are just totally backing at the completely wrong tree, and this idea that markets are efficient and so on is just ludicrous. These are proofs, if any more proofs are needed, of the fact that you can sell something which had the zero value before, by a simple act of saying now you are the owner of a copy which can be traced from the origin. 60 million or whatnot. That doesn’t bode well, so to speak right, for the theorists.

Adrien: [00:54:15] That’s true. Alex, I have a question, by an anonymous sender. I’m still going to ask it. What is your thoughts on the barricades against Bitcoin? That is, oppressive governments do not like competition, and over time will crush Bitcoin by whatever means necessary? Appropriation, prohibition, overregulation, taxation, et cetera. What do you think, Alex?

Alex: [00:54:37] I think this is entirely possible, in actual fact. The fact that Bitcoin is decentralized and cannot be controlled by any single party is only partially true. It’s a much more nuanced situation than meets the eye.

First and foremost, as I was mentioning before, the mining is done in a highly centralized fashion. To imagine that governments do not know where the mining occurs is just not realistic. For example, we all know that a lot of mining is done and Mongolia and China, towards the Mongolian and Russian border, et cetera. Then of course, a lot of it is also done where there is available hydroelectricity and things like that.

But by the very nature of this mining, mining is not decentralized. It’s done on a humongous hangar full of rigs. If governments were to really go after that, they certainly have technical means of doing it. Whether they want to do it, remains to be seen. But taxation and things like that is desirable, because it will be wrong in some sense, to have an…

Adrien [00:56:03] I don’t know about that!

Alex [00:56:09] In my mind. I’m not speaking for both of us, I’m speaking for myself. I think that taxation is necessary. All right, let’s not go there! But taxation is desirable to make it a reasonable asset class and more institutionalized and so on and so forth. Money, as I mentioned already, comes along with KYC, to some degree AML, which certainly needs to be robustly implemented in taxation. All these per se is not so bad.

Let me put it this way: whether a government really wants to shut down Bitcoin remains to be seen. If they do want to do this, they do have technical means of doing it. Perhaps not at the level of an individual government, but as the level of say a group of governments. Let me leave it at that.

Adrien: [00:57:05] Alex, thank you very much for your time. We’d like to remind everybody that attended this discussion that the book that Alex and I co-authored, is now available. You can pre-order it. It’s on the publisher, but the link is available on the invites to our Metaco talk today.

Alex, thank you again, and I hope that we have do have the occasion to follow up on this fascinating discussion.

Alex: [00:57:32] Thank you, Adrien. It was a real pleasure. I wish every success to Metaco. It was a pleasure writing a book with you. Hopefully, if we manage to do this, we might be able to sell it for one of the cryptocurrencies. If we managed to overcome technical hurdles, which are not insignificant. But it would be a good test case. Thank you, Adrien, best of luck. Thanks everybody else. Goodbye.

Adrien: [00:58:01] Thank you.


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