Still grappling with crypto basics? You’re not alone

‘At present, society is split between a small minority of players with a PhD-level of understanding and a kindergarten audience’

Gillian Tett

    © Shonagh Rae

In recent weeks, I have embarked on a journey that many investors have travelled before me. 

I put a metaphorical wet towel over my head and immersed myself in the world of cryptocurrencies.

It has been strikingly hard. 

This is partly because crypto, like any area of accelerated innovation, is a cultish place where insiders have extensive knowledge that defines them as a tribe. 

At present, society is split between a small minority of players with a PhD-level understanding and a kindergarten audience, with little in between.

The other problem is that this world requires an unusual blend of intellectual skills. 

Alexander Lipton, a friend, Wall Street veteran and maths professor, outlines the issue in a book he recently co-authored on the topic, Blockchain and Distributed Ledgers.

Cryptocurrencies, the book notes, lie at the intersection of three fields: “(a) cryptography (to ensure the integrity of transactions); (b) game theory (to establish consensus on the state of the ledger); and (c) economics (to design proper economic initiatives)”.

Most people may understand two of the three, but “mastering all of them is a tall order”. 

In other words, working out whether a particular cryptocurrency is a Ponzi scheme or not demands a knowledge of computer science and finance and psychology or anthropology.

To see why this matters, consider the issue of “decentralised autonomous organisations” or DAOs, a feature of the ethereum ecosystem. 

These are quasi companies, but they are run by automated computing programs, not humans, to organise participants to perform joint projects (usually financed with cryptocurrencies).

If there was an institution such as a regulator overseeing DAOs, or a well-known bank running one, investors could judge whether a DAO was trustworthy based on their level of trust in that institution. 

But there isn’t. Instead, trust rests on the computer code, which is (supposedly) structured in a way that creates incentives for all DAO participants to behave responsibly (for example, by offering a transparent way to track behaviour and ensuring that anybody who misbehaves will suffer penalties).

However, you cannot check whether trust is justified unless you understand that computer code. 

And you probably can’t work out the worth of a DAO’s activity without knowledge of economics and game theory, which would allow you to ascertain, for example, whether the community has a joint interest in protecting its value.

(This is not a theoretical issue. 

As two recent books, The Infinite Machine and Out of the Ether, explain, there was a massive hack on a DAO project in 2016 that almost saw the entire ethereum system implode until the community rallied to save it.)

So why do relatively few people understand all three crypto fields? 

Basically, our education systems do not yet train students in this way, while institutions such as banks tend to put people with these skills into different departments. 

The IT team is not the same as the economics research group.

In the regulatory world, the institutions with oversight of IT and finance have also traditionally been kept separate. 

And even if you “just” consider financial regulation, there is another challenge around definitions. 

In a country such as the US, products that are securities are regulated by the Securities and Exchange Commission. 

So, if bitcoin is a security, it falls under the SEC.

But if it is also a money or payments system, as many crypto evangelists insist, it should fall under the wing of the Federal Reserve or the Office of the Comptroller of the Currency. 

If it is better viewed as a commodity such as gold, then it is the responsibility of the Commodity Futures Trading Commission.

Crypto evangelists say their tokens are all three. 

But a world where everybody could take charge is a place where nobody might actually feel empowered to act, particularly given that regulators are national in scope but the market is cross-border in nature.

So you don’t just need three pools of knowledge to understand cryptocurrencies on a micro-level, but on a macro-level too: you cannot predict the future of crypto without judging the health of fiat currency and the global financial system, nor without a knowledge of computing trends. (A judgment about the value of crypto is also a forecast about whether breakthrough technologies such as quantum computing might enable cryptographic passwords to be hacked.)

To predict the future of crypto also requires political and social analysis: will governments try to control this? 

Could they? 

Will they work together?

Of course, such problems of epistemology are not unique to cryptocurrencies. 

But it is the speed, scale and ambition that make it so hard for our institutions to catch up. 

Along with our brains.

So if, like me, you feel stuck in crypto kindergarten, don’t be ashamed. 

There is a good reason for this, and it’s the same reason regulators and organisations need to reorganise themselves for the 21st century, as do schools and universities. 

Faced with crypto, we need to deploy curiosity and humility — not qualities normally displayed by educated elites.

The people’s panopticon

The promise of open-source intelligence

It is a welcome threat to malefactors and governments with something to hide

The great hope of the 1990s and 2000s was that the internet would be a force for openness and freedom. 

As Stewart Brand, a pioneer of online communities, put it: “Information wants to be free, because the cost of getting it out is getting lower and lower all the time.” 

It was not to be. 

Bad information often drove out good. 

Authoritarian states co-opted the technologies that were supposed to loosen their grip. 

Information was wielded as a weapon of war. 

Amid this disappointment one development offers cause for fresh hope: the emerging era of open-source intelligence (osint).

New sensors, from humdrum dashboard cameras to satellites that can see across the electromagnetic spectrum, are examining the planet and its people as never before. 

The information they collect is becoming cheaper. 

Satellite images cost several thousand dollars 20 years ago, today they are often provided free and are of incomparably higher quality. 

A photograph of any spot on Earth, of a stricken tanker or the routes taken by joggers in a city is available with a few clicks. 

And online communities and collaborative tools, like Slack, enable hobbyists and experts to use this cornucopia of information to solve riddles and unearth misdeeds with astonishing speed.

Human Rights Watch has analysed satellite imagery to document ethnic cleansing in Myanmar. 

Nanosatellites tag the automatic identification system of vessels that are fishing illegally. 

Amateur sleuths have helped Europol, the European Union’s policing agency, investigate child sexual exploitation by identifying geographical clues in the background of photographs. 

Even hedge funds routinely track the movements of company executives in private jets, monitored by a web of amateurs around the world, to predict mergers and acquisitions.

osint thus bolsters civil society, strengthens law enforcement and makes markets more efficient. 

It can also humble some of the world’s most powerful countries.

In the face of vehement denials from the Kremlin, Bellingcat, an investigative group, meticulously demonstrated Russia’s role in the downing of Malaysian Airlines Flight mh17 over Ukraine in 2014, using little more than a handful of photographs, satellite images and elementary geometry. 

It went on to identify the Russian agents who attempted to assassinate Sergei Skripal, a former Russian spy, in England in 2018. amateur analysts and journalists used osint to piece together the full extent of Uyghur internment camps in Xinjiang. 

In recent weeks researchers poring over satellite imagery have spotted China constructing hundreds of nuclear-missile silos in the desert.

Such an emancipation of information promises to have profound effects. 

The decentralised and egalitarian nature of osint erodes the power of traditional arbiters of truth and falsehood, in particular governments and their spies and soldiers. 

For those like this newspaper who believe that secrecy can too easily be abused by people in power, osint is welcome.

The likelihood that the truth will be uncovered raises the cost of wrongdoing for governments. 

Although osint might not prevent Russia from invading Ukraine or China from building its gulag, it exposes the flimsiness of their lies. 

Eliot Higgins, Bellingcat’s founder, is right when he describes his organisation as “an intelligence agency for the people”. 

No wonder that Russia’s spy chief railed against it, most recently just this month.

Liberal democracies will also be kept more honest. 

Citizens will no longer have to take their governments on trust. 

News outlets will have new ways of holding them to account. 

Today’s open sources and methods would have shone a brighter light on the Bush administration’s accusation in 2003 that Iraq was developing chemical, biological and nuclear weapons. 

That would have subjected America’s invasion of the country to greater scrutiny. 

It might even have prevented it.

Some will warn that osint threatens national security—as when, for example, researchers use data from fitness trackers to reveal remote cia outposts and radar satellites to locate American missile-defence systems. 

But, if osint can tell the world about such things, a country’s enemies are already able to know them. 

Pretending otherwise does not make states any safer.

Others will point out that osint can be wrong. 

After the Boston Marathon bombing in 2013 internet users scrutinised the crime scene and identified several suspects. 

All were innocent bystanders. 

Or osint could be used by bad actors to spread misinformation and conspiracy theories.

However, every source of information is fallible and the scrutiny of imagery and data is more empirical than most of them. 

Hence, when osint is mistaken or malign, competing osint is often the best way to put the record straight. 

And over time, researchers and investigators can build a reputation for honesty, sound analysis and good judgment, making it easier for people to distinguish trustworthy sources of intelligence from charlatans.

The greatest worry is that the explosion of data behind open-source investigations also threatens individual privacy. 

The data generated by phones and sold by brokers let Bellingcat identify the Russian spies who last year poisoned Alexei Navalny, an opposition leader. 

Similar data were exploited to pick out a senior Catholic priest in America, who resigned last month after his location was linked to his use of Grindr, a gay dating app.

A see-through world

The privacy of individuals in a digital age is fraught with trade-offs. 

At the level of states and organisations, however, osint promises to be a force for good. 

It is also unstoppable. 

Before the invasion of Afghanistan in 2001, America’s government was able to buy up virtually all the relevant commercial satellite imagery. 

Today too much data are available for that to be possible.

A world where many American, European, Chinese and Russian satellite companies vie to sell images is one of mutually assured surveillance. 

This is a future that open societies would be wise to embrace. 

Tools and communities that can unearth missile silos and unveil spies will make the world less mysterious and a little less dangerous. 

Information still wants to be free—and osint is on a mission to liberate it. 

Here’s what globalisation has done to inflation

We’re not sure we buy Powell’s argument that this trend survive the pandemic unscathed.

Claire Jones 

          © Bloomberg

Lots of words will be written about what Grandmaster Jay had to say about tapering at Jackson Hole. 

We’re not going to add to the chatter.

Instead, we want to draw your attention to another aspect of his speech: the chart below. 

The graphic shows that the cost of durables, often made abroad, has persistently fallen over the past 25 years — by an average of 1.9 per cent a year, according to Powell. 

At least, up until the pandemic began. 

Inflation in services, which are often produced domestically, meanwhile, has increased every year.

It’s a great example of the disinflationary impact of globalisation in the US and, indeed, elsewhere.

For reference, here’s what’s happened to world trade and global GDP over broadly the same period:

One part of Powell’s speech that surprised us was his confidence that global forces would remain as deflationary post pandemic:

The pattern of low inflation likely reflects sustained disinflationary forces, including technology, globalisation and perhaps demographic factors, as well as a stronger and more successful commitment by central banks to maintain price stability . . . 

. . . While the underlying global disinflationary factors are likely to evolve over time, there is little reason to think that they have suddenly reversed or abated. 

It seems more likely that they will continue to weigh on inflation as the pandemic passes into history.

This doesn’t square with what we’re hearing in trade circles. 

A report produced by US bank Citi and the Economist Intelligence Unit, which came out earlier this week, for instance, was full of examples of executives saying they want to diversify their supply chains, or move production closer to home. 

That won’t come cheap.

Of course, a lot of this is just talk. 

But we’re nowhere near as confident as the Fed seems to be that executives won’t at some point start putting their money where their mouth is.

Wavering US investors cut leverage for first time since start of pandemic

Borrowings to buy securities dipped to lowest level since March

Eric Platt, Ortenca Aliaj, Madison Darbyshire and Joe Rennison in New York

The decline in loan balances follows a stellar run for US stocks, with the S&P 500 up 19.7% this year © Bloomberg

Investors in the US have started to dial back their use of leverage for the first time since financial markets were rattled by the coronavirus crisis last year, removing some of the borrowed money that has since fuelled a rally in stocks.

Investors had borrowed $844bn against their portfolios in July, down from a record $882bn a month earlier and the lowest level since March, according to data collected by Wall Street’s self-regulatory body, the Financial Industry Regulatory Authority.

Separate data from Goldman Sachs, which runs one of the largest prime brokerages in the world, showed that the investment bank’s hedge fund clients had cut both net and gross leverage in recent weeks. Morgan Stanley has also reported long-short equity hedge funds that trade through it reducing their leverage, while bankers at other large New York-based prime brokers said a similar trend was under way.

Finra does not publicly disclose who is driving the shifts in leverage each month, and it was unclear if the many retail investors who began day trading during the pandemic have also curtailed use of margin loans. 

More comprehensive data from the Federal Reserve on hedge fund leverage is not yet available.

Interactive Brokers, which serves 1.5m customers, disclosed this month that margin loan balances among its clients had declined 2 per cent in July from the month before to $47.9bn. 

At Charles Schwab, margin balances in July rose by the smallest pace since the retail broker began disclosing the figure on a monthly basis this year, although it still hit a record of $79.9bn.

Mark Aldoroty, who runs prime services for Pershing, a division of Bank of New York Mellon, said fund managers had less faith in how the market might trade in the months ahead.

He pointed to the unexpected move by Chinese regulators to tighten their grip over both the technology and education sectors, which wrongfooted funds that owned Chinese stocks. 

The swings in US stocks in recent weeks, as economic data has broadly fallen short of expectations, has also shaken investor confidence in the rally.

“You have to start thinking, ‘My conviction might be right but does it matter?’” Aldoroty added. 

“Because of the way the market has traded, it’s not necessarily that pure fundamental research drives decisions any more.”

The losses on Chinese tech stocks have been particularly painful for large hedge funds. 

The Nasdaq Golden Dragon China index has fallen just over 46 per cent from an all-time high set in February.

In an analysis of 813 hedge funds with nearly $3tn of gross equity positions, Goldman Sachs noted that a third held Chinese stocks at the start of the third quarter, with many making large bets on one: Alibaba. 

The company was among the 10 largest holdings at Bridgewater, the world’s largest hedge fund, and was also a sizeable stake at Tiger Global Management and David Tepper’s Appaloosa Management at the end of June, according to filings with the Securities and Exchange Commission.

Many large hedge funds cut their stakes in Chinese securities during the second quarter, given the share price declines.

In the US the economic picture has also grown hazier, as coronavirus cases have surged and economic indicators such as consumer sentiment and manufacturing indices have shown a cooling trend.

The reduction in borrowing follows a stellar run for US stocks, with the benchmark S&P 500 index up 19.7 per cent so far this year. 

The rise has been supercharged by economic stimulus out of Washington. 

But the fact that many investors have bought into the market with borrowed money has raised red flags for regulators, particularly given the limitations of data that do not capture some trades involving swap derivatives.

It was a point crystallised by the implosion of Archegos Capital Management in March. 

The investment group’s soured bets resulted in more than $10bn in losses for its trading counterparties including Credit Suisse and Morgan Stanley. 

And the fact the investment group used total return swaps, instead of buying the stocks outright, meant regulators had little insight into brewing troubles.

The Federal Reserve warned in May that the tools it and other regulators had to gauge hedge fund leverage “may not be capturing important risks”. Many hedge funds also use options to magnify returns.

Banks have tightened the terms of margin lending with some clients after the Archegos affair, requiring some hedge funds to post additional collateral, according to bankers at several large dealers. 

But the bankers said those reviews were mostly undertaken months ago and were not driving the recent decline in leverage.

Trading activity has also moderated in the months since Archegos captivated Wall Street, including in many of the stocks that had been propelled by new retail traders who had taken to free apps such as Robinhood to try their hand in markets for the first time.

“There was a certain level of aggressiveness in the trading early this year that made people more willing to make levered bets,” said Steve Sosnick, chief strategist at Interactive Brokers. 

“Now the levels of margin we are seeing seem to be less about speculating via margin, and more about investing via margin.

“The levels of participation we were seeing at the start of the year were unprecedented and probably unsustainable.”

Helping the Poor to Survive Lockdown

The Hrishipara Daily Diaries Project has been tracking the daily spending of 60 poor households in rural Bangladesh for the last six years. Analysis of the data collected – especially the changes to spending patterns that have occurred during the pandemic – reveals four areas where policymakers should step in.

Risto Rönkkö, Stuart Rutherford, Kunal Sen

HELSINKI – Even as rich countries begin to glimpse the light at the end of the pandemic tunnel, developing countries are struggling to contain COVID-19. 

But there are important lessons from the past year that can help governments to devise more effective policies and programs to support their poorest residents amid continued outbreaks and lockdowns.

One valuable source of such lessons is the Hrishipara Daily Diaries Project (HDDP), which has been tracking the daily financial transactions of 60 poor households in rural Bangladesh for the last six years. 

Analysis of the data collected – especially the changes to spending patterns that have occurred during the pandemic – reveals four areas where governments should step in.

First, policymakers should ensure access to emergency cash. 

The rural poor are no strangers to shocks to their livelihoods. 

Droughts and floods are recurrent features of their lives, as are serious illness and job losses. 

But they usually have some access to lifelines: they can tap into family-based mutual-aid networks or borrow from microfinance institutions, money lenders, and friends and family.

That was not true during the COVID-19 pandemic. 

Restrictions on movement meant that households could not visit extended family to seek financial support. 

And even if they could, with everyone’s livelihoods squeezed at the same time, friends and family often had nothing to offer.

Harsh lockdowns in many places also forced microfinance providers and other financial institutions to close, preventing households from borrowing or even withdrawing their savings. 

The 60 Bangladeshi households in the HDDP study halted almost all financial transactions during the government-imposed lockdown.

This highlights the urgent need for large-scale unconditional cash transfers from the state, disbursed directly to the poor with minimal paperwork. 

A crisis of this magnitude is no time for fiscal rectitude.

Second, poor people’s capacity to exercise agency and entrepreneurial spirit should be supported. 

The HDDP households were agile and resourceful in their response to the COVID shock, and showed impressive money-management skills.

Sometimes this took an entrepreneurial form. 

For example, Samarth, a farmer who grows crops and rears dairy cows on a tiny parcel of land, quickly recognized that barriers to road transport were driving up prices of goods from the capital, thereby driving down the prices of local produce that was usually exported. 

So, Samarth bought produce from desperate local farmers at very low prices and sold it at a temporary street market he set up inside Hrishipara. 

Local people, confined to their neighborhoods, provided the demand, and Samarth ended up with a major
boost to his daily income during lockdown.

Policymakers rarely account for such entrepreneurial instincts in devising programs to support the poor. 

This should change, with policies that encourage and reward these instincts – and improve poor households’ ability to harness them. 

For example, low-income households could be brought into consideration when devising “ease of doing business” regulations.

The private sector also has a role to play. 

In particular, the financial sector should develop flexible products that enable poor people to take advantage of opportunities that come their way. 

Of course, this also requires that governments ensure uninterrupted access to financial services during lockdowns.

Third, the poor need generous food aid, especially during lockdown. 

Even under the most difficult of circumstances, the HDDP subjects found ways to put food on the table, but at the cost of drastic cuts in other expenditures. 

Our analysis shows a sharp reduction in recurrent household expenditures other than food in the first month of lockdown (April 2020). 

Moreover, it was only in October – several months after lockdown ended – that those expenditures returned to pre-pandemic levels.

Finally, low-income households’ cash reserves need to be protected. 

Most of the HDDP subjects kept some cash at home for emergencies. 

The COVID-19 pandemic – and especially the lack of access to savings – meant that they kept those reserves to buy food and meet other basic needs.

Government and the financial sector should find ways not only to help secure these home-based reserves, but also to make it easier for the poor to replenish them.

Expanding the scope of cash disbursements, and making delivery more efficient, is vital, as is keeping mobile-money agents open during crises.

The Hrishipara diaries show that, during COVID-19 lockdowns, the poor had to fend mostly for themselves. 

Thanks to their ingenuity, money-management skills, personal networks, and past crisis planning, they managed to survive. 

But they also had to make great sacrifices. 

As governments devise strategies to support the poor not only during COVID-19 lockdowns but also in future crises, they should reflect on what happened to the HDDP households during the pandemic so that, next time, such sacrifices will not be needed.

Risto Rönkkö is a research assistant at UNU-WIDER.

Stuart Rutherford is Founder of Shohoz Shonchoy.

Kunal Sen, a professor at the University of Manchester, is Director of UNU-WIDER.