Web3 is a Scam, Not a Revolution

Paris Marx: Stephen, welcome to Tech Won’t Save Us!

Stephen Diehl: Hi Paris! Thanks for having me on. Been a longtime fan of the podcast and it’s great to be on today.

PM: Thanks so much! It’s great to speak with you. You’ve had a fantastic series of blog posts that you’ve released recently on cryptocurrencies, blockchains, NFTs, web3 — all of the things that seem to be in the conversation these days and that naturally don’t get enough critical analysis and critical perspective, and so I wanted to dig into these topics with you today. In the past I’ve talked to journalists and academics about this but you work in the tech industry as a software engineer and you know the technical side of these things so I think you can give us perspective that I didn’t get from those other people to give the listeners a fuller understanding of what’s going on here. I was hoping to start with a division that exists among technologists that you talked about in one of your blog posts, where you wrote that there’s one camp that is critical of these technologies that sees the deficiencies with them, but then there’s another camp that buys into the hype, that wants to believe in what is being promised. And naturally, you are on the more critical side of that — that’s why you’re on the podcast. So can you talk a little bit about this divide that exists, and why you find yourself on the critical side instead of the side that’s buying into all the hype.

SD: Absolutely, that’s a great question. So you’re right. Cryptocurrencies are probably one of the most divisive concepts in technology that I’ve ever seen in my entire career, actually. There’s a lot of things in technology that draw a lot of debate, like artificial intelligence and the efficacy of introducing bias into algorithms and those things, and there’s an ambient level of debate about those things. But there are thoughtful arguments on both sides about, you know, we should probably put more controls on these technologies, we should better regulate social media. These are all debates. And then there’s the cryptocurrency debate, which, at least among technologists that I know, is like Marmite. It defines a room; you either absolutely hate it, or you think it’s the Messiah, come to save us all from everything.

PM: I’ll just say on the Marmite question, not a fan.

SD: [laughs] Neither am I myself, actually. But then, you know the conversations I have with other software engineers, the way we talk amongst each other, when nobody’s listening, I daresay most of the people in our industry view these technologies with a great deal of skepticism because they’re very much solutions in search of problems, and when you ask people the most basic questions like “what is it useful for?” you’re either gonna get two answers: you’re gonna get some long decentralized technobabble, or you’re gonna get libertarian politics. You know, the state is debasing money supply and we need to put this technology in place that’s gonna safeguard us against the evil Fed or something. And as a technologist, I can see through the technobabble. That’s fine. What I find very strange is that it’s a very political technology at its heart. And that’s very hard to reconcile, because a lot of us in the technology sector, we don’t happen to share those conspiratorial views about monetary theory, so it becomes kind of hard to reconcile, like what is this technology actually useful for? Is it having a good impact on the world? And that’s the big divide I see among technologists.

PM: When I had David Golumbia on earlier this year he talked about some of that conspiracism that exists around these ideas that are associated with cryptocurrencies and these other technologies that we’re talking about.

SD: David Golumbia’s book is absolutely brilliant: The Politics of Bitcoin: Software as Right-Wing Extremism. He really goes into a whole history of the ideas that led up to the development of cryptocurrency, from the Austrian economists to the cypherpunks in the 90s to more right-shifting attitudes amongst venture capitalists and Silicon Valley. And that all feeds into the narrative that’s morphed into what has become the cryptocurrency movement.

PM: As you say, beyond the tech industry, there are also opinions by other people who are involved in this conversation and some of those big players would be investors who are putting a lot of money into this area, but also tech journalists who are covering it and who are giving the public the context to try to understand what is going on here. And as you write in your blogs, they also have certain incentives coming in to buy into the narratives that are being formed around them. Because they can either be good stories, or they can produce an opportunity for people to make a lot of money. So what do you see in their approaches to the issue of cryptocurrencies, blockchains, and things like this?

SD: That’s an astute observation, and it’s something that struck me when I started writing about cryptocurrency skepticism. I saw that the narrative that was being pushed by mainstream journalism — like Bloomberg, how Bloomberg covers blockchain technologies, or CNBC, or the traditional outlets — it’s always very, very optimistic and it’s always very, very short on the technical details. And as a technologist I would read these articles and I would be scratching my head about like “what are these people talking about?” They’re talking about things that are like perpetual motion machines and, like, oh we’re going to build a square circle — things that are completely logically incoherent. And all the time, the narrative of the project is always “oh, and also there’s a token attached to it that you should buy because this project is gonna go to the future.”

These crypto company has been around for, like, 13 years now. As far as successful businesses that have been built around this technology, you’re looking at exchanges. So, companies that literally their sole purpose is to bring more people in to trade more crypto tokens. There’s not a whole lot of use for any of this technology except speculation. There’s not a whole lot of businesses being built, and a fundamental question and the disconnect I see in how these things are being reported on, is there’s almost like no there there. It’s like if the iPhone was developed 13 years ago and was being sold as a coupon that you could eventually redeem for an iPhone at some point in the future, after 13 years. And that’s the way I see all of cryptocurrency. We’re still waiting for the killer app because I have not seen it yet. And that, to me, is this disconnect between the presentation, the marketing, and the technical reality, is a very strange phenomenon.

PM: You imagine the iPhone, there are no apps, it doesn’t even work as a phone.

SD: It’s a store of phone value. [laughs]

PM: You’ve talked about how all these technologies are solutions in search of a problem to solve, right? The technology that underpins a lot of this area is the blockchain, and the idea that all of these things should be on the blockchain, and this should be the foundation for how we develop these technologies in the future and everything should be developed on the blockchain. So can you talk about what the blockchain is, how it actually works, and what the problems that you see with it are?

SD: The blockchain is a very simple thing. In computer science terms, it’s what’s called a data structure. It’s a way of aggregating a bunch of transactions so they can be stored and reduced down to a single number called a hash. Then you combine that with something called a consensus algorithm, which is a way of reconciling changes to this ledger structure over time. It introduces this game theoretic mechanic by which different participants can add additional transactions to this ever-growing data structure. And that gives rise to something that you can use to sort of simulate financial transactions. You can think of it like a bank ledger that evolves over time, that says who owes who and it’s all denominated in this native currency of the blockchain, which is a Bitcoin or another token.

Blockchains work in the sense that they’re a one-trick pony for building cryptocurrencies — and cryptocurrencies do work. Obviously the networks are all running, it’s impossible to say that they don’t actually exist. It’s just unclear what they work to do. Because the narrative was that these things were being pushed as like a peer-to-peer payment system. Well, most people scrapped that idea like ten years ago when they realized that the technology doesn’t actually scale up fast enough to run more than like a small supermarket. These things are just incredibly slow, you know, thinking like you’re going to spend three days to confirm a transaction on some of these chains. And every single transaction is going to consume a vast amount of computational power to confirm the addition of one of these transactions, because that’s part of the consensus algorithm, which is this method by which you solve math puzzles to form a lottery in which people compete in this gamed adding of transactions. This is an insanely wasteful process that is wasteful by design in order to give the world this global lottery in which the tokens will be distributed out to the participants who confirm transactions.

This is a terrible way to build a currency. In fact, there’s a strong academic argument that these things could never possibly function as money themselves. But if we just look at the technology — yeah, you could build cryptocurrency. You could build speculative investments that are censorship resistant on top of them. And that does work. However, that’s not a terribly useful thing for the world: a speculative investment which exists to basically arbitrage financial regulation around the world? In which people can gamble on the random price movements of an asset that has no underlying value? Yeah, it works. It’s a cute trick, but I’m not sure what the societal value of that actually is. And then when people try to apply blockchain to anywhere outside the realm of cryptocurrencies, you end up with a solution which is effectively either completely pointless, doesn’t scale, or is strictly worse than just using a centralized database. That’s the big problem I see with these technologies: they don’t really work.

PM: What you’re saying about the time that it can take for these transactions to work reminds me of a video that was circulating a few weeks ago of a guy in El Salvador who was trying to buy a beer with cryptocurrency and he was standing at the beer stand for 20 seconds waiting for the transaction to actually go through. And it was like, if he had just used his credit card it would be immediate, it’d be done.

It’s important to point out the issues with these blockchains. In one of your articles, you wrote that Silicon Valley ran out of ideas and created the blockchain, and you called it a “simulacrum of innovation.” It’s a good term, and I wonder if you can go into that a little bit more because, as you just said there, many of these “applications” that blockchains are applied to could be better solved through centralized databases. And the worries and issues that can come out of that — if people want to know more about that, they can go back to my conversation with Olivier Jutel where we talked about how blockchain is applied in the Global South and how it’s used to marketize and create land databases — it’s a very neoliberal kind of politics. So can you talk a little bit about that element of it?

SD: It is kind of a simulacrum — this postmodernist term — of innovation because it’s a technology that precedes its use case. It’s a development that was invented and then it was in search of an application for itself. That’s a very strange thing, because usually innovation proceeds the other way around.

The use case about the beer is actually quite relevant because it’s much slower technology, and if you picture yourself as, say, you own a pub and you want to theoretically transact in Bitcoin, you’re gonna have to go to the brewery and you’re gonna have to source kegs of beer and bring them to your pub and ultimately serve them to customers, and if all these transactions are being done in Bitcoin, this hyper-volatile speculative asset, the time between the shipment to the brewery and a payment being confirmed from one of your customers — if the price of the asset is gonna change, or draw down like 80%, you’re losing money on the time between when you get paid for the beer, when you pump it into the pint of the customer, and when they actually settle their payment. And then you have to constantly update all of these prices because the underlying payment can change 80% in one day if Elon Musk had a bad day and tweets two emojis — suddenly your pub loses 90% of its inventory. This is not something you could ever run an economy on, and there’s no reason to think that these kinds of currencies will ever stabilize because there’s no central bank or issuer controlling the supply relative to domestic goods.

So when people talk about trying to apply these technologies, getting it to be like a widespread treasury layer for some theoretical technolibertarian utopia, they just don’t really think through the end state of what that would actually look like for your average person that tried to use it. That’s why the guy is sitting there tapping his phone on the beer line getting frustrated with it because it’s technology that, by design, could never function that way, and yet people are convinced that we need to keep selling it as a currency. That’s part of the narrative. It’s this sleight of hand between saying it’s a currency when it’s beneficial to call it a currency and it’s a speculative asset when we want to say, “how can I get rich off of it?” But those two are diametrically opposite. They’re logically incoherent, logically inconsistent with each other.

You don’t want a currency that’s gonna go up or down 80% in a day because you can’t run an economy on that, but you also don’t want a speculative asset that stays at 2% growth for 10 years because you’re not gonna get rich off of that, and I can’t reconcile the fact that people like to hold both of those thoughts in their minds at the same time about these assets and that internal logical inconsistency is what really bothers me about the technology and financial narrative around it.

PM: That makes a lot of sense, especially when you consider that something like Bitcoin is not used by a whole hell of a lot of people right now, and when you think about regular transactions that aren’t used for speculation. If you were to expand that and have every shop accepting Bitcoin, the time that it would take for those transactions would only increase because of the pressure on the network to process all these transactions because it’s not designed in an efficient way. It’s just fundamentally not something that is going to work in the long term if we’re thinking about how to build a proper financial system that is going to work in any meaningful way.

SD: The only way these things scale is ultimately by becoming the very centralized systems that they were designed to replace. The best way to run a great payment system is to recreate Visa, and you recreate a bank. At scale, the problem I see with these technologies is they’re based on this whole decentralization, libertarian narrative about not having any intermediaries or third parties. Yet, the very way that they would ever possibly be used is by becoming the very thing they were designed to replace. Maybe there is a place for some of these things to exist alongside the traditional financial system, but the only way that I possibly see that they would become that is by becoming part of very inefficient versions of technologies that already exist.

For example, wiring money across the world is a solved problem for the most part. I mean, we know how to move two digits in the computer. Two banks basically credit one account and they debit another account and that can get done as fast as you can update the database. If there are any inefficiencies in these processes, they’re entirely related to regulation, compliance, just the brute facts if you have two nation-states with two separate laws and two separate jurisdictions and two sets of consumer protections. Those are the roadblocks that most consumers hit up against in the traditional financial system, but those are not necessarily baked into the technology in any way, and if crypto technology is solving any of those problems, it’s because it’s basically just ignoring all the regulations. It’s a means to arbitrage capital controls or “KYC” — know your customer — requirements or terrorist financing restrictions, that kind of stuff.

Having worked in the financial services sector, those are very important things to be doing as a financial institution and they’re there for a very good reason, because if you remove them, then literally all sorts of criminal elements start using your service to launder money and all manner of bad things happen. The truth is that the financial services system has never been perfectly able to block all of those things, but it is a best effort and it does so in a way that protects most consumers, far more than they probably understand.

The big issue with the cryptocurrency system is it’s like capitalism but with all of the brakes and all of the controls basically just removed and this complete anarchic system in which everybody has to be their own bank, you have to run your own information security, and you have to safeguard your private keys against anyone who would kidnap and torture you to get them. I can’t possibly expect a world in which my grandmother has to become her own bank and defend her private keys from armed robbers who would want to steal her pension. I just don’t see this as a utopian vision of the world; I see it as a dystopia.

PM: As you describe, it’s a vision that only really works for the really technologically savvy people who were behind this from the beginning and forming the ideas behind it and not thinking about how it applies to everyone else. But what you were saying earlier about the only real goal with these technologies, the only real end game, being to recreate the system that already exists but with new players controlling it gets much closer to the reality than a lot of people who are putting out these narratives are admitting.

You can start to see that with what some of the major crypto companies are doing when they’re trying to lobby for favorable regulations in the United States right now. For me, what it does is remind me of the story of PayPal, which also emerged with all these promises of disrupting the financial system and giving everyone their own bank account and all of these grand promises and then when it came time to actually make money they started working with the government, they started following the financial rules, so they could be just another one of the big middlemen who are making a ton of money in the sector instead following through on all the libertarian ideas that were associated with the brand early on. So if you look back at that history you can see something similar playing out with cryptocurrencies today, and that if there is going to be a business and use case, it’s not going to be this decentralized libertarian utopia, they’re just going to become the new major company that is working in this space.

You mentioned the decentralization aspect of this, and that’s the next point that I wanted to get to. In one of your blog posts, you explain that these ideas of decentralization really work to justify a lot of technological utopianism that occurs in this space but around these technologies in particular right now. So can you talk about that issue of what these ideas about decentralization create and also how they misunderstand the idea of decentralization itself?

SD: That’s a really good point. So my industry in particular, in software, we fetishize this word “decentralization,” and it’s used analogously to a word like “democratization.” The conflation of the two is a fulcrum on which a lot of sophistry rests.

Decentralization is a term that comes from network topology, basically talking about distribution of data and how it flows through systems of computers, and there are certain networks that are decentralized. You’ve probably used these things like Tor or BitTorrent, those are examples of decentralized technologies where there’s no single point of failure in a system. These are very cool technologies, in a way. BitTorrent was a very successful protocol, even though it has use cases that were extralegal, but ultimately it was very useful as a pure technology. So decentralization tends to be the catalyst by which people pitch new ideas, and they use that word interchangeably with “democratized” — that we’re gonna treat people as if they were computers. Instead of taking data as it’s being distributed through a network, we’re going to actually diffuse power through a network of people. That’s the implicit assumption.

Generally from what I’ve seen of decentralized technologies so far, and we see this manifested everywhere in crypto, is: who’s actually getting rich off of these things? The answer is usually billionaires — people who have resources to allocate towards the development of these technologies, and to understand them enough to profit off, to continue their existence. These are the miners, the exchanges, all of the billionaires that are stockpiling crypto. This is the exact opposite of democratization; this is plutocracy: distribution of wealth to the already wealthy. My fear about cryptocurrency is it is this plutocratic technology that wraps itself in this populist narrative: “we’re gonna liberate the people from all of the perils that led up to the global financial crisis, we’re gonna fix all the problems with the banks, and we’re gonna decentralize them and remove all the middlemen that are causing all of your problems in your life, and if you could just invest in this coin today, it’s gonna solve all of your problems tomorrow.”

What actually happens is, at a macro-level, the cryptocurrency space looks like a giant regressive tax that transfers money from the poor and technically illiterate to sophisticated investors and early adopters and technologists. For a lot of people in my field, that’s great — they’ve gotten fabulously wealthy on the back of issuing these things. But if we ask the question of “what is it actually doing for the world?”, it’s reverse-Robinhood. It’s stealing from the poor to give to the rich. And I don’t see a way that these technologies morph into the populist narrative because of the logical and technical inconsistencies that are there.

PM: You’ve hit the nail on the head. As you were saying that, it brought to mind something that I hear on the crypto left as well, the people who say that they’re socialists but cryptocurrencies and blockchains are a means to some kind of liberatory politics that has a left-wing slant to it. They make the argument that these technologies are offering this unique opportunity for democratization through decentralization and also to empower people in ways that they haven’t had before because they’re getting away from these gatekeepers and massive companies and blah, blah, blah.

But at the same time, as soon as you start to interrogate and critique that question, when you start to point out, as you just did, that so much of this is controlled by really rich people and they’re the ones who are making the money off of it, all of a sudden they start to say, “yeah, but this is already a really unequal system, we can’t expect this to change anything right now without changing something greater.” And it’s like, okay, so now you are admitting that these technologies are not actually creating the benefits that you are saying, and that ultimately, to have those benefits, we’re going to need to change larger social structures. So then why would we base that change around these really libertarian technologies that are not delivering the benefits anyway? It just doesn’t make any sense.

SD: You see that narrative all over on the crypto left, that somehow these technologies are a shortcut to not engage with the political system and not actually interact with people and engage the political bodies and effect reform. We can do it with technology itself. We can just fix social problems with technology. And the history of technology has always taught us that you cannot fix human problems with technology. If anything, technology tends to introduce more human problems at the end of the day. So I remain very skeptical because these arguments are very lacking in details, they’re all very hand-wavy, like how is Bitcoin going to liberate the world? It seems to be doing the opposite.

There’s this reductive quality to a lot of those arguments. People see deep issues with our financial system — and don’t get me wrong, there are some deep problems with the current system, especially in the United States, with how it’s set up and banking access and income inequality and these are financial phenomena — but it’s overly reductive to say that they’re monetary phenomena. Those phenomena arise, in my opinion, out of the neoliberal policies for the last 40 years that have basically gutted the middle class and the dissolution of labor unions and the non-increase of the minimum wage. These are things that have largely given rise to the despair and the income inequality that we see in a lot of Western countries. To reduce that down to monetary policy is a very reductive argument. It’s a very seductive one, to say that there’s this one root cause and if we just fix that we’ll fix all of society. The Fed’s interest rate does affect macroeconomics and people’s lives, but there are probably six or seven other factors that I would say are largely contributing to the degradation of people’s lives far more than quantitative easing on the dollar, for instance, and I think we really ought to defy reduction down to monetary policy because it’s a simple answer but it’s also probably the wrong one.

PM: There’s also this really strong technological utopianism that comes with this, right? This belief that these technologies will deliver what the narratives say, ignoring the history of every other time that those narratives have been used in history and not delivered. When we think of a crypto left, then the solution is to adopt these technologies instead of having public banking and actually designing a banking system that serves the public, instead just hoping that these technologies are going to deliver something beneficial in the end. It just seems wild.

As you were talking about there, there needs to be this deeper understanding of cryptocurrencies, and you’ve already talked about them in relation to assets rather than currencies and why they don’t work well as currencies themselves. I wonder if you could maybe draw that distinction a little more because in one of your essays you talk about them not as cryptocurrencies but as crypto assets. So can you talk about that distinction?

SD: Cryptocurrency, for good or for ill, has become the term that the public has used to refer to a lot of different tokens, and if you look at the way the finance people and policymakers talk about these things, they usually refer to them as crypto assets. So if you read a white paper by the Bank of International Settlements where they do traditional financial analysis of these things, the term most people call it is an “asset.” They’re not a currency. So there’s a space of financial instruments that we have to understand. You have the monetary and the currency instruments, which is one category (things like the dollar, the yen, sterling). They serve as the function that fulfills three different purposes: it’s a medium of exchange, a store of value, and a unit of account. So things like the pound sterling satisfy that as the mechanism by which an economy sustains itself, by which we transact in, go to the pub and tap my card and get a pint of beer, it all just kind of works. They function in that capacity.

PM: And you don’t have to wait a few minutes for it to work.

SD: It’s contactless, Visa settles in three days, it’s like magic. [laughs]

So monetary instruments are much different than commodities. A commodity would be something like a cow, gold, wheat, or petrol. These are physical goods that are used as inputs to other economic processes to produce downstream consumer products. They’re priced in terms of their intrinsic value because you can eat wheat, you can make bread out of it, you can burn petrol, it produces energy, you can turn the cow into steak. There’s a process by which we can value those things in terms of their impact on human lives. Those are commodities.

Then we have securities, which are financial instruments which are kind of a fiction. They don’t actually exist. These are things like stocks, bonds, derivatives, swaps, futures. They’re a shared delusion about a contract that exists between different parties which gives certain parties legal rights to certain cash flows based on what the contract specifies, like an underlying asset. They’re a way of distributing money between people based on a formula. Things like stock in a company are securities, for instance.

Then you have a fourth class, which is alternatives and things like art. These are very difficult things to value, like what’s the value of a Monet? Economics doesn’t have an answer to that question. It’s a piece of art that sits on the wall and it has value by whatever someone will pay for it. But economics doesn’t concern itself with what should we price a Picasso or Monet, right? It’s a weird asset.

If we look at cryptocurrency, we talked about why it didn’t satisfy the monetary category, because it can’t function as a store of value or medium of exchange. As a commodity, there’s nothing inside of a Bitcoin that can be used for any human process. There’s no non-circular use case for a Bitcoin or anything inside a Bitcoin that can be used like a cow or a gallon of petrol can. So it’s not a commodity. Then you’re left with securities.

If you value cryptocurrencies as securities they end up being very pathological because if you apply the traditional valuation models to them, they’re an asset class that has no income. It doesn’t have an underlying thing it’s attached to and it has no external cash flows. This is a really important thing to note about crypto assets is that they are what’s called a zero-sum game, which is a game theory term which says that the only money that pays out investors is money that’s from new investors paying out old investors. Or to put it another way, if you bought low and sold high, somebody else bought high and sold low. There’s no money coming into the system that’s not by bringing more investors into the system.

So if you apply the traditional quantitative finance models into these things, like this cash flow model, you get answers that say that these things should basically be worthless. They have no income, their entire terminal value depends on an infinite chain of fools that will just keep buying this thing forever, which are like absurdities. They can’t possibly have a non-zero value as a security. And securities are very regulated in the United States, and for good reason, because you can construct them out of thin air, just like cryptocurrencies. They’re fiction. They exist to give people rights to cash flows on economic enterprises. But with Bitcoin, there’s no economic enterprise. With Ethereum, there’s no economic enterprise. It’s purely an investment whose value is derived from the theory of the greater fool — that like, if I buy an asset I have to pass this on to another fool so it’s an infinite hot potato. By inductive reasoning, you end up with these absurdities if you try to price them as securities.

Then you can say that they’re like art. So Bitcoin is like a piece of libertarian performance art split into 21 million parts. It wouldn’t be the first time somebody’s actually done that in history, but that’s a significantly less coherent story, that Bitcoin’s a performance art. It doesn’t jive with the narrative we keep hearing about it being treated as a financial instrument but it’s actually this piece of performance art… so I reject that one outright.

You’re left with the logical conclusion that we have these valueless penny-stock assets that are being traded purely on the theory of the greater fool, and that looks like a speculative bubble. Those things do happen in economics, it’s just they always have one outcome. Ultimately the history of these things trends towards one place — which is zero.

PM: Exactly. I don’t think we need to go into it too deeply, but there are very clear relationships you can draw to historical events. One that keeps coming to mind whenever I read about these stories is the Wall Street crash of 1929, but in one of your essays you also mentioned the Albanian pyramid scheme crisis in the 1990s, where post-Communist Albania seemed to be having this economic miracle but it was just that half the economy got involved in pyramid schemes and then it ultimately collapsed. I wonder if there’s anything that you wanna say about either of those examples.

SD: Both of those are great historical analogues about what we’re living through. The lesson about history is that history repeats itself, first as tragedy and then as farce. What we’re seeing is the farcical version of those two events kind of repeating, and I guess we’re doomed to repeat the same cycles in history.

To go back to the 1920s, and every journalist I talk to right now says, “oh, it’s like the 1920s again,” and they’re right. What you’re seeing right now is what happens when you have a wild speculative medium. We saw that in the 1920s when America was first building its market economy. We were still figuring things out about how to actually build a stock market. These have been around a while, since the 1700s, but it reached a fever pitch as the US industrialized and entered the early 20th century. So things like the New York Stock Exchange exploded in popularity and there was a Cambrian explosion of companies and all sorts of financial instruments and all this financial innovation, if you will, and the retail public, which is like everyday citizens, started investing very heavily in financial instruments, in companies that they didn’t understand. This created a massive bubble which ultimately led up to the Great Depression and the Great Market Crash of 1929 when the entire house of cards ended up falling down because all of this was based on hot air.

There was a very interesting set of laws that came into effect in the United States, which were called Blue Sky laws, which were explicit prohibitions on the type of securities that cryptocurrencies are most like. Blue Sky laws were a restriction around trading securities that are backed by nothing more than the blue sky of Kansas. They were instruments that had no underlying fundamentals. People would just sell these things and they were like the Dogecoin of the day. What’s the value of the blue sky? What’s the value of a dog meme? They were asking the same kinds of questions back then in 1929. Ultimately, the US decided, these things are probably bad because, how do you price these things? What’s the value of the blue sky? So most states banned these things and it got codified into what became the Securities Act of the 1930s. Turns out you probably don’t want to actually have these things because they’re predatory instruments.

You’re seeing all the historical analogues repeating themselves as farce again now. These things look like securities. Full stop. Like, most cryptocurrencies (and the SEC sort of agrees on this) look like Blue Sky securities, Blue Sky contracts. Since the US has decided not to regulate them at the moment, or has not stepped up to do that, you’re seeing exactly the same patterns repeat themselves. Ultimately it’s going to take something like a Securities Act for cryptocurrencies to come in and clean up the mess. Unfortunately, though, I think most of those securities will probably disappear because they’re backed by nothing. What’s the value of Dogecoin or something? History told us what happened to most of those — they went to zero when they became illegal.

The second one was the pyramid schemes of Albania, which is actually a really interesting story, and the Financial Times did a story last year about this, which is really good. To summarize this for people who don’t know the story, Albania came out of the Communist bloc and transitioned from a centrally planned economy into a market economy. The people of Albania, they lived their whole life under Communism so they didn’t have the same institutions and cultural norms around what to expect from interacting with a market economy. It was basically like a libertarian paradise in Albania at the time where there was no regulation, anybody could start these large investment funds, and lots of people did. They started these large infrastructure development funds that people would pile in, and they would promise things like 5-6% return initially, and they would allegedly take the funds and invest them into infrastructure, which would then generate yield, and then they’d pay it back to the shareholders. Except they forgot to do the investment part of it because turns out if you take people’s money and there’s no regulation, there’s a perverse incentive just to run off with it, and that’s exactly what happened.

These things became massive pyramid schemes which ended up consuming large chunks of GDP of the entire country, to the point where the government was basically in on the action. All the government officials were like, “well, we could regulate this, or we could just pay ourselves.” By the end of this farce, they were promising like 50-60% returns, I think they got to like 120% returns, because they were just robbing Peter to pay Paul. They were paying out a small group of people to keep the illusion going under the hopes that most people would not withdraw their money. Well, what eventually happened? People wanted to withdraw their money and what always happens with these schemes is that outflows exceed inflows and the entire structure becomes insolvent and goes poof! And that took down the entire economy with it and people descended into civil war for several years.

That’s a cautionary tale about the size that large financial frauds can get if left unchecked and when government fails to do its job, when there’s no clear role of the state to step in and be the guarantor of last resort against systemic risk. Albania should be a very, very cautionary tale for cryptocurrency because left unchecked, I see the same patterns repeating themselves.

PM: They seem like such important analogues to remember, especially when you think back to the 1920s and what you said about the regulations coming in later. One of the great things about technology is that it just pretends that existing regulation don’t apply to it unless it’s actually forced on them, and usually it takes a long time for governments to come around and do it, at least in this period of time. It’s also interesting you say like, especially in the case of Albania, you constantly need more people to come in and that’s why you see people like the Winklevoss twins on Twitter all the time saying you have to get into Bitcoin, you have to put everything you have into cryptocurrencies because this is the only way that you can get rich or help yourself or whatever, right? You can see these trends playing out and continuing.

You described cryptocurrencies as some combination of a Ponzi scheme, a pyramid scheme, that you say could even be considered a snowball scheme. Do you wanna talk briefly about how you see cryptocurrencies in that way?

SD: Cryptocurrencies are very weird because traditionally speaking they don’t fit into any one of the categories of the traditional financial frauds. The question I always ask is like, “what would you call a Ponzi scheme before Charles Ponzi invented it?” You wouldn’t have a term of art for it. I think cryptocurrencies are something that, in the future, we’re going to have a term of art for it because it’s going to be illegal. It’s this sort of proto-fraud that we’re still grappling with. But you’re right, they synthesize different aspects of the major types of financial fraud that we see already.

A Ponzi scheme is an investment fund that robs Peter to pay Paul. You’re paying out people a return by bringing in more money to pay off the next person, and the next person, and you have to keep this going on and on forever. Ultimately that’s unsustainable because you run out of people or outflows eventually exceed inflows or you start making returns that are uncorrelated to the market. That’s how Madoff’s fund eventually got busted because they were pretending to give 8% when they were in a bear market. It doesn’t make any sense, and that’s how they eventually got caught. But they ran it for 20 years. People don’t remember this, but Madoff ran his fund for 20 years, so these things can go on for quite a while.

Then you have pyramid schemes. Pyramid schemes are basically a form of Ponzi scheme, except they have these tiered players by which people are recruited, and then the payouts are basically a result of you bringing in more people to allegedly buy some utility or product, some utility coin if you will, to justify the entire structure. You’re buying vitamins, or you’re buying leggings, or some phony thing to justify the entire scheme. You purchasing that bullshit product feeds money back up the pyramid and pays off people at the top of the pyramid, and that money slowly trickles fractionally down different levels. Except the problem is that if you do this with 15 levels of a pyramid, you’ve basically recruited everybody on Earth into this scheme. So it’s inherently an unsustainable enterprise. And the sad thing is that pyramid schemes are rampant in the United States. They’re called multi-level marketing companies and for very strange historical reasons under the Nixon administration, these things were let to exist even though they’re purely predatory schemes that just suck wealth from the poor to do nothing in the economy. They’re a cancer, honestly. But they’re let to run.

Then you have high-yield investment fraud, which is the third type of investment fraud, which is like a Ponzi scheme, but it’s an investment scheme that sucks in a lot of money from a very small number of investors with a pool of money that’s seeded by the initial schemers and it pays out enormous dividends. Those people take the money and go to their friends and say, “look at how much money I just got paid out of this scheme,” and then a bunch of people pile in with their money and then the perpetrators of the scheme run off with it. It’s a very ephemeral Ponzi scheme, if you will.

Then you have multi level marketing companies, which are a form of pyramid scheme except they’re based very, very heavily on recruiting. They have a very cult-like mentality. I can’t name them because they’re all very litigious companies, but maybe you know some companies in the United States that meet this criterion.

Crypto happens to synthesize different aspects of all these frauds in different ways, but it’s not subsumed by any single one of them. Strictly speaking, it’s not a Ponzi scheme because there’s no central operator, but it has the kind of obscure cash flow mechanisms and the robbing of Peter to pay Paul — paying out old investors from new investors, it’s very Ponzi-like. It has the recruiting mechanism that you see in pyramid schemes, and the down-line mechanics between people who bought early and bought later. There are certainly DeFi products that look like high-yield investment fraud, very ephemeral tokens that are like pump and dump tokens that look like investment fraud. And they share the cult-like recruiting mechanisms that multi-level marketing schemes have, where they’re not based on financial returns but on this culture that we’re all pursuing financial liberation and being our own boss and we’re gonna create generational wealth through belief in this message that’s been brought down to us which is gonna bring us into this financial utopia.

Cryptocurrency is a whole other type of fraud and history books are gonna have a term for it, but it would draw on all four of those categories to synthesize into this new form. It’s a very internet phenomenon. These things could not exist without technology, and the scary thing is that these things can grow extraordinarily large. Madoff ran his fund for 20 years and it got to around $60 billion — just to show you how large these things can grow. Cryptocurrencies, like Madoff’s fund, can just grow to a very large point. But ultimately with all these frauds, at some point outflows exceed inflows and there’s only one outcome that happens.

PM: That’s a really good description of the space and these different frauds to give us a way to think about cryptocurrencies even though they don’t necessarily fit into each category. On the MLM piece that you brought up, I’m not specifically making this comparison but I saw someone on Twitter the other day say that cryptocurrencies were like Mary Kay for young men. So, you know, just a tweet that I saw. Not something that I’m necessarily saying, right?

SD: Not necessarily inaccurate though.

PM: We’ve discussed what technologists think on the divide between this, we’ve discussed blockchain and the various concerns around that, the belief in decentralization as something more than what it really is, and the issues that exist with cryptocurrencies. Now we’re seeing this term web3 emerge to provide a narrative to weave all these things together and make people believe that this is the future of the internet, the future of digital technology, and things like that. One of your most recent blog posts was on the issue with this concept of web3, why it’s this inherent marketization, and a significant problem. We should end with that question: what is web3, and what is the problem with positioning it as the future of the internet?

SD: Yeah, so my latest post is called “Web3 is Bullshit.” It’s subtle. The point it’s trying to get across is that web3 is a marketing term. If you go in front of a room of developers and say web3, you’re probably gonna get laughed at because it’s one of those words like “agile,” “synergy,” or something. It doesn’t actually mean anything; it means whatever you want it to mean. So it’s a marketing term that several large investment firms have been pushing and my thesis is that largely it’s because the crypto brand is so toxic at this point that it’s synonymous with scams and fraud and people need a new word to talk about their allegedly legitimate businesses.

So web3 has been like, “what if we re-envisioned the internet?” Anytime somebody tells you that they’re going to re-envision the internet, you should take whatever they say with a very large grain of salt. I don’t know if you’ve ever seen Silicon Valley, the TV show? — that’s the whole punchline of the entire show is we’re gonna reinvent the internet. If you take the biggest innovation that humanity’s ever done and you start comparing anything to that, it’s always gonna have this aura effect. Who wouldn’t want to re-envision a more egalitarian internet? What’s always lacking in these descriptions of web3 is the details about how that will actually be achieved.

When I look at people talking about what they’re going to build on top of web3, 1) it’s not really well-defined because the terms are so ill-defined, 2) it always involves some sort of blockchain technology, and 3) it always involves one of these thinly veiled schemes by which the company basically launches some sort of product and they simultaneously launch a token alongside of it. The thing about these token schemes that people have to realize is that there’s a presale that happens on these tokens. There are some very large investors that buy up most of the supply of this token and the space of tokens that will ever exist, and they buy them for fractions on the penny. They buy them before the alleged company is ever formed. That gives them an enormous market advantage, because you’re sitting on 90% of the supply of the token that will allegedly be used for some web application which will probably fail in the next year and a half, but they launch the token and the application. Allegedly the token is some sort of slot machine, it’s used to push into the machine to get some sort of outcome or deliver some service. But in practice what most people buy these tokens for is for price appreciation. They’re buying them to speculate on price movements in the token.

Of all the projects that are being pushed in web3, they all look like thinly veiled ways of issuing these tokens as a proxy for equity in a company. That’s problematic because equity in early stage ventures is regulated as a security in the United States, and it’s gated to a very small group of individuals who are sophisticated investors who are given the risk and return to invest in early ventures. It turns out when investing in those kinds of companies, you typically have to wait about ten years before you can sell those things to the public. You can only sell equity in a startup when it gets listed in an IPO. So that’s like ten years. That’s a long time in terms of technology, and it’s a long time before the initial investors can actually realize their returns on their initial investment.

What you have with tokens are a way of circumventing that whole process. You can launch a product and it can be the most alpha, early stage thing that doesn’t even work, but you can launch the token, just like you would an IPO. Then you can offload that on the public, initially. So people are speculating on what’s a six month old company which doesn’t have a product, has no customers, has no revenue, has no semblance of a business model, but they have a token, and it has a market cap of $16 billion or something like a decaunicorn in Silicon Valley terms.

Then what inevitably happens on these projects is that people trade them on the speculative hype of there being an eventual product, but usually the founder gets rich off of the initial pump of the initial offering, and then they exit and the product never manifests. This is what you saw with most of these Initial Coin Offering companies, that they were a thinly veiled way of getting around securities regulation and selling securities to the public directly on companies that were always doomed to fail. On a macro-level, that’s a giant wealth transfer from the public speculating on what’s mostly nonsense to early investors who bought into this pre-sale.

A lot of people have called the game on this thing and people needed a new marketing term, a new umbrella, which we can put this new class of ventures under, and web3 has become that thing. It’s still going to be used as a term to promote decentralized applications which run on tokens now. If I see the arc of where some of the large investors want to take our industry, it’s that they wanna turn every single app on your phone into a pay-to-play slot machine where you have to purchase a token from this infinite array of rent-seeking token issuers and exchanges to run every single service that you currently use. We’re going to put toll roads on every single aspect of the internet and everything is going to be a pay-to-play slot machine. Because, quite frankly, these pay-to-play slot machines feed into people’s gambling addictions and they’re a very lucrative business for people who get in early on them. Except they’re a way of crippling everything that already exists and taking the abundance of computer power and gating it and intentionally slowing it down and introducing artificial scarcity to do things that we already do — for some hand-wavy notion of decentralization, which doesn’t actually hold up to water.

That’s the way I see the whole web3 narrative: I think it’s mostly marketing to continue the gravy train of securities fraud.

PM: Your description illustrates why web3 needs to be opposed in any and all forms. I want to end with this quote from one of your blog posts, just to leave this with the listeners. You write, “web3 is a rhetorical trick to set up a false dichotomy between the legacy internet world of popup ads and Zuckerbergs — which legitimately does suck — and a fantasy world built on technologically incoherent pipe dreams and phony crypto-populism.” Stephen, I’ve really enjoyed the blogs, I’ve really enjoyed chatting with you today, so thanks so much.

SD: It was lovely chatting with you, Paris. Have a good day.