When MAS announced several months ago that it viewed crypto as unsuitable for retail investors, the public reaction was mixed, to say the least. A prominent article by an editor at Bankless was circulated, criticising the policy for stymying innovation in what is perhaps the most important upcoming technology of our modern world.
Yet, the crypto ecosystem has already lost its ethos of decentralisation– I’ve argued as much previously. Power in the crypto space lies not with individuals, but with institutions. But why?
Institutions provide a valuable function within the crypto space- aggregation. And this function will be critical for the development of the crypto ecosystem in the next few years.
Aggregation brings scale- something that crypto desperately needs
During the early days of Bitcoin, there was a civil war within the community- the blocksize war. On one side were proponents of small blocks- favouring decentralisation, and keeping it easy for smaller validators to remain as validators. On the other were those who favoured increasing the block size of Bitcoin, to allow for higher transaction volumes and therefore scale. The key question on the table was if the 1MB block size limit should be lifted.
Following the 2018 crypto crash, there was once again a discussion about the scalability of cryptocurrency. This time, the battle was between CeFi and DeFi.
There is a simple reason why the crypto ecosystem has, time and time again, gravitated towards centralisation and tech giants.
Tech giants and institutions bring stability, and with the onboarding of a singular institution, many individuals are immediately brought into the ecosystem.
Perhaps no better example exists than the institutional investors that MAS has been encouraging crypto companies to attract.
At the Token 2049 conference late last month, Kayvon Pirestani, head of APAC institutional sales at Coinbase, provided some insight to the differences between institutional and retail investors’ reactions to the crypto winter. “Retail volumes have dropped off disproportionately when compared to institutional investors,” Kayvon noted. “While both retail and institutional investment is pro-cyclical, institutions are larger and have longer time horizons- and this is driving their investment higher and keeping them in during the downturn”
These institutions are better funded because they do not depend on the fortunes of a single person. Instead, they aggregate investment from many such individuals, before investing this sum together. What may be a small fortune for an individual investor becomes much less significant when divided among many.
And this ability to invest for the long term is valuable- it means investment in infrastructure and utility rather than for speculative gains. Indeed as Kayvon pointed out, a reason for the perseverance of institutional investors was the quality of their investments- investors exit risky and speculative positions during a downturn in favour of safer and better quality investments.
Institutional investors, with long term investments, did not exhibit the same panic because they were less involved in speculation, and more in utility.
All this would not be possible without aggregation- and the institutions that provide it.
Institutions bring utility and community
Often, institutions are consumers’ first point of contact in the crypto ecosystem- think crypto exchanges for those who want to trade cryptocurrency, or NFT platforms like OpenSea for those who want to collect digital art.
Yet, not all institutions are equal. New coins and tokens are released constantly by companies both big and small.
Image Credit: Coinmarketcap, screenshot by Vulcan Post on 14 Oct
But how many of these coins succeed, and how many fail? How many of these coins are trustworthy, and how many of these coins are scam coins or ponzi schemes in disguise? More than 2000 coins have already failed– either from scams, loss of traction, or any number of other problems.
In either case, the problem faced by new coins remain clear- a lack of utility to drive adoption and legitimate use.
In the world of fiat currency, demand is driven by a need to transact in these currencies- citizens pay taxes in fiat, and therefore there is a need for them to obtain fiat and buy that currency. How can companies ensure that the tokens that they release will see similar utility for their tokens?
Small companies are particularly vulnerable to this issue- coins are released as native tokens in order to facilitate transactions within the ecosystem that the company has managed to build, but because this ecosystem is too small, demand is limited, and prices eventually fall.
Let’s compare it to a coin launched by a company with considerable size- Tokenize Xchange, a crypto exchange based in Singapore. Since its launch around 2 years ago, the TKX token has not only survived- it has hit a market capitalisation of US$1 billion to become a mid-cap cryptocurrency. The reason for this difference? Utility. By the time Tokenize released TKX, it was already a fairly large player- not the size of Binance or other exchanges, but with a fairly significant user base that would use the Token to transact within the ecosystem.
Users bring value and clout to the ecosystem, and the ecosystem provides utility and stability, which in turn brings in more users. This is a virtuous cycle that anyone launching a new token needs to consider. Tokens that bring no value as money wont be used, and since no one wants to use them, demand falls and the token fails.
Of course, smaller companies and smaller ecosystems can take advantage of this to try and grow their token values as well- but how much can they do with limited reach and resources? The larger the community, the stronger the word-of-mouth marketing, and the stronger the growth.
In his book ‘Zero to One’, Paypal co-founder Peter Thiel makes the case in favour of monopolies- that these companies are critical to development because the profit that they make is reinvested into research and development that provides further innovation.
Thiel is right- in other markets, profits get competed away by new entrants, and companies are left with no surplus to reinvest in developing new products and public goods. This is why large institutions are key- because without them, there would be no new innovations.
Granted, however, that size does not always imply reliability and trustworthiness. The recent crypto winter has seen companies and executives behave in some truly horrendous ways- Terraform Labs’ Do Kwon and Celsius’ Alex Mashinsky are just the tip of the iceberg.
But does this mean that institutions are inherently problematic? Absolutely not.
The failure of self regulation
When crypto began over a decade ago, one of its promises was to do away with regulation.
But, as the actions of some crypto companies have demonstrated so far, the industry can fail spectacularly when it comes to self-regulation. This is a conundrum- the ecosystem needs institutions to grow, yet these institutions cannot yet be trusted to keep consumers’ interests at heart when the chips are down.
Clearly, some oversight is needed for these institutions- and regulators have also been waking up to the idea that the crypto space needs these regulations.
In Singapore, MAS has reiterated that crypto is not suitable for retail investors, and has banned ads targeting Singaporeans. Instead, MAS wants crypto companies to secure institutional investment.
Beyond that, MAS has also been investigating measures that would help to ensure consumer protection.
Why? Because of the imbalance in bargaining power. Individuals like Do Kwon and Alex Mashinsky are able to do as they please because they hold all the power- they have an organisation under their control that individual consumers have little hope of winning against.
An ecosystem without regulation and laws is not the society of free men that John Locke asserts it is- but rather a world where might makes right and the war of all against all means that smaller players like individuals will lose out.
Regulators act as a balancing factor- to ensure that when push comes to shove, companies like Terraform Labs and Celsius cannot act without restraint and disregard their customers.
And it’s not only regulators that are entering the Web3 space- law practitioners and firms are also taking an interest, and courts have already begun ruling on disputes within the Web3 space.
Earlier this year, Shaun Leong from Withers Worldwide became the first lawyer to secure an injunction blocking the sale of an NFT from Singapore’s Supreme Court. As a result, NFTs have been recognised as assets that can be offered protection through the law.
This is not an isolated incident- similar cases have been presented in the UK, and Withers has expanded to Indonesia, with Shaun as a founding member. Evidently, firms like Withers are expecting disputes within the Web3 world, and for companies and individuals to require legal advice on matters within the Web3 world.
This is definitely a positive development. The crypto winter has presented many valuable and interesting lessons from the business and legal perspectives, which many can use to establish a great foundation for their Web3 projects, or to reinforce their existing processes to prevent a repeat of some of the disasters we have seen this winter. We are at present seeing a record number of crypto assets disputes in the market, which present plenty of opportunities for the development of strategic disputes management mechanisms for the future.
Shaun Leong, Withers Worldwide
The implication of this development is huge- it evens the playing field between individuals and organisations. The crypto world cannot survive without companies, but it also cannot allow companies to remain unchecked. Therefore, the entrance of legal and regulatory institutions will significantly help to ensure that there is order within the crypto ecosystem- one that is maintained by the rule of law rather than the idea of might makes right.
Furthermore, regulation of companies is likely to be far easier, and more productive as well. With so many companies in the crypto space, regulators are likely to have a difficult time understanding what each company does- much less what individuals do with their crypto.
Having large companies will mean that regulators have partners to engage in discussions with- and are better able to understand what the Web3 world hopes to achieve.
Imagine being a regulatory body and not knowing who to ask for updates on the crypto space- regulation would be a nightmare, and flying blind is no way to ensure that regulation is either helpful or reasonable.
As we can see, large companies and institutions play a key role in the crypto ecosystem. These companies are the ones that provide space for innovation, and help regulators better understand the complexities of the ecosystem. While many in the crypto world may baulk at the prospect of the space being dominated by institutions, we must also understand that this is also a result of our own failure to self-regulate over the past few years.
While decentralisation continues to be a goal for crypto, decentralisation when taken to the extreme also has costs that are too big to bear.
As Shaun put it, “The reality is institutions are not only relevant but necessary for the crypto ecosystem to thrive. There is no doubt that decentralization remains a key founding principle for many Web3 projects and presents value and utility. But absolute decentralization presents infinite opportunities for abuse. The chaos that gives birth to innovations may be too high a price to pay and if left unbridled, would eventually be the bane that brings about crypto’s demise.”
And I agree wholeheartedly with this sentiment. Institutions are indispensable- and provide order to an otherwise lawless ecosystem.
In ‘Leviathan’, Thomas Hobbes establishes that there are two ways in which power is stripped from individuals and put in the hands of authority: “The attaining to this sovereign power is by two ways. One, by natural force: as when a man maketh his children to submit themselves, and their children, to his government, as being able to destroy them if they refuse; or by war subdueth his enemies to his will, giving them their lives on that condition. The other, is when men agree amongst themselves to submit to some man, or assembly of men, voluntarily, on confidence to be protected by him against all others.”
Thus far, the crypto world has examples of both. Companies have gained massive support and trust from providing utility to customers and respecting their rights. In some cases such as Decentralised Autonomous Organisations, individuals have formed collectives to govern actions and make decisions.
But it is also true that power in the crypto world has been taken by force- and that some large companies have perpetrated abuses of power that are made possible by the accumulation of wealth and size.
To ensure that this does not become a regular occurrence, institutions are needed- most of all regulators and legal counsels, to even the playing field between organisations and individuals. As ironic as it seems, decentralisation will not free people from tyranny, but subject them to it- unless potential tyrants can be checked and balanced.
Featured Image Credit: Blake Harris Law
