Cryptocurrencies are increasingly traded on centralized exchanges, such as Gemini and Coinbase. This fact itself has generated some resentment in the crypto world, because the very idea of centralized exchange seems to violate the original anarchic animating spirit of the cryptocurrencies, even of “Satoshi” himself.
Vitalik Buterin, who as the creator of Ethereum has a rank almost equivalent to Satoshi’s, has expressed this resentment, saying that he hopes “centralized exchanges burn in hell as much as possible.”
One of the roads to such a Dantesque sentiment is the degree to which exchanges are vulnerable to hacks. JPMorgan has said that fully one-third of centralized crypto exchanges have been hacked.
Yet as G.K. Chesterton famously said, where there is a fence there is usually a reason for a fence. Somebody built that fence there, and had a reason for doing so.
Chesterton wrote: “There exists … a fence or gate erected across a road. The more modern type of reformer goes gaily up to it and says, ‘I don’t see the use of this; let us clear it away.’ To which the more intelligent type of reformer will do well to answer: ‘If you don’t see the use of it, I certainly won’t let you clear it away. Go away and think. Then, when you can come back and tell me that you do see the use of it, I may allow you to destroy it.’”
Does this principle apply to centralized exchanges as well as to gates? Are the Buterins of the world hastily trying to “clear away” an institution that serves a purpose?
The Reason for the Fence
That is the contention of the Streetwise Professor, a/k/a Craig Pirrong, in a recent blog post. Pirrong starts with some basics: transacting, with cryptocurrencies or otherwise, requires two parties. They have to find each other. They have to negotiate a price (whether for something standardized, like a bitcoin, or for something more tailor-made). When information about value is not readily available to either or perhaps (when it is, in a word, “diffuse”) then the costs of having two parties with no background of trust, haggling over a price, can be high.
Centralization exists to reduce such costs, as well as to result in better (and more symmetric) distribution of information relevant to the costs. Due to such considerations, Pirrong, who is professor of finance and energy markets and director of the Global Energy Management Institute at the Bauer College of Business, University of Houston, says that liquidity is centripetal rather than centrifugal. Centralization is the consequence of a spontaneous ordering.
Buterin and others who think as he does seem to think that they’ve made liquidity centrifugal by reducing the costs of buyers finding sellers or vice versa. This Pirrong disputes, writing “centralization is here to stay and, if anything, this segment of the market will become more centralized.
Pirrong also makes reference to recent reports in the press that R3, a bank-led blockchain consortium, is planning an initial public offering. He sees both developments — the complaints about centralized exchanges and the prospective IPO, as evidence of a very frothy market in cryptos, evidence that “we have reached peak hype.”
Pirrong also says, though, that it isn’t all froth. Blockchains and distributed ledgers have real value. He simply thinks the True Believers have done what True Believers in one cause or another generically do: they have stretched their points.
The R3 Story
The Bloomberg report about the prospect of an IPO for R3 is attributed to a familiar source, “people familiar with the matter.”
In response to such speculation, the company has put out a statement that it isn’t surprised at the talk, but that an IPO isn’t “a path we’re pursuing at this time.”
It is R3 that generated the Corda software, an open source version of which is available.
JPMorgan is not part of the R3 consortium. It has its own blockchain project, and it has considered spinning that off into a stand-alone business.