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Nathan Hunt: This is The Essential Podcast from S&P Global. My name is Nathan Hunt. It's been a tough year for cryptocurrencies. Much of the crypto market remains highly speculative, and speculation has fallen out of favor as the cheap money era has given way to the moderately priced money era. Investors are seeking alpha elsewhere. This has led to the much-discussed crypto winter. In practical terms, it isn't clear yet whether the crypto winter is a temporary market correction in which we see tomorrow Warren Buffett's memorable phrase, "who's been swimming without a swimsuit" or if this is an indicator of a more fundamental problem with crypto markets.

This year, it is possible to draw a line of contagion from the twin collapses of the Terra and LUNA cryptocurrencies to the sudden bankruptcy of crypto exchange, FTX. The question is how far and how fast can the contagion spread? To discuss these issues, I welcome to the podcast a crypto skeptic. Nicholas Weaver is the Senior Staff Researcher at the International Computer Science Institute and former lecturer at UC Berkeley. He is now Chief Mad Scientist at Skerry Technologies. He is famous. Some might say infamous for a lecture he gave at Berkeley that is viewable on YouTube entitled Blockchains and Cryptocurrencies: Burn It With Fire. Nick, welcome to the podcast.

Nicholas Weaver: Thank you for having me.

Nathan Hunt: Nick, the pace of contagion in the crypto world is moving quickly right now. So I feel like it's important to point out, we are recording this on November 18 at 1:00 in the afternoon Eastern Standard Time. So Nick, as of this moment, how are things going for crypto?

Nicholas Weaver: Absolutely gloriously as expected because the thing is, is cryptocurrency at its heart is a self-assembled Ponzi scheme. There's no asset value in the space other than what some other poor fool will pay for it later on. And so as a consequence, it's fundamentally zero value, but it has thrived due to not a lack of regulation but an abdication of regulation; that pretty much everything goes and says, "Hi, I pass the Howey Test. I'm now on a registered security. Have a nice day," and the authorities basically took a hands-off approach. And that's basically encouraged the worst actors and worst behavior.

So FTX has been described by the guy who unwound Enron as way worse than Enron.

Nathan Hunt: A lot of people, Nick, would -- particularly people in crypto, would insist that FTX and SAM Bankman-Fried are just bad actors, who used client funds to bail out their investment fund and got on the wrong side of some bets. Do you agree with that assessment?

Nicholas Weaver: No, because just a little over 1.5 weeks ago, Sam Bankman-Fried was viewed as the most reputable person in crypto or in cryptocurrency. Remember, there's 3 things that can be crypto: cryptocurrency, cryptography and cryptosporidia. But what ended up happening with the cryptocurrency space is they've invited this [ current behavior in ] because there's no actual utility value. And since there's no actual utility value and no enforcement, basically the only actors in the cryptocurrency space are bad actors. The question is, are they self-diluted fraudsters or outright fraudsters?

Nathan Hunt: Like a lot of people, I've been reading Matt Levine's Bloomberg column to understand what happened with FTX. He recently pointed out that the assets FTX listed against liabilities, which are FTT and Serum are 2 cryptocurrencies that FTX basically made up and in which they hold the vast majority of the tokens. That feels pretty sketchy. I believe he uses the phrase "magic beans" to describe the transactions. Are magic beans, in your opinion, unique to FTX? Or might there be other magic beans out there?

Nicholas Weaver: No, they're all magic beans. So Crypto.com, for example, has their own set of magic beans, Binance has their own set of magic beans and overall, effectively every cryptocurrency because it's not actually useful for anything. That's the thing, that cryptocurrency is not useful so it's not a currency. And it's not a interest-bearing stock, so it's zero sum to negative sum and effectively a Ponzi scheme. Everything in the space is magic beans, and the bigger players are actually the ones that are best at creating new sets of magic beans that get the suckers to believe it for a while.

Nathan Hunt: Nick, I'm going to confess to you and to our listeners that I personally don't really understand cryptocurrencies. And since I don't understand cryptocurrencies, about a year ago, I went online and watched SEC Chair, Gary Gensler's entire MIT course on blockchain and money. 24 hours of YouTube viewing later, I was even more confused. You see, Gary Gensler said, as you say, that the blockchain cannot process transactions fast enough to replace our current financial system. Why is this the case?

Nicholas Weaver: So let's actually go with a technical explanation of what the objective of cryptocurrencies were. So this is the objective right from the start of Bitcoin, is we want to make a peer-to-peer money system. So if I want to transfer you 100 quatloos for the winning bet on the [ green thrall ], the idea is there should be no intermediary like cash but electronic. In order to do this with no central intermediaries, the idea is we just keep a record of all the checks that have ever been cashed in the system. And so what you do is you check the ledger, see that my balance is good. I write you a check saying, pay you 100 quatloos and then that gets posted into the ledger of all the canceled checks.

And due to how the system works, the ledger is public and universal and massively duplicated and they have a choice. They can either only allow a few checks per second to be added or they allow a huge number of checks to be added, in which case, it gets just ground in spam and massively duplicated spam at that. So as a consequence, the Bitcoin folks have a parameter that basically says you can only process somewhere between 3 to 7 checks per second on a worldwide basis.

And then the cryptocurrency folks go, "But oh, there's this Layer 2 system that we can build on top that can process more," except that, that Layer 2 system can only add or remove 3 to 7 users per second on a global basis. And so you heard about El Salvador using Bitcoin as currency, right?

Nathan Hunt: Right.

Nicholas Weaver: The joy is that's actually a lot. They did not use Bitcoin as currency. What instead they did was everybody who wanted to participate signed up for the service called Chivo and had a Chivo Wallet that was given some initial amount of Bitcoin to get people to use it. And almost all Bitcoin transactions in El Salvador were Chivo Wallet to Chivo Wallet, which meant all Chivo was doing was updating an entry in a database trusted and owned by Chivo because that's what conventional payment systems do.

Nathan Hunt: Okay. But Nick, how bad is this transaction volume problem? I mean is it a requirement for the way money works today, the way finance works today to do higher levels of transaction than what the blockchain is capable of doing or blockchains are capable of doing?

Nicholas Weaver: Of course, that if you look at the transaction volume of Visa, that's what retail payments are. But truth be told, it isn't actually the transaction limits, it's that cryptocurrency itself fundamentally doesn't work for payments even if we didn't have the transaction limit problem. So how many times have you seen a business say, we accept Bitcoin as payment?

Nathan Hunt: Yes.

Nicholas Weaver: A few times. And what tends to happen is they say they take Bitcoin, find out it's useless, find out that nobody wants to buy anything with it and quietly drop the project after 6 months. But in almost all the cases, they don't actually take Bitcoin. What instead they do is they sign up with a service. And what this service allows them to do is price in actual money because that's what the companies want. They price in actual money. The Bitcoin comes in, gets converted to actual money, which means we had a mandatory currency conversion step. And in order to -- for the system to balance, somebody had to buy the cryptocurrency in the first place. And so we have 2 mandatory currency conversion steps for any real-world transaction that actually gets payment in money.

Nathan Hunt: Okay. So here's the part that's really confusing to me. When I look at crypto valuations and the valuations of crypto-related firms, even in this crypto winter, they only really make sense if you assume crypto is the future of money. But you're saying crypto can't be the future of money. So what am I missing here?

Nicholas Weaver: You're missing the fact that this has effectively created a self-assembling Ponzi scheme. Now I'm a savvy investor. And by savvy investor, I mean I put my money in mutual funds, index funds and let it sit for 3 decades. Now when I sell my index fund, my gain is not just the amount I paid or the amount somebody paid minus the amount I paid, it's also the gains from all the dividends and buybacks and everything else. This is positive sum.

Cryptocurrency at heart is a zero-sum investment. It is only a sucker's game. The only value of a cryptocurrency is what somebody else will pay for it later. There's no intrinsic dividends, there's no interest payments. There's nothing else that makes it positive sum. And that's why I describe it as a self-assembled Ponzi scheme. Proceeds from new investors going into the space are what the people who earned money take out.

Nathan Hunt: So that's cryptocurrency. But blockchain itself, I've been told by people who are very knowledgeable, is a valuable technology. It can be used to power all kinds of different things. Do you disagree with that statement?

Nicholas Weaver: Yes. And it's for two reasons. First of all, the technology of a append-only digital ledger, we've known to build -- how to build for a generation. If your problem was solved by append-only digital ledger, it already was solved. Now the notion of blockchain hyping something else: a, it's usually used to hype cryptocurrencies; or b, it's done by consultants. And so consultants are basically somebody who takes your watch and tell you see your time. It's just that the blockchain consultants take your watch and tells you, "It's time to thank you for that nice Rolex. Bye." It just doesn't actually work.

And so here's a concrete example. I have my iron law of blockchain. Anyone who says blockchain can solve X doesn't understand X and you can ignore them. And this is actually a very powerful feature. So I attended a blockchain class at Berkeley to give a rebuttal. And this was 2017, 2018, and they had a blockchain proponent go, "Hey, you can solve supply chain issues with vaccines in India with blockchain. If the vaccine gets too hot, it's no good and that would be bad, and we can solve it with blockchain." And my response internally is what the bleep, because anyone who has 30 seconds familiarity with cold chain knows that you go out and buy these things called ShockWatch temperature watch labels. You stick it on the package, you rip out a little internal divider, and that sticker changes color if it ever gets out of temperature spec. That's how you solve cold chain issues.

Every time I see a blockchain project in practice, it is either a failure; it is something led by consultants taking advantage of people; it's a fraud to justify cryptocurrency; or it's an internal project. And the internal projects are [ taken off this form ]. You're in charge of IT infrastructure. You go up to your boss and say, "Hey, boss, I need $10 million to restructure my back-end database, provide a new set of flyer-facing infrastructure," blah, blah, blah. And the boss goes, "No." But if you go up to the boss, say, "Boss, I need $10 million to implement blockchain technology." The boss goes, "Okey-doke." And then what you do is you spend all the money improving your database infrastructure, your supplier-facing applications, blah, blah, blah, and then just take the feed of updates into the database, run it into a little script that cryptographically signs it and says, "Oh, I have a blockchain. So you spent $9,999,000 on doing what you actually needed to get done and $1,000 to put a little lipstick on the pig."

Nathan Hunt: Okay. But Nick, in preparation for this podcast, I went and did some research on effective blockchain applications. And this is one that I found. It said basically, in the wine industry, there's a huge amount of fraud. What we need is a blockchain for wine, okay, so that there is a ledger that goes back over time, identifying who held the bottle so that you can go back to the beginning of that bottle's history and know that you're tracing it to this vineyard this year. Why is that not a great application?

Nicholas Weaver: So how do you know that somebody along the chain of custody didn't take a core event to the thing, remove the wine and repackage some cheap plonk inside. The chain-of-custody problem is something that is not solved by the record-keeping interface, that we know how to do chain-of-custody record-keeping. We've done it for generations. What do you think your real estate needs are is really just pointers into a centrally managed database of stuff.

Nathan Hunt: So let's leave aside blockchain and crypto in the general sense. And I want to talk to you specifically about Tether. What is Tether and what purpose does it fill in crypto markets?

Nicholas Weaver: So Tether is a very interesting recapitulation of the 19th century banking system. So get out that piece of paper from your wallet. And you say -- see it's not a dollar, it's a banknote. And that's because in old times, what would happen is the governments would issue coins and you would go to the bank and you deposit the coin and get basically a banknote saying anybody with this note can go back to the bank and take the coin back. So Tether at heart is supposed to be a digital banknote. And in practice, it's almost certainly a wildcat bank. That is a bank that is issuing banknotes that are actually not backed.

So why would the cryptocurrency community be so dependent on these banknotes? Because that's all they are, is digital banknotes. It's that most of the cryptocurrency space is actually cut off from banking. So you have Coinbase, you have a couple other exchanges in the U.S., but almost everybody else is basically persona non grata from the banking system. For example, to deposit money at FTX international, you actually had to use Alameda Research's bank account because FTX was considered persona non grata, they couldn't put the name FTX on the bank account.

And so what Tether is, is effectively casino chips; that cryptocurrency because it's purely a greater full game is you can think of it as Ponzi scheme, the other thing you can think about is gambling. And in the casino, you need casino chips to gamble, and these are the casino chips of the cryptocurrency casino. And it's almost certainly not backed casino chips so that everybody went to the cashier and said, "Give me my money," they'd be out of luck. Fortunately, you can't actually redeem the casino chips at all.

Nathan Hunt: So it sounds like some version of what people in the crypto space call stablecoins and what you're calling casino chips could make sense. If you really held one-to-one stable assets like treasuries or U.S. dollars to back each coin, it could be useful. Is there any reason to believe that Tether isn't what it claims to be?

Nicholas Weaver: Yes. So during the massive -- let me actually pull up the numbers, hold on a second. So Tether back in 2020, there was $4 billion outstanding Tether that was clearly unbacked. During the run-up to the crash of 2021, the number of Tether went up by $75 billion in order to believe that Tether is legit, you'd have to believe that there were $75 billion worth of supposedly savvy investors who wanted to invest in the cryptocurrency space but didn't just want to go to Coinbase or Gemini or one of the supposedly reputable exchanges that have banking. And that just boggles the mind to think that, that's legit.

Nathan Hunt: Tether has claimed that for a long time, their stablecoin was backed with commercial paper. Basically, they loaned out money to corporations and they got paid back that money. They have since said that they have converted all of their commercial paper to U.S. treasuries. Is there any reason to believe that, that isn't true?

Nicholas Weaver: There's no reason to believe anything that Tether has ever said. So Tether, for the longest time said, they've always at least been backed. But it turns out back in 2017, 2018 when they were just a couple of billion dollars, that at least 1/4 of the purported backing had not existed because it was tied up in Crypto Capital Corp. and other things that went bye-bye, and it was only years later that they admitted the truth.

Let's face it, they've never been audited. They refused to get audited. They claim that somehow they can't be audited. Not necessarily that audits are guaranteed to work, but if a company refuses to get an audit, why should you trust them with your money?

Nathan Hunt: You've referred to the cryptocurrency market as a greater fool market on a number of occasions. What do you mean by that? What do you mean by greater fool?

Nicholas Weaver: So the only value in a cryptocurrency because it's not useful for utility, it doesn't give dividends, and in the end actually because of mining at a steeply negative sum, the only way you can make money at cryptocurrency is get somebody else to pay more than what you did, which means you have to have some new fool come in. And this is why I think that this is not crypto winter but crypto nuclear winter, is how many fools are left that a sucker born every minute is still a finite supply of suckers. Suckers aren't a renewable resource. And how many suckers saw Matt Damon's ad and either are not going to respond at this point, that the suckers are gone, and we can see this in Coinbase.

So Coinbase is unique as a cryptocurrency exchange and that they are remotely honest if they're bookkeeping. And that's because the SEC has basically forced them to be. And so customer dollars have gone down by like from $10 billion to $5 billion. Customer cryptocurrency has also gone way down. And as a company, they say there's only a minor chance that they might do Chapter 11, in which case, everybody who's a cryptocurrency investor on Coinbase is unsecured creditor and potentially loses all of their money.

Nathan Hunt: So Nick, there are a lot of people, and I suspect I'm going to hear from a few of them after this podcast, but there are a lot of people who think crypto is still pretty awesome. They're going to say, as Coinbase's, Brian Armstrong said in the FT today that the solution to all of these crypto problems is more crypto, because it's obvious we're in a trustless environment. Given that traditional financial markets also have issues with fraud and Ponzi schemes, could they be right?

Nicholas Weaver: No. And it's for two reasons. First of all, these systems, these cryptocurrency systems are not trustless. You're trusting a lot of entities and actors. It's mostly playing games of hide the trust. But critically, we do know how to trust financial institutions, it's called regulation, that the proper regulations when properly applied are what make the system trustworthy. So back in 2008, there were major banks failing. I was banking with Washington Mutual. I knew WaMu was going to fail. What did I do about it? Absolutely nothing. Because I knew between the regulations and the insurance and the government backstop on FDIC, I'd be okay. And indeed, I go to sleep one night and I'm a Chase -- or I'm a Washington Mutual customer, and I wake up and I'm a Chase customer.

We know how to deal with these markets and keep them mostly honest that Enron was an outlier in the financial space. Enron is status quo in the cryptocurrency space because there's no regulatory enforcement, that if you have proper regulatory enforcement, 90% of the problems go away because you get caught and thrown in jail.

Nathan Hunt: Nick, in a recent interview, you suggested that the solution to the problems in the crypto market is, and I'm quoting you here, "for the SEC to grow a pair." How would that work in practice?

Nicholas Weaver: So let's look actually at the FTX collapse. So FTX was acting as FTX in the U.S. for U.S. people, was acting as a broker-dealer. Now if you're a regulated broker-dealer like Charles Schwab, you have very important aspects. First of all, you're under strong SEC authority, and you aren't going to be listing things that are unregistered securities. You have FINRA, which if they're suspicious at all, will subject you to an accounting proctology exam and you have SIPC insurance. So even if those 2 fail, I as a consumer, is protected for $250,000 cash and $250,000 worth of assets. So most of the victims of FTX, if it was regulated under the rules that they should be regulated under already, would be safe.

Nathan Hunt: But why should the SEC involve themselves? Not to be too cynical here, but isn't the crypto winter the best advertising regulators ever had? If a bunch of libertarians get burned by con artists, why should the SEC exert themselves?

Nicholas Weaver: Well, there's the Schadenfreude factor of, yes, cryptocurrency teaching libertarians why regulations exist from 2011. Remind them about Pirate@40 and they'll go, "Huh" because the cryptocurrency space can't even remember its own scams. But really, there's too many innocent people who are getting caught in it, that if it really was just the libertarian types losing their money, I wouldn't care. But we have things like the Matt Damon ad or the Larry David ad or the Stephen Curry promoting cryptocurrency or Tom and Gisele Bündchen being the official brand ambassadors for FTX, that mean it isn't just limited to those who don't think regulation shouldn't exist, it's affecting a lot of normal people, people who have grown up in a world where, yes, the 2008 financial crisis was awful and horrible but you didn't lose your bank account.

Nathan Hunt: Nick, I'm going to ask you to project yourself into the mind of a crypto entrepreneur for a second. Do you think that an SBF, for example, Sam Bankman-Fried, for example, was aware that what he was doing was fundamentally a Ponzi scheme, that it was fraud? Or do you think he was in earnest and just caught up in something that got away from him?

Nicholas Weaver: He knew or should have known everything that was going on. And even after the collapse, even after he removed himself as CEO, he still is spouting these lunatic tales about recovery. We see the same thing with Alex Mashinsky at Celsius. Celsius has this grand plan to resurrect as a crypto mining firm when it is provably impossible for them to resurrect themselves as a crypto mining firm, but it doesn't stop them from spreading it. The best actors in the cryptocurrency space are just delusional.

The second best actors are delusional with financial interest. So if you have your start-up that is literally privacy-preserving machine learning on the blockchain with the token that you issued and got listed and sold out to suckers, you're still going to be a believer.

Nathan Hunt: Final question, Nick. Finish this sentence: The crypto winter ends when...

Nicholas Weaver: The crypto winter ends never, that because the space has no fundamental value and it just grossly ripped off a huge number of people and is already subject to a huge amount of regulation that would regulate them out of existence, it's just it hasn't been enforced. And because there's no new suckers left, I think it's going to die, period. So what's going to happen is, a, you're going to get some bills that do things like if you walk like an exchange, yes, you've always been under the Exchange Act of 1939. Either comply or get shut down.

And when you do that, that wipes out so much. Hopefully, the SEC will grow a pair and not just go after every token issue that gleefully violates the Howey act, but the venture capital firms behind it that decided to turn securities fraud by proxy into a profit center; and at the same time, how many suckers have money you can extract anymore. Between those things, I hope that this will be not crypto winter but nuclear winter. And if I can drop a few extra bombs to make sure of that, I will.

Nathan Hunt: Nicholas Weaver, Chief Mad Scientist at Skerry Technologies, thank you for joining me on the podcast today.

Nicholas Weaver: Thank you for having me.

Nathan Hunt: The Essential Podcast is produced by Patrick Moroney with assistance from Kurt Burger and Kyle May. At S&P Global, we accelerate progress in the world by providing intelligence that is essential for governments, companies and individuals to make decisions with conviction. From the majestic heights of 55 Water Street in Manhattan, I am Nathan Hunt . Thank you for listening.

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