CryptoPolitics: The Irony of the SEC Tough Position on ICOs Part II: Law vs. Newton
This is the second part of an essay that presents some of the ironies of the fears about initial coin offerings(ICOs) presented by the U.S Securities Exchange Commission and its comparison with the world of financial derivatives. Although the SEC has been somewhat cautious about taking an official position about ICOs, its most notorious remarks have risen a warning about token offerings highlighting the risks that they could be regulated as securities.
The first part of this essay presented some statistics that demonstrated the relatively small harm that a collapse on ICOs can cause to financial markets. More importantly, I find it a bit ironic that the SEC is so outraged about ICOs when we are experiencing a market plagued with virtually unregulated financial derivatives that have been the cause of more than one financial crisis.
The purpose of this essay is not to trash financial derivative products. I am a big fan of derivatives and believe that quantitive trading has been one of the greatest innovations of financial markets. However, it is undeniable that the quadrillion dollar size market of financial derivatives is the biggest casino on earth.
One of the strongest arguments against digital currencies and token offerings is the fact that they are not backed by real tangible financial assets. Technically, that argument is somewhat flawed as the proof-of-work computation required to mine cryptocoins serves as the equivalent of an underlying asset but that’s a debate for another post. A more interesting point to notice is that derivatives have built a quadrillion dollar markets out of sophisticated statistical models which have been the cause of every major financial crisis of the last 30 years. From that perspective, stressing about ICOs doesn’t seem entirely logical.
Just like digital tokens, financial derivatives don’t operate backed by physical assets like gold or silver. Have you ever wondered where did the departure between monetary systems and precious metals started? Let me take you back to Scotland in the 1700s.
Law vs. Newton
In 1705 the Scottish government was pushing for a union with the more powerful England. One of the leaders who opposed the union was a mathematician and an avid gambler named John Law. Considering that England’s financial success was one of the main arguments in favor of the union, Law proposed the creation of a Scottish central bank and a new paper currency not backed by gold or silver but by the state. The Scottish parliament eventually rejected Law’s proposal and the mathematician was forced to live the country and moved to France.
Paris in the 1700s was completely bankrupt after the lavish spending of Louis XIV the “Sun King”. Law’s ideas certainly resonated among the Parisian elite and he was quickly appointed Controller General of Finances by Philippe d’ Orleans. The Scotsman rapidly proceeded to launch Banque Generale which issued a paper currency backed by gold and silver. At the same time, Law’s created a company called The Mississippi Company (which had sort of a trade monopoly in the state of Louisiana) which issued paper notes that could be bought only using the currency issued by Banque Generale( sounds like an ICO? ;)). In 1718, Law’s bank was nationalized and it was announced that the notes would no longer be redeemable by gold or silver. Law’s maneuvers have finally succeeded decoupling money from precious metals.
With the state being able to literally “print money” the French economy boomed and shares of The Mississippi Company went from 500 livres to over 10,000 livres. Eventually, the notes of the company finally collapsed and Law was forced to leave the country exiling in Venice when he became a celebrity.
The opposite of Law could be considered Sir Isaac Newton who during his tenure as Warden of the Mint of England worked tiressly to tie the British Pound to the “gold standard”. During Newton’s years, currency counterfeiting in England was a crime punishable by death.
The difference between Law’s and Newton’s approaches are not about “fake” vs. “real” currencies but more about mathematics and finances ;) 300 years later, Law’s ideas have been taken to a different level by the boom of statistical models and machine learning creating the world of financial derivatives. Just like the fall of The Mississippi Company, derivatives have been the cause behind massive crashes in the financial markets. More about that in a future post.