Many believe the 2008 financial crisis was the defining moment of the United States’ political economy in the twenty-first century. When the markets crashed, the country overwhelmingly voted out the Republican party, who was seen as not only responsible for the crash, but also in charge of a stimulus package for the top Wall Street banks, which was widely hated as a “bail-out” of the country’s wealthiest citizens.
In came President Obama, who extended this stimulus toward everyday people defaulting on their mortgages; raising the ire of more conservative taxpayers who believed that they were being made to pay for even more irresponsible wagers and mortgages. This, many believe, to be the birth of the tea party and the swell of anti-establishment populism that put Trump in power.
But how did this crisis begin? To say that hyper-financialization caused this crisis gets it only half right. Financialization refers to the process in which financial institutions create and leverage financial instruments (that largely structure insurance and debt) in order to support and profit from underlying transactions and endeavours (like mortgage payments, trade, yields, etc.). A bedrock of financialization was (and still is) necessary to support many of the structures and institutions that now underpin our global economy–from agriculture to international trade, to everyday homeownership. Unfortunately, the impulse to profit from financialization has led Wall Street to create riskier and riskier instruments.
A product arrived in the 1970s, the mortgage-back security (MBS), was designed to make insuring homes a safer and more widespread practice. Through MBS’s, banks would be able to ensure not just the wealthiest homeowners, but in fact link those well-credited, safe mortgages to other mortgages that were riskier, effectively widening homeownership. In order to earn greater returns, however, the finance industry then created ways to refinance those pools of mortgages, underpinning the entire American housing market, with more risk: the Collateralized Debt Obligation (CDO) and the Credit Default Swap (CDS). These allowed risk and debt to accumulate to such a degree that defaulting could only be felt on a massive, widespread scale. In 2008, that’s exactly what happened, as millions lost their homes, their jobs, and their savings.
As the fallout from the second Covid-19 pandemic wave across the world has recently started to become increasingly more detrimental, its impact is likely going to be felt more and more on the global capital markets. With regulators in these markets becoming concerned about the increasing use, especially from banks, of financial instruments from micro-lenders or third-party technology platforms to underwrite loans amid fears defaults could rise and the quality of loans deteriorate in economies hit by the coronavirus pandemic, further impacting capital market stability.
The greatest factor enabling these products to wreak havoc on our economic systems is their lack of transparency. To understand the instruments themselves requires specialization, and to understand the impact that they will have on the economy requires even more knowledge–knowledge the banking industry clearly lacks. So how can we make these systems safer, while allowing them to insure and support necessary economic endeavours?
This question was certainly on the minds of Chinese government officials and economic regulators when they halted the process of the largest IPO in history, the public offering of the Ant Group, at $313 billion the world’s highest-valued FinTech company, which supports much of the financial infrastructure of China. Regulators in China were concerned, surely, with the business model of Ant, which heavily relies on the issuance of Asset-Backed Securities, which necessitate systemic risk and which (history has shown) remain largely non-transparent until a moment of collapse.
Blockchain offers a solution to these problems. Blockchain can serve as a layer for the regulators to trace and monitor the status of the financial products, as a matter of routine, and to get early warnings of potential risks. Because blockchains enable an unprecedented level of transparency for anything created on-chain, from transactions to contracts to programs, regulators will no longer be faced with the choice of allowing innovation that undergirds financial growth and preventing risk which can create widespread panic, pain, and devastation. With blockchain, these become two sides of the same coin, as accountability is a primary organizing factor of all decentralized technology. Because transactions are automated, they facilitate production and invention at a much greater pace, but accountability is baked-in, so to speak. It is inseparable from the engine of innovation and growth.
Like so much of our current political-economic landscape Bitcoin was itself born of the irresponsibility of the 2008 financial crisis. By far, the technology underpinning it is our most promising answer to these still-lingering problems.
About The Author
Sky Guo is Chief Executive Officer at Cypherium. His extensive knowledge of blockchain consensus, transaction, and cryptographic algorithms stems from his background in computer science. With a B.S. from Pepperdine University and a degree in Entrepreneurship from Draper University, Sky also serves as a columnist for Caixin, China’s top financial media outlet.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.