In the blockchain movement’s ideology, the 2008 financial crisis holds a special spot. A critical juncture in the history of global capitalism, it readily provides a bedrock narrative that justifies the very purpose of a decentralized digital currency. This is what happens when we put too much trust in centralized custodians of wealth; this is what the breakdown of centralized trust — taken to the extreme — looks like. The year of 2008 is thus the legendary beginning of cryptocurrency — both the moment of the incumbent institutions’ great meltdown that paved the way for digital money’s being, and also the alleged inspiration for Nakamoto’s scripture, published the same year.
A part of the foundational narrative is the idea that the crisis wouldn’t have happened had blockchain been around at the time. Correspondingly, distributed ledger technology (DLT), if widely deployed in finance in the near future, could save us from the next Great Depression. At least that’s what many crypto visionaries and financial experts often claim — the latest being Pang Huadong, the former vice president of North American investment banking for J.P. Morgan Chase.
The ex-Wall Street executive offered little detail beyond his observation that blockchain is capable of reducing global financial risks and establishing trust at a low cost. In order to pin down Huadong’s argument, it wouldn’t go amiss to review how other influential crypto thinkers have reflected on the relationship between financial crises and blockchain technology.
The crisis of trust
In the recently published The Truth Machine, fintech journalists Michael Casey and Paul Vigna invoke the story of the Lehman Brothers’ collapse to illustrate one of the overarching ideas of their book — that of trust as a vital social resource. They maintain that, while many in the world of finance still view the events of 2008 as a crisis of short-term liquidity, this evaluation is fundamentally superficial. The root cause of what happened during the subprime mortgage bubble and then carried over to the whole global banking system was, in fact, society’s unquestioning faith in financial institutions and the integrity of their record-keeping systems and practices. This unbending faith empowered bankers to manipulate their ledgers, accumulating and reselling assets that had little to no value for years.
The fact that the investment bank Lehman Brothers had posted record earnings of $4.2 billion just nine month before folding at the height of the crisis suggests that the firm’s financial statements were not quite indicative of reality. Even the notion of some undisputable ‘reality’ is precarious in this context — as Casey and Vigna argue — citing Bloomberg journalist Matt Levine — big banks’ balance sheets have grown so complex that even honest accounting became no more than a series of educated guesses about how much the bank’s assets could be worth in the market. It is virtually impossible for a human to know with certainty whether a given bank has made or lost money the previous quarter. In a certain sense, the incumbent bookkeeping system has reached its scalability limits.
Casey and Vigna point out that at the heart of bank accounting there is still the centuries-old practice of double-entry bookkeeping — the one that rests on reconciling debits and credits in the process of asset valuation. This system has been an integral part of modern capitalism’s making, and as such, enjoys an enormous amount of knee-jerk trust that we tend to grant to entrenched ‘default options.’ Yet this trust might have been misplaced. In addition to inefficiency, double-entry accounting affords ample ground for manipulation.
While sinking in debt, the notorious Lehman Brothers employed a number of shady tricks to make their books look like the firm was thriving. One of them, according to Casey and Vigna, entailed moving vast amounts of debt off the books at the end of the quarter and temporarily storing it in repo transactions — a tool designed to provide short-term liquidity. Once the embellished quarterly report was in, the debt was returned to the balance sheets. Another scheme exploited the notion of ‘hard-to-value’ assets, as the bank’s accountants assigned random high values to such resources. Essentially, the bank was running two parallel ledgers: one internal, and one public-facing.