Financialization Destroyed Crypto's Chance to be a Positive Force
Crypto needs to stop repeating the mistakes of traditional finance in faster, decentralized form
Recently, Oren Cass wrote a comprehensive and incisive take-down of financialization as a destructive force in the economy. Read it, please. For context, Cass isn’t some wild-eyed anti-capitalist activist, he’s the chief economist at a conservative economic think tank and former consultant at Bain Capital.
His article brilliantly breaks down maybe the primary underlying force that created the dot-com bubble, the 2008 financial crisis, the loss of competitiveness of US industry, the yawning economic gap, the growing AI bubble, memestocks, and much more of the dysfunction of the economy we see today. It’s the kind of informed, specific call for change that the Occupy Wall Street movement sadly could never articulate.
I want to talk about crypto for a moment though. The desire to escape the pervasive economic dysfunction of our financial system is what originally inspired the creation of Bitcoin, and many of us started working and building in crypto (and DeFi and Web3) because we recognized the potential for the technology to create better solutions to real financial problems.
Despite its potential, I think we have to admit that crypto has failed miserably to achieve that goal. In fact it’s created a new parallel set of assets and markets that largely embody the worst of what Cass points out in TradFi – just faster and more decentralized, even if less impactful to the economy at large. It sometimes feels like crypto was even the proving ground for absurdities that have now moved into traditional finance, like memestocks and complex circular leveraged lending schemes to sustain the appearance of success.
Financialization looks a lot like the primary reason for that failure. The economic and technological mechanisms of crypto make it essentially self-financializing, and we’re unlikely to break out of the cycle without some aggressive changes to how crypto works.
Financialization Removes the Invisible Hand
Financialization, as Cass explains it, is when...
... financial markets and transactions [become] ends unto themselves, disconnected from — and often at the expense of — the societal benefits that support human flourishing and are capitalism’s proper purpose.
It happens when the real drivers of the economy – consumers, investors, businesses, physical assets, etc. – are abstracted away behind stocks, derivatives, packaged financial instruments, and complex financial schemes. Absent any regulation on the creation and use of those abstractions, the best ways to make money quickly cease to be guided by the invisible hand that historically has made capitalism such a powerful force to improve the world. The finance industry ceases to profit alongside the economy by benefitting it, and begins profiting at the economy’s expense.
That kind of financialized activity, Cass argues, now dominates finance.
Less than 10 percent of Goldman’s work in 2024, measured by revenue, was helping businesses raise capital. Loans of Goldman’s own funds to operating businesses accounted for less than 2 percent of its assets. At JPMorgan Chase the figures were 4 and 5 percent; at Morgan Stanley, 7 and 2 percent. Even the efforts at helping to raise capital are misleading, because less than a tenth of it goes toward building anything new. The rest funds debt refinancing, balance sheet restructuring and mergers and acquisitions.
In a heavily financialized economy, there are endless opportunities for short-term profit through abstractions, downing out more difficult and long-term traditional opportunities in the good and beneficial allocation of capital. Consumers, investors, businesses, and physical assets are no longer seen by finance as engines for economic growth to profitably support, but resources that can be packaged up as interchangeable financial assets that can be for mined for quick short-term profit by extracting their value, trading them, and moving on.
The rational actor has no incentive to allocate capital anywhere but quick wins. CEOs are pressured by shareholders to deliver immediate stock growth through buybacks, cost-cutting, and (increasingly) riding the latest meme wave, killing investments that create long-term competitiveness productivity. High-frequency traders exploit markets to skim off profit, increasing volatility rather than providing useful liquidity. Layered derivatives and circular financial schemes let insiders take risky bets while shifting the risk to the broader economy. Startups are required by VCs to shoot for mass-scale rapid-growth unicorns, leaving little room for companies taking the time to build innovative solutions to difficult problems.
The Self-Financialization of Crypto
Many of us who got into crypto and DeFi went in with the belief that we could fix these problems by disempowering the people who have caused the problems. Decentralization! Disintermediation! Unbundling! By creating the mechanisms of finance more efficiently and on open platforms, middle-men would be circumvented, rent-seeking silos would be eliminated, and transparency rather than secrecy would be the norm.
Cass, however, points out that it isn’t really the people that are the problem with big finance, but the fact that the highly abstracted mechanisms of financialization have been allowed to flourish. With those mechanisms offering the possibility of a shortcut to profit, the profit urge is gravitationally drawn towards the shortcuts and away from beneficial investments and services.
Traditional finance was initially created to solve real economic problems, but financialization has crept in where lack of regulation and new technological capabilities have created the shortcuts. Crypto and DeFi, however, were (perhaps naively) created with the belief that if the technology allows any sort of financial mechanism to be built by anyone, people will do the right thing more often than not and the people solving real problems will win.
Unfortunately, more than a decade into crypto we have discovered that the easiest and most immediately profitable thing to do with blockchain and smart contracts is to re-create precisely the mechanisms of financialization that caused the problems in the first place. Except now they’re more efficient than ever before and available to everyone.
Bitcoin was imagined as a democratized form of digital cash, but instead has become a tool of speculation – another gold-like asset for traders with value abstracted away from any utility. When Ethereum introduced smart contracts, the first application was to create tokens that could act as abstractions to financialize literally anything (or, in many cases, nothing but a meme). As new blockchains with new capabilities have been invented, the first and dominant applications on those platforms are always those that enable faster speculation and greater leverage. Volatility in markets is held up as a goal, to increase the potential for speculation that creates the primary motive for capital to seek those assets. Real utility and solving real financial problems can’t compete; it’s too slow, too boring, not a 100x.
New blockchain platforms have also self-financialized. Their open consensus designs have always included a platform token, with the token’s value providing an economic cost to attack the network – and also often providing a source of funding for the original developers. The existence of a platform token whose value is expected to rise instantly instantly financializes the platform itself, locking it into a set of feedback loops that turbocharge the negatives we see in traditional finance. VCs and token holders demand that platform creators focus on nothing but quick and massive token price increases. The only thing that matters is buybacks and lockups, empty meme marketing, hype-driven development, and market-making that verges on market manipulation – and that pressure comes with a righteous anger at any sort of operating costs. If your platform isn’t doing those things to pump your token this week, some other platform is, and that’s where the capital will flow.
Surprised that crypto mostly remains a bunch of insider speculation, fraud, and scams and legitimate, long-term-focused projects get nowhere? Sadly I’m not anymore, much as it could have gone a better way.
A Solution for Crypto
Frankly I’m not optimistic about turning crypto around. The financialized mindset has become so entrenched that, like in traditional finance, it seems to be now taken as a positive. Anything that makes money must be good, right? And because crypto is such an effective place to play financialized games without restraint, it has become dominated by users and developers who don’t want it any other way and actively resist change.
Taking suggestions from Cass’s article, perhaps the way forward is something crypto has generally considered anathema: regulation. Absolutely unrestrained activity on a finance platform leads to rampant financialization, and so we may need new crypto platforms that apply some different incentives and technological limits on what is possible. Creators need to be willing to sit down and think about what real problems they want their platform to solve in the world and design the mechanisms so that the natural profit-seeking motive more often than not aligns with those goals, rather than expecting that it will all sort itself out as long as people are making money.
Profitable finance is a tool that society can wield to build, if we can remember that building, not profit, is the goal.