> The sort of activity which led to the financial crisis would not be mitigated by the establishment of a decentralized currency.
It actually would deal with the issue that led to the GFC.
Remember --- the problem wasn't that there were fraudulent mortgages -- it is that these mortgages were packaged and repackaged in ways that deliberately obscured the risk involved so that people were buying stuff that had no underlying value. The lack of transparency is what encouraged the fraud and created the incentives for it, which is why the behaviour only stopped when there was a 65% fall in the value of pretty much all mortgage-backed-securities.
A mortgage CDO built on something like Ethereum would be programmatically transparent and anyone could look in real-time to see the value of their tranche. It would be trivial to distinguish between good and bad investments. And while there's still the potential for people to purchase things that do not have value, it becomes pretty much impossible for 2008 to happen again in a financial system run on crypto fintech -- intermediaries in the financial system would simply not be able to deliberately obscure transparency into which assets were owned and covered by which securities: if you wanted to check repayment rates you could script something to do the work in real-time by simply monitoring the blockchain.
This seems to me to be naive at best. Risks were obscured due to the mathematical structure of CDOs, not by hiding money transactions.
You could spend all day real time looking at the fact that few of the mortgages in your CDO are failing, and then when they fail systemically, you could watch in real time that a lot of assets that were thought to be pretty robust are not.
Your argument seems to be simply that radically more data would enable better predictors. Whether that is true or not, it's unclear whether bitcoin et.al. could help much with delivering that data. If we agree to a contract that I will pay you 5 bitcoin tomorrow in return for 4.9 bitcoin today, that contract is not publically available on bitcoin. Nor is, the fact that a certain money stream is part of a mortgage.
So unless you force every contract to be public, blockchain technology will not help you that much. And if you force every contract to be public, then you don't need a blockchain.
> Your argument seems to be simply that radically more data would enable better predictors.
The point is that transparency enables markets to accurately price risk and prevents the sort of market paralysis that caused the liquidity crunch.
Yes, it's true that people COULD have spent weeks figuring out the status of at least some of the CDOs on the market. But in reality no-one was reading 200 page long prospects that listed the exact mortgage originators and housing complexes of their CDOs. Buyers and sellers did not necessarily even have this data in peer-to-peer marketplaces. Financial institutions and their brokers bought securities based on their ratings, and dumped them ASAP once it became clear the entire sector was poisoned and they were doubtless overvalued.
> unless you force every contract to be public, blockchain technology will not help you that much
Smart contracts are public BECAUSE blockchains are open access. All parties can see the transfer of tokens on the network for the contracts that matter to them. No-one in the public necessarily knows what any contract represents, but if I am sold one I can monitor it in real-time. That was not possible with mortgage backed securities in 2007.
The problem with this is that overall losses were nowhere near 65 cents on the dollar -- only 20 percent of US mortgages were subprime at the peak of the GFC.
If the market was rational and had full insight into the performance of its securities, losses would have been no more than 20-35 cents on the dollar. That is enough to cause a major crisis, but it wouldn't trigger the paralysis of the global financial system.
Bitcoin would prevent the immoral bailouts that happened after the burst and that told the industry "don't worry, you're too big to fail, feel free to try harder next time".
Real-time (compared to equities) pricing as you know it does not exist in mortgages and would not be enabled by what you're describing. Transparency in something like this also does not help in the case of massive gaps downward in price which happened with a lot of these instruments and in fact would probably accelerate sell-offs. Transparency of the underlying was not the issue. Anyone investing in this stuff could have figured it out if they wanted to.
Transparency was absolutely the underlying issue. Read "Too Big To Fail" or "The Great Short" or any of the other histories of the Financial Crisis. The way CDOs were bundled and tranched made it effectively impossible for purchasers or banks to know which properties were actually covered by any CDO.
No-one knew what was in them -- the value was asserted by the ratings agencies and they were purchased based on expected rate-of-return. Even the people who went short on the market ended up using heuristics: there is a wonderful passage in The Great Short which describes a character who tells his broker that he will short anything bought by one of the people he has just met.
Once the extent of fraud became clear the entire market dumped down to 35 cents on the dollar. The fact that transparency was an issue is also apparent right here, since nowhere near 65% of consumer mortgages failed. But no-one would buy because no-one could tell if any particular CDO was backed by anyone who was still capable of making payments.
With Ethereum and smart-contract based mortgage systems this completely disappears, since the blockchain broadcasts every single payment made in real-time and it is possible for anyone to simply look and see if whether defaults are rising or falling among the mortgages that underpin their collateralized securities.
The fact that CDOs were trading 35cents on the dollar is largely a part of default EXPECTATIONS resetting up. Smart contracts cannot expedite this process of resetting expectations. Ethereum (which, by the way, is too slow to run CDO pricing models) can only broadcast what the latest market price is. Ethereum helps price dissemination no more than a Bloomberg terminal can.
> is largely a part of default EXPECTATIONS resetting up
Yes, exactly! But take the next step and ask what sets EXPECTATIONS about the worth of a security in a smart-contract environment? It stops being generalized market fear and it starts being actual DATA about performance.
> Ethereum (which, by the way, is too slow to run CDO pricing models)
You don't run the monitoring software ON the blockchain (you could but it would be inefficient). You run that off-chain using blockchain analysis software.
You're right that it was possible for people to consult the original (think, paper-based prospecti) in at least some cases, but most people relied on the ratings agencies and they claim to have essentially greenlit their ratings on what the Black–Scholes equation told them, using assumptions that were convenient but untrue (i.e. Gaussian cupola -- that defaults would not be correlated).
> it is not possible even in principle to tell if the ibank has rigged a CDO to have more than it's share of lemons!
Yes, you can purchase a bad CDO on a blockchain just as easily as you can purchase bad real estate in real life. Nothing prevents humans from misrepresenting data. But that isn't the point of the blockchain.
The point is that the transparency of the blockchain lets you (and others) know when you're holding a lemon, because you can see in real-time that no-one is paying off the mortgages in your CDO. What you do when that happens is a good question and the blockchain can't help [1], but it doesn't crash the entire market because people can tell the difference between your CDO and the quality ones that are still 100% good.
[1] it actually can help in one important way -- it provides an indisputable record of contract execution and payments that is not contained within the computer system of your counterparts (the bank). So if there is fraud it will be much easier to prove it to the courts than if you need to subpoena records out of the bowels of a corporate banking system.
It actually would deal with the issue that led to the GFC.
It really wouldn't. The decisions that led to this were made by people who had access to all the data they needed to achieve better understanding, but that didn't help.
The idea that it would become trivial to distinguish between good and bad investments seems to me to be incredibly naive.
> The idea that it would become trivial to distinguish between good and bad investments seems to me to be incredibly naive.
It is not naive. It is exactly how smart contracts work.
If you purchase a CDO on a blockchain, you are purchasing a share of whatever revenue paid into another contract. You can monitor those contracts, and the ones that are programmed to pay into THEM, and the ones that are programmed to pay into THEM ad infinitum.
That's a fantasy. The problem with 2008 for example wasn't the inability to make simple algorithmic decisions based on metric, it was that the fundamental risk was obscured (intentionally). Smart people mis-analyzed this and made poor decisions, because to some degree the instruments were designed for that purpose. Smart contracts do nearly nothing to mitigate this problem.
> The problem with 2008 ... was that the fundamental risk was obscured
Yes. And this is impossible with smart contracts. You can commit fraud by pricing the asset, but you can't prevent the market from demonstrating its quality in real-time.
With smart contracts there would have been a housing bubble, but there would also have been an inflow of capital when the market-value of the majority of CDOs crashed below about 80 cents on the dollar.
Bitcoin wouldn't prevent the GFC, it would prevent the immoral bailouts that happened after that and that told the industry "don't worry, you're too big to fail, feel free to try harder next time".
It actually would deal with the issue that led to the GFC.
Remember --- the problem wasn't that there were fraudulent mortgages -- it is that these mortgages were packaged and repackaged in ways that deliberately obscured the risk involved so that people were buying stuff that had no underlying value. The lack of transparency is what encouraged the fraud and created the incentives for it, which is why the behaviour only stopped when there was a 65% fall in the value of pretty much all mortgage-backed-securities.
A mortgage CDO built on something like Ethereum would be programmatically transparent and anyone could look in real-time to see the value of their tranche. It would be trivial to distinguish between good and bad investments. And while there's still the potential for people to purchase things that do not have value, it becomes pretty much impossible for 2008 to happen again in a financial system run on crypto fintech -- intermediaries in the financial system would simply not be able to deliberately obscure transparency into which assets were owned and covered by which securities: if you wanted to check repayment rates you could script something to do the work in real-time by simply monitoring the blockchain.