Guest User

December 9, 2021

Understanding Crypto

Episode 179: Prof. Marco Di Maggio: Crypto, DeFi, and Monetary Policy

Guest User

December 9, 2021

Understanding Crypto

Marco Di Maggio is the Ogunlesi Family Professor of Finance at Harvard Business School. Professor Di Maggio collaborated with numerous companies in multiple industries, from consumer lending to asset management and cryptocurrency markets, to raise capital, launch new products, deal with regulatory challenges, exploit customer data and design novel revenue models.

He holds a PhD in Economics from MIT. Professor Di Maggio’s current research focuses on financial intermediation with a particular focus on how new technologies have disrupted financial markets and its effects on firms and individuals. His work has been published in leading academic peer-reviewed journals and widely cited by outlets such as Bloomberg, Forbes, The Economist, The Wall Street Journal, among others.

Of all of the possible disruptive uses of cryptocurrency and blockchain, decentralised finance (or DeFi) might be the one most likely to bring this technology to a wider audience; and challenge the established finance industry in the process. For this week’s episode on crypto-based decentralised finance, we welcome economist and faculty member in the Finance Unit at Harvard Business School, Professor Marco Di Maggio. Tuning in, you’ll learn everything you need to know about DeFi and cryptocurrency, from the most basic definitions to the potential macroeconomic and geopolitical implications of a decentralised reserve currency and the effects of decentralisation on monetary policy transmission. Tuning in, you’ll learn the definitions for DAOs, DEX, NFTs and more, and Marco elaborates on some of the reasons that decentralisation is seen as an improvement over central systems as well as some of the issues that it represents. Make sure not to miss this enlightening conversation with Professor Marco Di Maggio as he shares his powerful contrasting perspectives on this inherently libertarian technology.

Key Points From This Episode:

Marco defines cryptocurrency; simply put, it’s digital currency. [0:02:59]
Find out what a DAO is; a community-led entity with no central authority. [0:03:58]
How a DAO is different from a corporation in the way it values decentralisation. [0:05:56]
Stablecoins as cryptocurrency pegged to fiat currency and backed by collateral. [0:07:07]
Learn about decentralised exchanges or DEX, the bonding curve, and Uniswap. [0:09:28]
Why decentralisation is seen as an improvement over centralisation; greater transparency and access requiring no counterparty. [0:12:32]
When decentralisation is not a good solution given the lack of accountability. [0:14:40]
Marco expands on some other issues with the technology, including its environmental impact, volatility, and regulatory uncertainty. [0:16:07]
Understanding counterparty risk, returns, and interest rates in the DeFi space. [0:18:39]
Why Marco considers blockchain and crypto DeFi a technological revolution. [0:21:41]
How someone who owns a total stock market index fund, for example, can benefit from the potential economic gains of this revolution. [0:23:45]
Bitcoin versus Ethereum and how Ethereum is used to develop DeFi apps. [0:26:06]
Whether Marco predicts a winner-take-all outcome for blockchain technology. [0:28:23]
Why rubber stamp regulation and clarity are important for the success of DeFi. [0:29:37]
How to approach investing in the DeFi space, looking at risk, exposure, and value. [0:31:30]
Marco explains why the Chinese central bank has launched the digital yuan and how the US is lagging behind this innovation [0:34:21]
Find out how DeFi ‘super apps’ provide better solutions than online banks. [0:38:33]
Distinguishing crypto from fiat currency and the macroeconomic and geopolitical implications of a decentralised reserve currency. [0:40:17]
Marco on the potential effect of crypto-based DeFi on monetary policy transmission. [0:42:44]
What NFTs are, why they sell for such high prices, and how they can be useful. [0:46:22]
How Marco defines success: through the lens of others in his life. [0:49:30]

Read the Transcript:

Excellent. We're very excited to have you. And this is such a current topic. So let's kick it off with a straightforward question which may not have a straightforward answer, what is cryptocurrency?

Okay. So actually we start directly with the tough question in the sense that it has been such a long and exciting rollercoaster that we have seen cryptocurrency mutate radically from the early days of Bitcoin to what we have seen nowadays. But in general, it's sort of a digital currency. So something that you can use as a means of payment or store value, or as an investment that has only digital forms and usually is backed by a more decentralized system. But I'm sure that we're going to go into ... Bitcoin is one example, but one thing that I want to make sure everybody's clear on is that crypto is not just Bitcoin. There are many more interesting, I would say, currencies as well as in general, in the same way in which the technology blockchain is not Bitcoin.

Okay. I think a lot of people have heard of cryptocurrencies at this point. Less people maybe have heard of a DAO. What is a DAO?

Yes. So DAO is one of the things that help for the decentralization, meaning that DAO is sort of the way in which most of these protocols are nowadays organized. Each user receives what are called the governance tokens. And you can think about these as sort of your equity stake in a small startup, a young startup. And then with these governance tokens, you have the possibility of voting on decisions that are going to affect the future of these protocols. And so that's where decentralization comes from, in the sense that the pioneers, the early adopters, will get these governance tokens, together with the ones that have developed the protocol in the first place.

And then all together they are going to make decisions. And the incentives are aligned because they own these governance tokens, whose value is going to improve as they take sort of the "right decisions". And so, as the protocol evolves the network becomes bigger. More and more users adopt the underlying technology, the underlying currency. There is going to be higher demand to take a stance on the different decisions that the protocols are going to make, and so there is going to be higher demand also for the governance token.

And so overall the DAO itself is just a set of smart contracts. And smart contracts are not even that smart, they are just sort of a line of codes that tell us a series of if dot, dot, dot then. And so it gives you a lot of those type of statements. And those statements allow you to make transactions, allow you to make decisions, and allow you to reach consensus in this type of decentralized organization.

So you talked about the early people that are involved in a project getting more of the governance tokens and their increasing in value over time. That sounds a lot like a corporation where people who started get a lot of the shares and have votes, but then over time more people can get access to voting shares. How is a DAO different from a corporation?

Well, in a sense, it's very similar. The thing that I would say it's different is that there is a community that really values the decentralization piece. And so since everything is transparent, also the way in which decisions are made is extremely transparent, in the sense that you are going to see proposals that come up and you are going to see how the different, let me call them users, are going to vote on these proposals. You have an immediate feedback on how your community is reacting to where the products are going, and what is the current offering.

And that's sort of different than the company, because we are used to nowadays to the class A and class B shares. There is class A, one share, one vote. And then there is class B, one share, 1000 votes. And so there is still a very different dissonance between, oh, we are the one in control and you are ripping off some of the potential economic benefits, but you are not really having a say on the way in which we are developing the company. While here it's much more hands on.

So let's keep going with another definition. What is a stable coin?

Oh, yes. So this is one of my favorite areas in the cryptocurrency. And the reason for that is because for most people that only read, let me call it mainstream newspapers, and that's the exposure they get to the crypto world, they know Bitcoin and their main reaction is always well, but this is volatile. Why the heck should somebody should use this as a means of payment? Well, that's something that has been solved, and is a problem that's been solved for a while. The way in which this has been solved is with the creation of stable coins.

What are these? This is digital currency that is backed to either a fiat currency, like the dollar, or to a basket currency, like SDR run by IMF. And the way in which these work, there are least three different ways. Either they have reserves, meaning, for every $1 worth of this stable coin, I'm going to have $1 worth in my vault. Or they have collateral. Usually this is crypto collateral, meaning that now in my vault, I don't have fiat reserves in dollars, but I have Bitcoin or I have Ethereum or I have other cryptocurrencies. And usually they tend to be over collateralized given the volatility of the other cryptocurrency. And so for every $1 worth of stable coin, they're going to have $1.50 worth of collateral.

Or there is the third way, where for instance, I have been involved in, which is what's called algorithmic stable coin. Meaning that I set up potentially incentives to market participants value of this cryptocurrency is always as close as possible to the $1. And as soon as there is deviation in one end or the other, so above or below this band, then the arbitrageurs come in and close the gap. And so now with these stable coins, why they're super exciting is because with those you can do whatever you might like in terms of using it as a means of payment, using them as an investment vehicle.

You can deposit and earn interest on them. And so that sort of opened up a new world, which is really the one focused on DeFi, decentralized finance. Which is much more based on stable coins than on the cryptocurrency that people might have heard about like Bitcoin or Ethereum.

On decentralized finance, can you explain what a DEX is?

Yes. So this is the ones that have attracted the most attention in this space. These are decentralized exchanges. So if you think about Coinbase. Coinbase is a centralized exchange, meaning that you work exactly in the same way in which the NASDAQ works, meaning there is an order book. And so there are going to be buy and sell orders, and there is an intermediary that's going to match the buy and the sell order.

A decentralized exchange works without the intermediary. And it's either peer to peer, or peer to contract, meaning that there are going to be, let me call them investors or users, that decide to provide the liquidity, meaning that they are going to be able to meet any type of demand between price X and price Y. Why they are so generous in providing liquidity is because they get fees. The more transactions there are in this price band, the more money they accrue. And also they get subsidized by the protocol with, for instance, governance tokens.

So there are these liquidity pools, and every time I want to transact, my transaction is always a market order. It's not a limit order. It's a market order, and you always have sort of a certainty that it is going to be executed, and it's going to be executed without having any type of counterparty risk, in the sense that there is either no intermediary, and also your buyer or your seller on the other side already has committed capital to meet that demand.

And then if you want to go one layer deeper, what is exciting as well here is that they work through what are called bonding curves. What are these? These are basically the way in which the price will move as there is more demand or supply. But you would expect that the higher demand, the higher the price should go. The higher the supply, the lower the demand should go. That's algorithmically determined. And this also means that you can provide infinite liquidity, infinite depth with finite liquidity, in sense that if you want, there are no gaps in the limit of the book, which is one of the issue in centralized exchanges. Meaning, I can send an order, but there is no way in which I can execute that immediately. Here, since it's full, the curve, and they provide sort of liquidity for all price ranges, I can always execute those.

Just to give you a couple of names so that people associate DEX with names that they might hear at some point, you have Uniswap. Uniswap is the most famous DEX out there that allows you to exchange cryptocurrency. And so the liquidity providers give you liquidity on payers, for instance, Bitcoin and Ethereum, or Bitcoin and a stable coin, meaning that I deposit the Bitcoin and I exchange it, swap it, for the other currency. Uniswap is sort of the best example, but since we are in the realm of open protocols, they basically copied and pasted the same protocol with very small changes, and they've created other types like PancakeSwap and SushiSwap.

So you mentioned the advantage of a DEX. What are some other applications where decentralization is an improvement over centralization?

Yes. So there are overall improvements, I think, at the high level. Meaning for instance, most of these DeFi apps give you transparency that usually you don't get in a centralized system or in traditional finance. Which, it's transparency both for the users as well as for the regulators in some sense. But if you think about the adoption of some of these new protocols within financial institutions, this will also mean that the regulator can just simply go and check immediately how these transactions have occurred, rather than being with the banks or intermediaries, reporting these to the regulator in different formats and different times, with the lag and so on. So one, I would say transparency.

The other one is access. This is sort of a mixed bag in the sense that it's easy and it's open to everybody to have access to any of these type of products. At the same time, it still requires some technical ability. And I think that's one area where we've seen and we are seeing more and more of the development happening, in the sense that providing a user interface which is much more friendly for users that are not crypto native, but would like to join this type of apps. So I would say transparency, access.

I would say also the fact that we don't need a counterparty also means that we don't need to trust a particular institution to handle our transactions. That might be less important for US based investors, but this is becoming so important for outside the US. Sure, we have the example of El Salvador, but we have a number of countries in Latin America, in East Europe, in Asia, where people would like to have a system that is farther away as possible from the government to transact, and also from the existing institutions as well. So I would say these three are the main ones, and then it all depends on different products.

Transparency, access, no counterparty. Though those all seem like great things, are there applications where decentralization is not a good solution?

Yes. So in some sense this boils down to what worries you the most. And what worries me the most in these type of applications is the lack of accountability. If there is a mistake, if there is an incident, if there is a materialization of risk that comes from, it might be a cybersecurity risk, it might be a flaw in the protocol, it might be something else unexpected. There is nobody who can actually take charge of that and make sure that this gets fixed. You have to rely on the fact that there are a number of actors, the ones participating in the DAO, that do have an interest to make sure that it is up and running again. But that's sort of fickle in a sense that people get scared if there is an incident or there is a materialization risk. They might just drop the governance tokens and move to the next interesting project.

And so I think that's the part that concerns me the most. What this means is also that for many of the applications we might potentially remind where nowadays financial intermediaries are involved, you naturally need to have some accountability. And so for many of those, we have to either reimagine them, or we're sort of giving that away. And so there are many things where I wouldn't expect that to happen anytime soon.

Interesting. So there's a ton of excitement around crypto and not so much about the worry side, but I'm curious if there's other problems that you see with the technology around crypto. With the technology itself.

So, obviously there is the environmental issue, and that is becoming more and more central, but that's also an issue that has been somewhat addressed. Although it's now taking a larger and larger scale, meaning that rather than the way in which Bitcoin works, which is proof of work, and that's time consuming, and it's energy consuming, and it's extremely inefficient. In the same way in which the volatility issue has been addressed, also this type of concern about the underlying technology has been addressed.

In the sense that there are protocols that work, for instance, with what is called proof of stake. Where rather than making the work, and so everybody sort of is running these wheels and spending resources and energy to figure out the answer to the mathematical puzzle like for Bitcoin, for other type of the end technologies, those work where you put a stake, and if you don't do the job right, which is you basically don't verify the transactions in the right way, you lose that stake. And so it works more about the financial incentives rather than spending resources on that. And so that has been addressed, but that's still something that we have not seen at full scale. And so that's definitely something that I'm concerned about.

The other thing is honestly, the regulatory uncertainty. The US has an approach of sort of regulating by enforcement, meaning sort of letting it run and then figuring out, oh, this was not supposed to happen, which is very different, and I will say less optimal than what's happening in other parts of the world. For instance, Singapore is way ahead of the curve in terms of allowing a bunch of projects to flourish within sandboxes and with sort of a closer oversight, and then making sure that absolutely they are compliant, rather than, as I said, sort of an enforcement approach. I would say those are the two things that worry me the most, because those are the ones that may affect both the adoption as well as the scalability of some of these projects.

One of the things that I've noticed poking around in the DeFi space is that their platform is paying like 5, 10%, maybe even more, on deposits. That's pretty crazy when a normal bank is paying well under 1%. Are risk and expected returns still related in DeFi, or is this free money?

Yeah, no. There is no free money. So the answer to that, the reason why this is happening is because when you deposit those currency, it's basically the way in which this currency then get reused. And usually they get reused by lending these to institutional investors who are making transactions based on leverage, using leverage. In fact, you see that the interest rate that these deposits offer, it's extremely possibly correlated with the amount of leverage that is in the crypto world. Who are offering them this currency to borrow are going to be the ones that are offering these deposits, and they are basically making money by the difference in the interest rate spread. That's sort of the reason why they can offer this type of interest rate.

The other one is because part of those interest rates that you see advertised also are coming from capital gains, meaning that yes, if you go on Compound, for instance, which is one of the largest that offer this type of deposit, you are going to see your APR specified in a couple of different ways. One is the APR directly on your deposits, but then you have an APR that comes from the fact that by the posting you also get an extra token. And the token, the more deposits there are, the more demand there is going to be, it might appreciate as well.

And so you get part of that APY is coming from the appreciation of these tokens that you get. Why do you get these tokens is because the protocols want to subsidize the deposits in the first place. The fact that part of it comes from the subsidy also opens the question of whether this is sustainable or not. And I think we are still at a very early stage. Honestly, since part of this, it's really about the subsidy. Probably we're not going to see those very high interest rate for long. But it's also true that by just the way in which the financial market is working in DeFi, we are still sort of in order of money larger than the 20 basis point that we're going to get from our savings account on Bank of America.

You mentioned why it's happening, why those interest rates are there. Would the risk then be the counterparty risk?

Yes. So there is somewhat a reallocation risk. So in some sense, if you think about these deposits, they look very similar to money market funds, because they sort of receive this money, they lend it out, there is some sort of a maturity transformation here, because you don't know where these bets are going and for how long, and you still sort of have an expectation you're going to be able to withdraw these funds almost one to one. And so in the same way in which for money market funds we have some risk and those are not insured deposits, you also are facing the same type of risk in these type of businesses. Obviously it's larger because these are new projects and more risk investment.

Is this whole area of crypto and blockchain decentralization a technological revolution? And if it is, how big a deal is it compared to others like rail, or auto, or even the internet?

So the first question is easy. Yes, it's a technological revolution. I think the second one it's way too early to assess and compare. I will say that one issue that's clear is that we shouldn't lack imagination, in sense that there was nobody that in '95 would have forecasted the advent of Facebook. Meaning that we went through 15 years or so where the thing has developed so fast in such new direction that we couldn't really foresight. I think the same thing is happening now.

You have the Netscape era. We are in the Netscape era. What's going to happen in the next 10 years is sort of tough. What I can tell you is that since the underlying technology can do the same things, plus many others of what we've used to, in the same way in which the internet, well, you can send the mail, which is just a more efficient way of sending paper mail, but you can do a lot of other things. I think that it's definitely going to be impactful in a number of different areas. And we are seeing that already with the web 3.0.

Some in the audience might be familiar with this, but there has been sort of this big push also from the investment side, in terms of how exciting VCs are about companies that are really taking advantage of the next phase also of the internet where you see the convolution of both, both the crypto space, as well as just a different way of offering financial services that accrue benefits, not just for the large corporations, which is basically the web 2.0, the Amazons of this world, but give benefits to a larger community. And this resonates very well, and it's very natural, fits in the DAO type of discussion and overall decentralization trend.

So we're in a technological revolution. If someone owns a total stock market index fund, do they have exposure to the potential economic gains from this revolution, or are they going to miss out?

So I think somewhat they do. And the reason is because you have exposures to other companies that are using the underlying technology. I will give you two large examples, Walmart and IBM. Walmart just announced a few weeks ago that they were using the blockchain technology to trace their supply chains, which is extremely important and much more efficient than their standard system, both from an organizational point of view, but imagine the case of an outbreak. Salmonella in salads, lettuce. It takes seven days for them to recognize and sort of see where this is coming from and what are the other places where it went to, the other sort of stores where this has been sold.

With blockchain it will take them seconds. And this is something that they have adopted and they have launched already. So this is something actively running. The other large corporation is IBM. So that's a corporation that has taken, I think, a big step forward of exploiting the underlying technology and making sure that they can offer solutions to large enterprises that are based on the underlying technology. NASDAQ is using blockchain for their private shares offerings. You have Fidelity, which has been one of the very early companies that have been both investing as well as actively mining Bitcoin. And then with Fidelity Ventures, they invest in startups in this segment.

So these are sort of the ones using the underlying technology. And then you have the larger cases of companies that invest their cash and the reserves in cryptocurrency like MicroStrategy, like Tesla, like Square. So yes, you definitely do get the rating exposure. It's indirect, but you do.

Did you say Fidelity's mining Bitcoin?

Yes. Since 2013.

Wow. Like in a fund? Or the company itself is mining Bitcoin?

So, I had among my guests in class the head of the crypto space within Fidelity, and they've been mining for themselves.

That's so interesting. What's the difference between Bitcoin and Ethereum?

So they are both digital currency. They're both cryptocurrency, but there are many differences. Bitcoin sort of... This was the initial vision would displace the US dollars. Ethereum doesn't have that as a vision. Ethereum is just a currency that helps in the use of technology. Because Ethereum is part of the Ethereum blockchain and part of a larger organization, which is called consensus. The underlying technology is the one that has been used so far the most for the development of DeFI apps.

And the reason it's technological in the sense that Bitcoin to each transaction, you can only add basically notes. On Ethereum you can add the contracts and those are basically the smart contracts. And so everybody who wants to offer a new protocol is going to have to plug into that type of chain and use Ethereum as a way of making transaction work. That also give you a sense that the difference in value is coming from very different point of view, right? So mainly sort of capital gains, but it doesn't really have a translation into utility, right? Because it's not really used even for method payment.

Ethereum means that the value comes from the actual demand that is happening on that network. The more DeFi apps are developed, the higher demand for Ethereum is going to be. And that's the reason why we've seen in the last 12, 18 months, a huge run up on Ethereum, because there is a large piping space. Absolute, this somewhat opens up the competition. That's why you have other chains coming up like Solana, and so on. That offer an alternative to that, because it's becoming too expensive to build on top of the Ethereum blockchain. But that's sort of the main difference I would say between the two.

That raises an interesting question though, because there are all of these competitors to Ethereum and like I've played around on the Ethereum blockchain, and it's expensive to do anything. The gas fees are crazy, but like you said, there's Solana and I've heard of a bunch of other ones that are being sort of championed as the Ethereum killer. Do you think going there's going to be a winner take all situation with one of these blockchains being the one? Or is it going to continue to be a bunch of them?

So I think there are going to be several large chains. The reason why I'm saying this is because it's becoming more and more common to see companies that do interchange bridges. And so they're already expecting that they would launch their products on multiple chains, that they can reach as much of a mass adoption as possible in this space. And so once you have sort of inexpensive solution like offering these bridges across chains, there is no reason why my network should take over the overall market.

You have sort of forces to centralization, which is the larger the network obviously you're going to have both direct indirect network effects. But given that these are priced, you always going to have then this additional reaction, which is we just copy and paste the same protocol, and try to launch it with this lower gas fees. And we may bootstrap adoption that way. And so that's a hard market where hard market for a winner takes it all. Where people can just copy and lower the price, right? Essentially.

Interesting. How important is regulatory adoption to crypto and DeFi succeeding?

So more on the adoption, I would say some sort of rubber stamp that's definitely important in having more clarity. And this is more important for institutions than for users, I think. Users in some sense will mirror the institutions. But I think that the way in which the regulator will sort of show the next steps in this space, for instance, it's going to be so important. For instance, there has been the news of the president working group on stable coin, which just came out, I think last week.

Those type of initiatives are going to be watched out pretty closely by anyone that is interested in crypto needs in this space, because they sort of are going to really shape the future of some of these companies. Given just a small example, if anybody who issues stable coin is regulated like bank, which is somewhat what is coming out of that working group. This will kill most of protocols in the US. And so there needs to be... I think a much clearer stance on what do we want to achieve here with our regulatory intervention?

Do we want to kill the market? Which basically means kill it for the US, doesn't mean kill it for everybody, right? Or do we really want to protect consumers? Do we want to make sure there is no systemic risk? We want to make sure there is low risk of fraud and cybersecurity risk. Those I think are much more achievable objectives and much more useful than going for larger strokes like those.

I want to come back to the not winner take all market idea for a second. So from what you said, I kind of understood that substitution is pretty easy with blockchain. And network effects don't necessarily benefit a single chain because you can cross over. That's kind of how I took what you said. So given that if someone wants to invest in this technology, it sounds like buying Ethereum, for example, might not be a representative asset for everything, or Bitcoin might not be a representative asset for crypto. How should someone think about investing in this technological revolution?

Yeah. So I think maybe we can sort of compose this in two ways. One is, will be... This is definitely not investment advice, but one way in which I look at this is the stock market is a $30 trillion market. All crypto is about $3 trillion. So that gives you more or less, if you want to fast rule about how much exposure would I need to be diversified. And then within that, what do I want to bet on? What type of companies do I want to invest? I think that since the next step it's really about the DeFi, there are tokens that are yes, less known, but are also the ones that are more easily actually to value in some sense.

Because you can definitely link their value to the type of products that they're offering, to the type of size of the network that they currently have. The roadmap that they're offering with the DAO organizations. And so those are the ones where I will focus on. I want to say also that there is one component of both Bitcoin and Ethereum, which is neither the store value nor the method of payment, nor the network, which is a little bit of being an index for the overall crypto market. Meaning that you see that there is an important correlation between alternative coins, alt coins and the overall Bitcoin and Ethereum there.

And so these also mean that the more excitement there is in this space, you will see an appreciation of these main currency, even if most of the excitement is coming from DeFi, because that's sort of the easiest entry point for most people and for most investors as well. And so I will say, yes, Ethereum is going to face competition, but it's also true that they have already an important network. And if talking with some of the startups that are launching in this space, that's their first step always sort of trying to build so that it works there. And maybe we are going to get there as a second chain and not the first one, just because at small scale, it's not worth the gas feeds. And so I will say that instances, there is still value there.

Interesting. So it is possible then that Bitcoin and Ethereum are sort of representative of...? That's really interesting, but it also sounds like to really get into the space. It's almost like security analysis, like looking at individual DeFi projects and... Yeah. That's fascinating.

I got a question about central banks. Would they, or could they issue their own digital currency?

Oh, absolutely. And the Chinese one already did. So they launched the digital one, which is what's called the central bank digital currency. The reason why the Chinese have done is I think for a couple of different reason. One was it's likely this project was initiated after Facebook launched their Libra/Diem project. The other reason is because overall their government has been going after the large FinTech companies like Alipay and Alibaba and so on. Meaning that they don't want to lose control of the financial market. And so issuing a digital currency would allow them to have a perfect view of all type of transactions that are current.

The other advantage is that the potentially there is an advantage, which is geopolitical, which is that by offering a digital one that has lower transaction cost to cross borders, it might displace the US dollar for international trade. That's sort of the big promise of that. What I have to give to the Chinese is that it's amazing how fast they have done this because they basically in 18 months or so, they went from an idea to launching already the pilots. They have distributed millions and millions of dollars to people to see how to sort of test out in pilots, the underlying technology.

So to answer your question, yes, in fact they have done it already. The thing that the worries me the most is that the US and somewhat also the ECB have been lagging these innovation, and these might have very strong repercussion on everybody because the digital currency has the power of being programmable. What that means is that supposed the way in which they have done the stimulus payments. We have heard all the stories about the stimulus payments, for instance. So billions going to dead people or people that were not eligible.

With the digital currency since you have an ID, which is much stronger than the one that currently provided. Those type of issues will be resolved. More interestingly, you would have deposits directly with the fed rather than with the intermediary. Well that opens the possibility to is for much better financial inclusion. There are 25 million people in the US that the FDIC consider what are called unbanked. And then there is I think another 28 million that are underserved, meaning that sort of they don't really have access to traditional financial institutions.

With the mobile phone, you will be able to have access to financial services because your intermediary will be directory. The fed, you don't need the brick and mortar office of your local bank. You will also be able to implement for instance, monetary policy, because you'll be able to implement negative interest rates. What are negative interest rates? Well, if you have deposits, I give you money that are on deposits. If those depreciate over time, if you don't spend them, I'm just implementing negative interest rates contractual matter immediately for everybody.

And I'm basically boosting aggregate demand for the economy. So as you can see, sort of opens up big possibilities. And so definitely there are talks about this. There are people that are interested, but we have not seen anything concrete coming out of the fed or ECB yet. And part of the reason is also because I think there is somewhat of a resistance from the banking system, right? Because the largest advantage that the banks have over any other type of company, but for instance, over the FinTech companies is having access to their deposits, because it's the cheapest form of funding. If now we start with a digital currency and now you compete with having deposits directly with the fed. You are eroding the huge advantage of the banks currently.

Something that I don't get with the under banked argument for blockchain and crypto is like, I can open up a bank account on my phone now. And in other countries where they don't have banking systems they've developed, I don't know the details, but stuff that works over text messages, how does crypto or DeFi provide a better solution than online banks to get? Like, if someone's not using an online bank today, why would they use their phone to access deposits directly at the fed?

Yes. So this true, the issue is that most of those online banks, although they are still a niche in the market, they do provide sort of better access than the current banks. The question is whether blockchain allows you to do more in terms of not just having deposits, but for instance, having the transactions, paying low fees in terms of... Think about the remittance market, it's a huge market in the US. And everybody, me included base $35 for every time I do a word transfer. Having that with a digital currency that lowers those fees is going to be extremely important, especially for the people that are on the low income spectrum on the left tail of the distribution.

And so sort of that in some sense, it's like allowing for building a super app. Something that allows you to do not just deposits, but a bunch of other services. And if I have the underlying technology with all the different DeFi apps, I can do all of that, right? I can participate in a stock market, which many people don't do in the US. I can have the 10% interest yield on my deposits account. And send and make transactions happening on that same app. Right? So in some sense, the online banking is one small piece of this equation.

Okay. Interesting. If I have a low income, I'm not going to use Ethereum because the gas usage... So it's got to be a different network. Okay. So Fiat money. Money that's based on trust has kind of taken a lot of flack since crypto's growing, and the interest in crypto has grown. But A question that I have is isn't crypto still Fiat money?

In the sense that its only value comes from all believing that it has value. Yes. The only difference that I will highlight and this is somewhat, I think natural. And the second thing is that there is no central figure that we need to put our trust in. Right? The network has been working for since 2009 without any trust, right? Because everybody will verify the transaction, somebody else without knowing anybody else without having any major instant. I think that's sort of the powerful view of this type of new. Let me call it new Fiat money.

So to follow up on that, there's a project that I've seen called Olympus and they're trying to create a decentralized reserve currency like a global reserve currency. Would that be a good thing for the world?

Well, I mean, in sense it's just trying to do the Facebook thing 2.0, right? Because that's in some sense what Facebook was trying to do, a global currency with reserves denominated in multiple currency, as well as with the commercial paper highly rated. And that didn't go anywhere because people, I think quickly realized that would undermine microeconomic policy all over the place. And we'll have also huge geopolitical implications. Why? Because, well, if now the money supply is not just given by how much the fact is injecting into the economy, but how much this private corporation is doing.

The other thing is that geopolitically, well, if these at scale, how does this company decide what type of asset they invest in? They will move the market. If they announce that they will buy corporate bonds, denominated in Euro rather than in USD. Right. And so is that a good thing? It's very risky and I think controversial thing to do. I think that the Facebook is sort of, had on top of that a lot of baggage, and that's why it was shut down prematurely. And it had to evolve and pivot over time, well because nobody knows them. They are not under the radar for now, but it also means that it's going to take them a while if they ever launch to take the scale, that which then we start wondering all of these things. But it's sort of an interesting experiment of creating the bridges across countries. So that's the positive view of all of this, right.

You touched on one of the other questions that I had for you, which is what is the impact on... The feds been doing all of this policy stuff on huge scale. If people are using crypto more than they're using USD, does that pose a problem for the transmission of monetary policy?

Absolutely. Because yeah, you have sort of a direct effect, which is that how the interest rate is set is by the market, but is influenced by how much money is in circulation. So the money supply, how much money is in circulation, depends on people expectation of using this money. If now they shift and start using cryptocurrency instead, stable coins, for instance, these will definitely undermine the effectiveness of monetary policy. Even more so if part of the investment of the crypto comes from buying treasury bills, buying treasury notes that are part of their reserves, right?

That will also affect the demand. And so will affect the interest rate that you can set in the market. That's definitely the most important. I think concern from a regulatory point of view is going to affect everybody, right? Because if really these things take off at some point, and that's the reason why I was upset with the fact, the progress so far, it would be much nicer to have an approach that is proactive and start also bringing in talent, right? The fed doesn't have anybody that is a blockchain expert. Just to give you a sense. Bank of Canada hired a blockchain lead, I think a few months ago.

The same bank of England. I mean the ex governor of Bank of England joined some of the board directors of some of these companies. So the world is moving in that direction. Right? And trying to understand more and see what are the places where there is a connection. There is something that they can proactively do, while I feel like we are still a little bit like in there. And we are facing a lot of risk. If somebody else is doing this, right? There is this concept of privatization of money and that's the overall risk. But if now money becomes privatized, everybody starting their own coin and these are used for transaction. Yeah. They're losing grip of the economy.

Yeah. It's crazy stuff. So I don't know if people seem to think that central banks have been doing bad evil stuff. I mean, their intention has been to help keep the economy going, but it sounds like it could be a negative thing if the central banks lose their ability to...

I'm sorry. I this degree totally with the view that what the central banks have been doing was something evil. One thing that I have to say to my crypto friend is that there is a lack of basic financial knowledge of how things work. Because with the respect, most of them are engineer computer scientists. And so there is a lack of financial literacy that views some of these intervention, something that, yes, so as accessible inflation has brought us all possible evil. But without that, we wouldn't have gone through the COVID recession. We'd never gone through the 2009 recession in the same way, much worse shapes. And so, yeah, I'm much more worried about what happens if crypto takes the center stage and we lose those of tools. Then the exit.

That's so interesting because I think reading DeFi projects like Olympus, for example, it's right on their main page of their website that not having that central bank influence is a good thing. And that's where we need to get to have a better world. But I mean, I agree with you. I know lots of crypto people would disagree with us, but just the misunderstanding of quantitative easing as money printing when obviously that that's not what's actually happening.

Yes.

Very quick question for you. What's an NFT and why would one of them sell for like 60, 70 million dollars?

So NFTs are non fungible tokens, which is basically a digital representation of whatever I might be in the real world. Meaning I might be a digital representation. So a string of numbers that represent the picture, represent the art, represent... It might represent also something else, like a ticket, and event. It might represent an hour of your time. It represent whatever it is in real world in a unique way. And it gets recorded. And as everything else in the blockchain, once it gets recorded is immutable, there is history and is transparent.

Why somebody will pay 69 million? So that's a little bit too far away on the crazy scale for me. The reason why... So let me put to the positive spin in general for why NFTs are growing so fast. In some sense, it's not that different from the way in which we were collecting other things in the past. When I was a kid, I would collect the soccer player figurines. And those will trade and then we will make fun of that. And we'll enjoy that. NFT in some sense, it's the same thing for somebody with digital native, right? Yes. It's just in the computer. I don't have it in my hand, but if everything else is just in my computer and even in my hand, what's the difference, right?

It's the same reason why I like reading books on paper, but people use their Kindle. I think there is a little bit of that generational difference. The other thing is the same way in which scarcity at the end of the day gives you value. The NFT is scarce in the sense that you know for certain, there is only one that gives you exactly that picture, or gives you that art form. I personally collect art, but I enjoy it in my office. And I like to see that all the time. But I imagine there are people that just the fact that they are the only owner of that would be enough. So I think that's the reason.

The NFTs itself, I will say are extremely helpful if you think about it, because our next step again, right now, it's not something that is a currency, but it's something that I create to resemble something that is happening in real world. And then in some of the example that I was giving you is for instance, oh, the creators coming in and creating an NFT that is linked to an event and they have a thousand people connected on their zoom. Everybody that wants to be connected, needs to buy one of those NFTs. For instance, just to give you an example, or I can create NFTs that tokenize a real estate property, right. And then I exchanged that because that is equivalent to a condo part found in Manhattan. So that's why I'm saying, in some sense, I know that the crazy stuff are the ones that attract a lot of attention, but the underlying technology is actually pretty cool.

It is very cool. This has been a great time spent with you. So our last question, Marco. How do you define success in your life?

Wow. You left the most difficult one for last. So honestly, if I have to think about that, I maybe a people pleaser, but the way I think about it is mostly through the lens of other people. And this is different in different areas, meaning that in general in life, when I look at my father, when my mom was here, the way in which they were looking at me, it would give me that peace of mind of thinking that in their eyes, I was a successful person. In my day to day job yesterday, I got an email from a PhD student from a not prestigious university that I was trying to help out. And she wrote me this beautiful email thanking me, that goes in my folder of the nice things to remember during darker times, that gives me a lot of satisfaction. And so that's honestly what keeps me happy.

A great answer. Well, this has been a very satisfying hour or so, Marco, thanks so much for your time.

Thank you so much for having me. This was a lot of fun.

Oh, Marco, this was great because it's not easy to find qualified economist who can speak in an informed way about cryptocurrency and blockchain, but also whatever you call it, traditional economics. So this is awesome.

Thank you.