We Are Seeing The Dangers Of 3rd Party Counter Risk

almost 2 years ago

We all heard it before: not your keys, not your crypto.

This is a mantra that was used almost exclusive a number of years back. Over time, we saw it waning a bit as larger firms got involved. With exchanges exploding in size, people felt confident in them.

Perhaps there is a lesson here. We have to be careful with who we trust.

Coinbase is now sharing that crypto depositors will be traded like creditors in bankruptcy.
Celsius is not allowing withdrawals and could face more troubles
Blockfi is being sued in what seems to be most states
Binance is apt to shut down withdrawal at any moment
Do we even need to mention Bittrex?

This is exposing what was Satoshi wanted to design around.

Source

Counter Risk

Cryptocurrency is a very immature industry. In fact, it is more accurate to describe it as embryotic. We are involved in something that is providing a paradigm shift. For that reason, the potential is enormous.

Of course, the unfortunate aspect to that is all kinds will come out of the woodwork. This means we see a great many who have nefarious intentions.

Even if the people are genuine in their intent to run a successful business, the reality is starts ups are difficult. Even for something like Coinbase, the path is mired with a lot of pitfalls. Moving from niche company to major financial player is not easy.

For this reason, central exchanges should be used for trading and not holdings.

Counter risk adds another variable to our investing. This is problematic because things are tough enough without that. We are confronted with the issue of what coins/tokens to hold as well as the systemic risk from the markets in general. When confronted with the risk associated with an application or platform, that only adds to it.

For a publicly traded company like Coinbase, there are some safeguards in place. However, there is still another degree of risk as compared to the existing financial system.

And, as we know, the safeguards might not really be that safe anyway.

Instilling Trust

What we are dealing with is an issue of trust. In fact, this is the entire basis of the financial and monetary system. Ultimately, we are in a search for consensus.

The present financial system is based upon the premise of size along with regulation means trust. This is what the politicians and bureaucrats are looking to bring to cryptocurrency. They believe regulation is how we generate a trustworthy system.

Of course, the track record there is spotty at best. We know the trusted institutions end up faltering. Often, the policies put in place have unintended consequences which lead to larger amounts of pain.

Cryptocurrency was designed based upon the premise of moving trust away from institutions and humans. Knowing they are flawed, could there be a way to ensure the stability of a monetary system without having to depend upon human decisions?

This was the emergence of Bitcoin. It was structured in a way that where counter party risk was eliminated. No need to trust anyone. A bunch of anonymous computers around the world were incentivized to ensure the transactions in the ledger were recorded properly.

Obviously, at the blockchain level, this is evident. As long as there is a degree of decentralization, we can safely trust the process. The challenge arises when we move passed this.

This is a dilemma because, quite frankly, additional layers are required to create a thriving financial and economic system. Blockchains recording transactions is only part of the process.

Greater Danger In A Young Industry

We are working on how to evolve things. There are going to be a lot of train wrecks going forward. This is simply how development occurs.

At the moment, post-UST implosion, we see questions about Tether and other stablecoins. Probably next on the list is USDD which is a token that was not built around value.

Nevertheless, this is all part of the process. Unfortunately, being so young, there is a greater chance of 3rd party counter risk than our established system. This is magnified the further away we move from the base layers.

Here is the quandary: we need second layer solutions to expand, grow, and create a legitimate financial system to serve the global needs. However, we are confronted with how to do that in a manner that reduces the risk involved.

For the moment, it appears, we are only adding to it.

This is where governments believe it is their job to step in to "protect investors". That said, we can see divergence between the track record and what they believe. The Great Financial Crisis, after all, was created by the rating of junk debt as high quality, unleashing a collateral crisis that collapsed the global economy.

Of course, tens of millions lost their jobs, homes and a lot of wealth due to this. So we can certainly dispute how the effectiveness of their regulations in protecting anything.

We will see the dual approach being employed. It is evident the regulators are circling the wagons. However, the industry will keep building and expanding. Through this, we will see experimentation, bringing up new ways to reduce the counter party risk. Ultimately, decentralized ledgers/wallets could serve the purpose. The question is how efficient can they be?

In the meantime, we each, individually, have to focus upon doing this ourselves. We have to be careful who we trust. There was a lesson applied with the rug pulls during the DeFi craze. However, there are levels of risk higher up the spectrum.

It is what we need to pay attention to.

If you found this article informative, please give an upvote and rehive.

gif by @doze

logo by @st8z