The Island of Crypto
or Why Crypto-for-Crypto is OK.
We often discuss how crypto and defi can be used to impact the “real” world. My view is that crypto-for-crypto is a normal part of a paradigm-changing shift, it’s to be expected, and follows a natural path – a similar path that the internet took. Crypto-for-crypto capital and tools create a flywheel effect that drives the ecosystem to get it to a stage ready to integrate with the “outside” world. Effort and time is needed to build an infrastructure that is useable by all, it doesn’t happen by magic.
Let’s use an analogy, which by definition is imperfect, but is helpful for building a mental model. The analogy is a physical one, but we’re using it to try to understand a new digital crypto-native economy.
The Island of Crypto
Imagine that a brand new island pops up in the middle of the ocean. It has certain quirks, and holds promise. There is initially no economy. Most people ignore it, but some enterprising explorers sail there, decide they like it, and start building. Nation states initially ignore it as too small and irrelevant, and there are some peculiarities that don’t fit into well-understood traditional paradigms.
What do we expect to happen? Do the explorers immediately start to import and export? Unlikely. They’re going to build for themselves. Rudimentary shelter, infrastructure, local commerce, villages and towns. Domestic tools are important to get the economy going. The tools are useful for the settlers, but not so for the outside world. The focus is inwards, not outwards.
Are the rules established? Well, some settlers bring in good ideas from their home countries, but the rules are largely still being figured out. This particular island, intriguingly, has a new way to manage financial and property rights, and the settlers have figured out how to automate some processes in new ways that work differently from the traditional paradigms of needing to rely on intermediaries.
Is this a tourist destination complete with luxury resorts, spas, and Michelin certified restaurants? Not yet: the infrastructure takes time to build to get to the quality level expected from tourists. Adventurous backpackers may be happy to learn the quirks and put up with some deficiencies, but this is not yet a destination for demanding package tourists.
Is this a hub for imports and exports? Perhaps some of the settlers import assets from their home countries. But initially the goods and services generated on the island are not of export quality, or at least doesn’t match foreign tastes, quite understandably.
The Island of Crypto behaves like a classic emerging market – there are great opportunities, but it is capital constrained. Many from the outside world would not be comfortable to lend to the explorers, as the risk profile is not yet well understood, and risk of default is high. As a result, interest rates are higher on the island than in the outside world. It’s expensive to borrow, and there are few lenders, but borrowed capital can be used to make even better returns.
The outside world looks in, some curious, some with skepticism. This is to be expected. Some people leave: this place is not for them. Some other people arrive, with new ideas, new capital, happy to enjoy the tradeoffs offered by quirks of the island. More people means more infrastructure, more certainty, more clearly defined social, political, and economic expectations and standards. Cultural norms emerge, complete with new vocabulary and colloquialisms.
Over time, value is created, seeded from outside capital, and levered through effort, skills, and entrepreneurism. For those who like it, it’s a great place to be. Those who don’t are free to leave.
What happens when some of the settlers find success on the island? Some may send money home, flipping it from local currency to the currency of their home countries. Others reinvest their domestic gains into yet more domestic ventures.
The island becomes self sustaining. It doesn’t necessarily need the outside world. But over time as it gets bigger, more people want to come in and out. They may not migrate, but they want to holiday there. Better tourist guides are written, and tourists know what to expect. Some people buy or build second homes there. The borders open up, products become export-quality. Goods and services created on the island can be exported, as they become acceptable to the outside world.
Eventually the bustling Island of Crypto becomes important and relevant enough for the world to take notice. It finds a place in the world order. The world appreciates it for what it is, and it understands its place in the world.
Ok, analogy over.
Now there are clearly some issues with the analogy. In the analogy, the Island of Crypto is depicted as a happy self-sovereign state that doesn’t need the rest of the world. But in the real world people live in countries with governments, laws, and societal norms that have been built up over time and experience. If they do things that conflict with the norms of the physical environment in which they live, they may be threatened with incarceration, violence, and in some cases, worse. This is the social contract under which we live in the physical world, and is well understood by crypto natives.
Crypto is also only possible owing to real world paradigms and the social contract: crypto natives rely on the stability and promises afforded them by the countries and governments they live and operate in. They travel on real world roads and fly on real world aeroplanes to visit each other and go to conferences. Many live comfortably knowing that if harm is done, the real world police will get the bad guys. When crypto natives get upset with each other, they start turn to the real world courts.
That said, I have found this analogy useful to explain what’s going on, and why I think there’s a time and a place for making crypto useful for non-natives, but why building and investing in crypto-for-crypto is a necessary step towards more mainstream adoption. Adoption can work in two ways: the island can export, or people can move in.
A final point aimed at the idea that crypto isn’t the “real” world: It actually already is. Crypto natives are real world people – we live and breathe in the real world, we have families, we need to eat, we buy stuff, and we contribute to the real economy. The value created is real, just as money made in traditional finance, such as by bankers, hedge funds and prop shops translates into consumption of physical food, real estate purchases, and the rest.