Hi There,
Do you know what unites the villain of the hour Sam Fried and Ladoum Sheep. Well apart from both being extremely expensive.
It is surplus hopefulness that characterises our ability to underestimate the probability of negative events and overestimate the possibility of huge spectacles of speculative enrichment. Let's start with sheep.
Senegal is not a very rich country, the GDP per head is US$ 1600. Therefore you would not expect a full blown Tulip mania like situation going there albeit with sheep. People in Senegal adore sheep, so much so that during Tabaski (Eid al-Adha) hundred and thousands of sheep are sacrificed and eaten. Which is no different from other parts of the world. However, in a country where a third lives below the poverty line, people reportedly take out crippling loans to not lose social standing. It is a feature of many developing countries where social standing is an imperative that has to be maintained. However, this is where Ladoum sheep have entered the picture.
The Ladoum sheep are majestic, some rams can weigh equivalent to three men. In a very short span of half a decade the sheep have taken over the fancy of the country. Ladoum sheep can command prices as high as US$ 80,000 to 90,000. The sheep can't be sheared as they have no wool, and are rarely sacrificed as they are too expensive, and beautiful. Therefore they are reared, and sold as objects of beauty and investments. The people buying them state happiness as their primary reason for investing in a Ladoum sheep, and that is a valid reason. The problem is sheep as a store of value just like any other store of value have their moments of steep rise, and precipitous fall. Just ask the Dutch during the Tulip mania, or your friend the crypto-enthusiast.
That brings us to the other sheep, the one of the crypto kind. Who would not trust central bankers but anyone trying to decentralise finance and without any valid business proposition is fair game.
Cue FTX meme.
First, let's start with what is behind the current proliferation of financial products based on blockchain technology.
According to CoinMarketCap.com, there are over 10,000 cryptocurrencies in circulation today with a total market cap of over - $860 billion. To put it in context, the total value of all US stocks is currently less than $42 trillion. Needless to say, this is a lot of money to lose if the crypto markets become unstable and the prices crash.
For a decentralised technology that aims to solve a number of inefficiencies in the financial markets and create a fairer society, it's hardly surprising that crypto itself has become riddled with scams and frauds. The ongoing FTX scandal is just the tip of the iceberg. The unregulated nature of the cryptocurrency market has resulted in the rise of numerous Ponzi schemes, pyramid schemes, malware attacks and many other fraudulent activities aimed at siphoning money from investors. While regulators around the world are busy developing a framework for the regulation of cryptocurrencies, their efforts will have little impact on the criminals operating in this space. In many ways, it is a variation of the old scam of the Nigerian prince who needs your bank account number to transfer millions of dollars to your account in exchange for a small fee.
The wild wild west space is here to stay, so now the question becomes 'how do we trust the systems in this environment?' The answer lies in a system of checks and balances that foster transparency and security. And in understanding the human psyche, we can ensure that regulatory frameworks and safeguards are put into place that protect the interests of the consumers as well as the companies in the space.
Regulation framing through a behaviour lens
A lot of people talk about regulation, but few have any real idea of how to move forward. But behaviour economics and second-order thinking can help us frame regulation and bring macro psychology into the fold to help regulate this market moving forwards.
Let's take a quick look at two concepts that are relevant to our discussion: First, Chesterton's Fence. Chesterton’s Fence is a heuristic inspired by a quote from the writer and polymath G. K. Chesterton’s 1929 book, The Thing. According to Chesterton, it means to not remove a fence until you know why it was put up in the first place. This is the idea that we should be wary of removing regulations that might restrict harmful behaviour without fully understanding the consequences.
So before we look at potential solutions we might employ to regulate the crypto market, we should consider why things are the way they are in the first place, so that we can avoid creating additional problems while trying to solve existing ones. This leads us to the second concept we'll examine here, which is second-order thinking. it refers to the process by which you first develop a solution to a problem and then go back and examine the reasoning behind that solution to see if there might be a better way to achieve the same goal with fewer unintended consequences. Like Chesterton's Fence, this idea acknowledges that good solutions tend to be the ones that have been tested and examined from many different angles before they are put into action. Applied to regulatory issues in the crypto space, this means that regulators should strive to develop solutions that have been thoroughly vetted and tested by the markets themselves before implementing them.
Looking again at the crypto market through the lens of both these concepts provides us with some interesting insights as to adopting an approach based on these two principles could help us address some of the key challenges facing the crypto industry today, including volatility, investor protection, and custody solutions.
The dramatic fluctuations in the price of these currencies over the last couple of years have made it difficult for newcomers to the crypto space to understand the risks they're taking when they buy in. In this sense, I feel that many people in the crypto space tend to be like Alice falling down the rabbit hole and losing sight of the big picture because they are so focused on finding the absolute cheapest crypto to buy that they can lose sight of what the long-term value of that particular asset actually is.
Psychological vulnerabilities in market participants play a key role here; for example, the tendency to follow the herd or engage in short-sighted decision-making can lead to serious losses for investors. Additionally, given the highly volatile nature of most cryptocurrencies and the fact that they are traded on unregulated exchanges with no customer protections in place, it would be a mistake to assume that investors are fully protected when trading in these assets.
Similarly, the financial ecosystem has many new products that disrupt traditional banking models, such as buy now pay later, and peer-to-peer lending. While these new models have the potential for massive growth and disruption, they also present significant challenges to consumers and investors that need to be addressed in order to ensure consumer safety and compliance with the law. The ease of credit access and accessibility of financial information online can pose a major challenge in terms of irrational financial decisions leading to potentially devastating consequences.
Moreover, the lack of regulatory frameworks to protect consumers from predatory behaviour by unscrupulous operators may also pose a threat to public confidence in these new models of finance.
It's clear that we need to improve consumer protection in the emerging digital economy. The first thing we need to work on creating a regulatory system with an effective control, and punishment system, of the same scope which works on effectively remedying the surplus hopefulness which trigger haircuts from Tulip, Crypto, and possibly Ladoum.
Till then Doveryay, no proveryay (Trust, but verify).