Dateline: Woking, 27th December 2022.

We’re in a crypto winter. Throughout the year, the price of all major cryptocurrencies fell off a cliff following the collapse of TerraUSD and Luna. As I write, the wünderkind Sam Bankman-Fried has led the crypto exchange FTX into bankruptcy and a great many crypto companies are staring into the abyss.

How should we deal with the next FTX? We want the man and woman in the street to be protected from charlatans and crooks, but how? Better regulation is a starting place, of course. The British government’s consultation on "Managing the failure of systemic digital settlement asset (including stablecoin) firms" earlier this year suggested that extensions to Financial Markets Infrastructure (FMI) Special Administration Regime (SAR) make sense for “systemic” Digital Settlement Asset (DSA) firms. With this approach, the Bank of England will have powers of direction over an appointed administrator that will enable it to pursue its statutory role with regard to financial stability. That’s good for dealing with firms that have collapsed, but what should we do to stop them from collapsing in the first place?

We could start by learning the lessons from a previous bout of irrational exuberance centred on new technology: Britain’s mid-19th century railway boom. Way back in 2011, I wrote an article for Financial World magazine, suggesting that this might be the best context for assessing the likely trajectory of cryptocurrency and I remain very fond of using this case study to explore what the government, industry and regulator’s responses to the crypto winter should be.

The announcer says that if you see anything unusual (for example: a train) then you should report it.

The historian Niall Ferguson comes to a similar conclusion. He recently asked whether we are seeing crypto’s Lehman moment, Long-Term Capital Management moment, dot bomb moment or Enron moment before concluding that to really understand what is going on and what to do about it, you do indeed need to go back to Victorian times.

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Let me remind you of the dynamics. The first passenger railway service in the world started running between Liverpool and Manchester in 1830 and less than twenty years later the London & North Western railway had become the biggest company in the world, the Apple of its day, by exploiting the new technology of steam.

The new technology was the focus of a speculative mania and that in turn led to the crash of 1866. In that case it was banks, rather than the crypto exchanges, who were lending money that was never going to get repaid. The British government was forced to respond and it did so by suspending the Bank Act of 1844 (which meant that lenders could pay out in their own tokens — i.e., paper money — rather than gold). This kept the wheels turning for a while, but the lenders were not too big to fail and the famous Overend & Gurney bank went under in May 1866 (the last run on a British bank until the Northern Rock debacle ) and led to the collapse of some 200 other companies.

(The directors of Overend and Gurney were, incidentally, charged with fraud but got off as the judge said that they were idiots, not criminals. I wonder if the same judgement awaits the FTX CEO?)

The railway companies were enormous and many retail investors had piled in to them. When their Directors went to see the Prime Minister in 1867 to ask for the nationalisation of the railway companies to stop them from collapsing because they could not repay their loans or attract new capital (with dread consequences for the whole of the British economy and in particular the widows and orphans who had invested in them), Benjamin Disraeli told them to get stuffed as he didn’t see why the public should bail out badly run businesses, no matter how big they might be.

This sets a wise precedent. Yes, we should let crypto burn. It’s sad that retail investors were looted, and where fraud occurred it should be dealt with through the courts, but that’s how capitalism works.

Crypto Mammals

That is not the point of this story though. Niall Ferguson comments on Nouriel Roubini’s doom-laded predictions of crypto-extinction by observing that had Roubini been around 300 years ago, he would have used the example of the South Sea Bubble to predict the end of the stock market. In reality, though, that boom-and-bust did not mark the end of equity financing any more than the various panics of the 19th century marked the end of joint-stock banking.

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The railway companies collapsed, and they were a much greater fraction of the economy than crypto is today. The crypto “market cap” is under a trillion dollars, only around the same as Tesla. But, as was noted in the Financial Times, while the collapse of Luna, FTX and so on may not pose systemic risks, the cost to retail investors means political fallout.

This is where the lessons from the railway crash should guide the politicians. As you may have noticed, while those pioneering railway companies went bankrupt, we still have railways. A new railway industry was born from the ruins, just as new digital asset markets will arise from the ruins of crypto.

The transport services kept running because the new industrial economy needed them and that economy kept on growing. The new post-industrial economy needs a new transport network, for bits rather than iron and coal, and Bitcoin’s heirs and descendants might well provide it. The impact of the railway crash was not restricted to rail transport and the industries that used it, just as the impact of the crypto winter will spread far beyond online drug dealing and mad speculation.

As I am sure must be obvious, we have repeatedly gone through this cyclic co-evolution of technology, business and regulation to end with fundamental changes to the way that society operates. What is important is to come through the cycle and make things better than they work before.

In my book “Before Babylon, Beyond Bitcoin ” I referred to Andrew Odlyzko’s superb paper “ The collapse of railway mania, the development of capital markets, and Robert Lucas Nash, a forgotten pioneer of financial analysis ” in which he argued convincingly that the introduction of basic corporate accounting standards following the collapse of the railway companies was a significant benefit to Britain and aided the development of Victorian capitalism.

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The vital lesson of that crash was not that people shouldn’t invest in railways but that new standards for accounting and reporting were needed. These standards gave confidence to investors in all industries, not only railways, and allowed them to send capital to far-flung enterprises with confidence. The railway industry caused the new standards to come into play but it was not the only beneficiary.

Benoît Cœuré, chair of the Committee on Payments and Market Infrastructures (BIS), and Jacqueline Loh, chair of the Markets Committee (BIS) made a very good point about this, writing that “while bitcoin and its cousins are something of a mirage, they might be an early sign of change, just as Palm Pilots paved the way for today’s smartphones”.

This, I think, is a sensible perspective.

But what exactly were the Celsius Network, Three Arrows Capital, Voyager Digital, FTX and their fellow crypto businesses “paving the way” for? I think it is for decentralised markets that trade in digital objects (to use the Law Society of England and Wales’ terminology), tokens with an institutional link to real-world assets. These are markets made up from money-like bearer instruments continuously trading in liquid markets where there is a new transparency and the potential for an ambient accountability analogous to the Victorian invention of accounting standards and auditors.

These will in turn help post-industrial capitalism to reinvent itself for the online age and we should all welcome the new age.

(An edited version of this article appeared on Forbes, 30th November 2022.)

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In the future, everyone will be famous for 15Mb

The Crypto Winter might be very good for us!