[FabHK]

> The purpose of financial markets, sometimes but not always wholly achieved, is to transfer risks to those best able to hold them.

That is just one of the purposes; others are:

- time-shifting of consumption: borrow when you study or build a house, then invest and save during work years, then live of retirement portfolio

- maturity transformation enabling investment: extra cash goes in the bank (and can be redeemed on demand), is bundled and lent (long-term) to fund construction or businesses [1]

- allocative function: send capital to its most productive use. For that, you need accurate prices, supported by equity research and markets.

So, in real financial markets, all the arbitrage games etc. [2] at least support actual productive purposes.

In crypto, it's just a pure cargo cult copy of financial markets without any underlying productive purpose.

[1] that whole banking business is somewhat precarious, but reasonably well understood (since Bagehot) and regulated/insured, though in recent times obviously hasn't worked great. Alternative models (narrow banks + private credit) are conceivable.

[2] and to be clear: the amount finance skims of the economy is way too large. Similarly, building a somewhat straighter fibre (and then microwave towers) from Chicago to NY has no societal benefit I can discern. (But the solution to that is fintech and regulation, not crypto.)

[MrPatan]

> But the solution to that is fintech and regulation, not crypto

Why? Now we have a trustless, decentralized, tech solution, why do you still want the "guys with guns" solution?

[notahacker]

Because whilst crypto provides an excellent solution for the "how to skim money from the economy by persuading less skilled investors to give you money" part of finance, it doesn't address the actual problems finance purports to solve like sending capital to its most productive use, maturity transformation, insurance, pensions etc.

[MrPatan]

It's the same application layer just running in a different tech and social stack.

It's clear why the current gatekeepers don't like permissionless alternatives, but why do you agree with them?

[notahacker]

The "social stack" is what actually makes finance's "application layer" happen, because it turns out that blockchains can't actually enforce delivery of barrels of oil or sue ICO recipient for spending their proceeds on coke and hookers, and things like hiring and receiving goods and valuing insurance losses all involve counterparties.

Much as you would like to personalise this debate, it's not about my level of agreement with straw gatekeepers. It's about the simple fact the "application layer" doesn't exist. You're not getting your mortgage or pension from a blockchain.

[MrPatan]

Nobody is saying delivery of assets is done on chain.

That's a strawman you've skewered twice already, well done.

What we're saying is: a lot of the low level infrastructure used now in finance (brokers! Dealers! Clearinghouses!) is easily replaced by some code, once you have trustless decentralized computers. Which we do now.

Then your oil barrel market is just some code nobody needs to trust, and yes, the "last mile" of it still needs "guys with guns" infra. So what? We made a part of that market freer and fairer.

Cool, isn't it?

[notahacker]

You started off asking "why do you still want the guys with guns solution" and insisting that blockchain provided a "trustless, decentralized" solution to the problems financial markets purport to solve.

So I don't think it's a "straw man" to point out the answer to your question is market participants want promises actually delivered upon which you now admit is entirely dependent on the "guys with guns" (and/or trust). By extension, blockchains don't actually provide a trustless or decentralized solution to the actual problems of finance. Actually knowing that your counterparty will send you oil isn't some unimportant detail of the oil barrel market which can be handwaved away, it's considerably more important than the implementation detail of the transaction record updates or whether brokers are involved.

You've moved more goalposts in this discussion than crypto has moved in the useful bits of finance.

[Breza]

All those levels of infrastructure already run on code. There's no tech reason that Robinhood can't sell you stock that it holds. The FTX situation shows you why they aren't allowed to do that.

[croes]

There is no such thing as trustless

[earnesti]

But there is varying degrees of trust required. Also the quality of trust.

[MrPatan]

Where's the trust in a bitcoin tx?

[Breza]

You have to trust that the restaurant where you're having lunch will accept BTC as payment. In reality, using Bitcoin requires the same trust-based infrastructure as everything else because the only way to buy anything with it is to trade it for fiat.

[croes]

That Bitcoins still have a value when you sell them

[MrPatan]

1 BTC = 1 BTC

[croes]

https://www.coinopsy.com/dead-coins/abandoned/

[Summershard]

Well, not really. Tainted coins is a real, growing problem that BTC hasn't solved yet.

In short, BTC is not fungible.

[notahacker]

sure, and 1 UST = 1 UST, but it turns out that people who thought they didn't need to trust the asset held its value are considerably poorer than they were before.

[agentgumshoe]

> So, in real financial markets, all the arbitrage games etc. [2] at least support actual productive purposes.

So without all those games, what would be substantially different?

[pembrook]

By referring to arbitrage as “games” OP’s comment has poisoned the well for this entire chain of responses. So to get an understanding, first we need to fix.

A “game” implies non-productive or zero sum.

By definition, an arbitrage is not that. Any arbitrage is the result of an inefficiency in prices or the economy.

When someone arbitrages prices back to where they should be, they are performing a service that everyone else benefits from, and are rightly compensated for this. Now, are finance people compensated too much for correcting price discrepancies? If yes, then that’s another arbitrage opportunity!

But the question of what would be substantially different is easy. No arbitrage = no markets = top-down command economy. Check out North Korea, Cuba, USSR, the former Yugoslavia, etc. for what would be different.

[less_less]

> When someone arbitrages prices back to where they should be, they are performing a service that everyone else benefits from, and are rightly compensated for this. Now, are finance people compensated too much for correcting price discrepancies? If yes, then that’s another arbitrage opportunity!

While I agree that finance serves a useful purpose, I don't understand this bit. Suppose hypothetically that arbitrage gives some social utility, but not in proportion to the amount of money it makes for arbitrageurs, and thus not in proportion to the effort put into it. Suppose that society is overproducing finance -- that most people would be better off if the world had slightly worse pricing information, fewer financial datacenters and low-latency microwave links, less human effort devoted to banking, and more of something else that could be built with those resources and that effort.

Maybe this creates another arbitrage opportunity -- maybe in an idealized free market (where there are no barriers to entry) more people would work in finance, and their competition would reduce profits. But it seems to me that this would only worsen the overproduction problem.

Or is there something I'm missing here? Why isn't this really an "opportunity" to (carefully) increase taxes on finance, so that it won't be overproduced by as much?

[nsvd]

I don't think it's the case that finance is over produced. If it were, then the value of financial services would drop.

Rather, because the gain produced by financial instruments is proportional to the wealth someone has, the returns of finance disproportionately benefit those with large amounts of wealth. One man can only make so much plumbing or being a mechanic, but can make an arbitrary about by investing in ETFs.

In other words, if the financial sector was largely a collection of small businesses run by middle class people, no one would think it was a problem that they make money. That would be great! But in reality it's a smaller amount of companies and smaller amount of wealthy people that benefit from it.

That problem isn't unique to finance, it affects many parts of our society.

[less_less]

> I don't think it's the case that finance is over produced. If it were, then the value of financial services would drop.

I don't think this follows for all financial services. Overproduction leads to a drop in value if the market is efficient, but real-life markets are not perfectly efficient. For arbitrage in particular, the whole point is that the market isn't efficient. Arbitrage makes it more efficient after the arbitrageurs have taken their cut, but the value of that service isn't necessarily determined efficiently. (At least as far as I know: I'm not an expert.)

> Rather, because the gain produced by financial instruments is proportional to the wealth someone has, the returns of finance disproportionately benefit those with large amounts of wealth. One man can only make so much plumbing or being a mechanic, but can make an arbitrary about by investing in ETFs.

> In other words, if the financial sector was largely a collection of small businesses run by middle class people, no one would think it was a problem that they make money. That would be great! But in reality it's a smaller amount of companies and smaller amount of wealthy people that benefit from it.

> That problem isn't unique to finance, it affects many parts of our society.

... but I do almost entirely agree with this.

[berniedurfee]

I think regulatory capture needs to be considered as well.

At some point those that amass large amounts of wealth are disproportionately able to influence government regulation to ‘game’ the system itself in their favor.

It seems in the realm of finance, it’s much easier to obscure regulatory capture than in other domains, where anti-competitive practices are much easier to suss out.

[wavemode]

It's much simpler than that. The utility provided by arbitrage is that a given security is no longer under- or over-priced in one market relative to other markets. Any buyer/seller of that security will then always be buying/selling for the best available price (rather than losing out on money by not buying/selling in a different market).

The price discrepancy which was corrected by arbitrage is, itself, the compensation the arbitrageur receives. If it weren't, that inherently also means that there still exists a price discrepancy, and thus an arbitrage opportunity.

This is all separate from the question of public policy. Should taxes on income from arbitrage be increased? Perhaps they should. Though that doesn't affect the mechanics of how arbitrage works, it simply decreases the net profit of the firm doing the arbitrage.

Conceivably, you could increase the taxes/regulations/restrictions on such firms to such a degree that they are either no longer allowed to perform arbitrage at all and/or can no longer justify the cost of the high-speed equipment involved. The end result of this would be that the markets become less efficient (there would be greater price discrepancies and they would arise more frequently).

How much does that matter? Well, that's more of a philosophical question. How much does it matter to you that you're buying something for the best possible price (versus knowing it might be available cheaper elsewhere)? Depends on the person.

[norswap]

I understood it as it's an arbitrage because it enables the creation of a new system that reward arbitrageurs less (but still enough that they would perform the arbitrage).

Though this is only true in a system where you don't face tons of hurdles to deploy these new systems, which is not the case in the current financial system.

[vinay_ys]

Most of the pricing inefficiency comes from information asymmetry. It might have made sense a 100 years ago when information traveled slowly. But in today's world, it travels fast. But still there is asymmetry due to purposeful obfuscation and complex packaging.

[lxgr]

You‘d probably see much larger spreads and lower liquidity when buying and selling stocks or commodities/currencies; you’d often overpay on insurance etc.

(All assuming a properly working market without collusion, illegal usage of non-public information etc. – which is unfortunately not always the case.)

[norswap]

I was nodding my head along (fantastic answer) until the stab at crypto.

Let me offer a (partial) defense of crypto if I can:

Broadly, crypto is divided into crypto-currencies and applications.

Let's tackled currencies first, some of which some are reputable and some of which are grifts, but which viewed in their most favorable light attempt to be a form of currency or asset that is decentralized. This means that no single party may unilateraly devalue them, or restrict their trade in any way.

(No I understand if that doesn't excite a lot of people, but this is clearly valued by some people!)

As may be obvious, crypto-currencies are too volatile to serve as actual "currencies", so they are at best "assets". But it is possible to use these assets as collateral for the minting of stablecoins. I'm not sure this is quite risk transfer, but it essentially relies on the willingness of some to hold speculative assets to enable the creation of a stable assets.

In turn, these assets are not typically useless — they hold value because there is demand for them to pay for transaction costs on blockchain.

Blockchains themselves are not useless. We may not think much of the difficulties of transferring money, but it is a real challenge in LARGE swaths of the world, where people are unbanked or live under tyrannical governments. I would argue that even in the west, the need becomes is becoming more pressing (Trudeau freezing trucker supporter bank accounts, banks imposing tons of restriction on cash withdrawals and "large" bank transfers).

Beyond transfer, they also serve to run decentralized applications. People are quick to dismiss those, and true it doesn't enable to do anything dazzingly new. It simply enables you to do things you could already do, but in a way where no single party (or even colluding parties) can shut it down. This may seem silly, but I think the world would truly be better if we for instance had a YouTube where copyright trolls couldn't strike down / demonetize legimate content.

Applications then. In reality, we're still far from decentralized YouTube (but we will get there). Most applications today are financial. And I think they're quite useful. The financial infrastructure being built is genuinely novel and useful.

The problem is that it is navel-gazing at the moment: that infrastructure is mostly used to perform financial operations on crypto tokens themselves. But there is no reason that they couldn't be used for other assets.

In fact this is starting to happen: you can now invest in real estate and US treasuries on the blockchain. We're still a way from mainstream adoption, and that has mostly to do with legal uncertainties that prevents established players from diving in (though many of them are experimenting). There are also entrenched interests there, it must be said.

So if anything else, crypto helps build a better financial infrastructure.

It's somewhat ridiculous that when you buy some stock, the trade is routed through three intermediaries and is only really settled 7 days later. The abstraction on top of this is actually leaky, with each intermediary coming with some risk and some agency to throw a wrench in the works. As in fact happened between Robinhood and its clearinghouse (or some such intermediary) during the GameStop frenzy.

[pcdoodle]

Another useful aspect:

Heat pumps will take a long time to reach every application that needs heating. EG: drying grain. Sometime heat pumps are not the answer (-21F for instance). Bitcoins resistive heating properties are almost 100% efficient.

With bitcoin mining: Money In = Heat + Air Flow = Money Out.

Electrical energy now has an opportunity to not be waisted where it normally would be. Think renewables where line loss / demand doesn't make a perfect system. Bitcoin can act as a storage device with near free movement allowing flexibility in these systems.

This monetary recovery can also be used to move money/energy to other places without the line loss.

[rprospero]

It’s that last step I’ve never understood. I get that some guy in Iceland has excess power generation and can use that to mine bitcoin. I can then buy those bitcoins from him. However, I’ve never heard an explanation for how I then recover the energy from the bitcoin?

The closest I’ve heard is that I could use the bitcoins to buy electricity from someone else, but I could have just paid that guy in the first first place and cut out the guy in Iceland. Also, it feels like we now have two power plants involved in charging my laptop, which feels like a lot of overhead.

I’ve heard this explanation enough that there must be something obvious that I’m missing.

[pcdoodle]

You could take the bitcoin from excess hydro generation in a northern climate and deploy solar panels in a climate where solar has great ROI for instance.