The Crypto Collapse and the End of the Magical
Thinking That Infected Capitalism
Jan. 16,
2023
By Mihir A.
Desai
Mr. Desai
is a professor at Harvard Business School and Harvard Law School.
At a guest
lecture at a military academy when the price of a single Bitcoin neared
$60,000, I was asked, as finance professors often are, what I thought about
cryptocurrencies. Rather than respond with my usual skepticism, I polled the
students. More than half of attendees had traded cryptocurrencies, often
financed by loans.
I was
stunned. How could this population of young people come to spend time and
energy in this way? And these students were hardly alone. The appetite for
crypto has been most pronounced among Gen Z and millennials. Those groups
became investors in the past 15 years at previously unseen rates and with
exceedingly optimistic expectations.
I have come
to view cryptocurrencies not simply as exotic assets but as a manifestation of
a magical thinking that had come to infect part of the generation who grew up
in the aftermath of the Great Recession — and American capitalism, more
broadly.
For these
purposes, magical thinking is the assumption that favored conditions will
continue on forever without regard for history. It is the minimizing of
constraints and trade-offs in favor of techno-utopianism and the exclusive
emphasis on positive outcomes and novelty. It is the conflation of virtue with
commerce.
Where did
this ideology come from? An exceptional period of low interest rates and excess
liquidity provided the fertile soil for fantastical dreams to flourish.
Pervasive consumer-facing technology allowed individuals to believe that the
latest platform company or arrogant tech entrepreneur could change everything.
Anger after the 2008 global financial crisis created a receptivity to radical
economic solutions, and disappointment with traditional politics displaced
social ambitions onto the world of commerce. The hothouse of Covid’s peaks
turbocharged all these impulses as we sat bored in front of screens, fueled by
seemingly free money.
With
Bitcoin now trading at around $17,000, and amid declining stock valuations and
tech sector layoffs, these ideas have begun to crack. The unwinding of magical
thinking will dominate this decade in painful but ultimately restorative ways —
and that unwinding will be most painful to the generation conditioned to
believe these fantasies.
Cryptocurrency
is the most ideal vessel of these impulses. A speculative asset with a tenuous
underlying predetermined value provides a blank slate that meaning can be
imposed onto. Crypto boosters have promised to replace governments by
supplanting traditional currencies. They vowed to reject the traditional
banking and financial system through decentralized finance. They said they
could reject the purported stranglehold of internet giants on commerce through
something called Web 3.0. They insisted we could reject the traditional path
toward success of education, savings and investment by getting in early on
dogecoin, a meme coin intended as a joke that reached a peak market
capitalization of over $80 billion.
These
illusory and ridiculous promises share a common anti-establishment sentiment
fueled by a technology that most of us never understood. Who needs governments,
banks, the traditional internet or homespun wisdom when we can operate above
and beyond?
Mainstream
financial markets came to manifest these same tendencies, as magical thinking
pervaded the wider investor class. During a period of declining and zero
interest rates, mistakes and mediocrities were obscured or forgiven, while
speculative assets with low probabilities of far-off success inflated in value
enormously. Hawkers pitching shiny new vehicles — like “stablecoins” that
purportedly transformed speculative assets into stable ones and novel ways of
taking companies public without typical regulatory scrutiny — promised greater
returns while dismissing greater risks, a hallmark of the ignorance of
trade-offs in magical thinking. For an extended period, many investors bought
the equivalent of lottery tickets. And many won.
The real
economy could not escape infection. Companies flourished by inflating their
scope and ambition to feed the desire for magical thinking. WeWork, a mundane
business that provided flexible work spaces, was portrayed as a spiritual
enterprise that would remake the human condition. Its valuation soared,
obscuring the questionable activities of its founders. Facebook and Google
reconceived themselves as technological powerhouses, rebranding as Meta and
Alphabet, respectively. They sought broad capabilities that they could flex at
will in the metaverse or with their “moonshot projects” when, in fact, they are
prosaic (if extremely effective) advertising businesses. They are now
struggling with many of their fantastical efforts.
Most
broadly, many corporations have come to embrace broader social missions in
response to the desire of younger investors and employees to use their capital
and employment as instruments for social change. Another manifestation of
magical thinking is believing that the best hope for progress on our greatest
challenges — climate change, racial injustice and economic inequality — are
corporations and individual investment and consumption choices, rather than
political mobilization and our communities.
I confess
that this screed reflects my own experience. For the past decade, being a
finance professor meant being asked about crypto or about novel valuation
methods for unprofitable companies — and being smiled at (and ignored) when I
would counter with traditional instincts. Every business problem, I am told,
can be solved in radically new and effective ways by applying artificial
intelligence to ever-increasing amounts of data with a dash of design thinking.
Many graduates coming of age in this period of financial giddiness and widening
corporate ambition have been taught to chase these glittery objects with their
human and financial capital instead of investing in sustainable paths — a habit
that will be harder to instill at later ages.
Embracing
novelty and ambition in the face of huge problems is to be lauded, but the
unhinged variety of these admirable traits that we have seen so much of in
recent years is counterproductive. The fundamentals of business have not
changed merely because of new technologies or low interest rates. The way to
prosper is still by solving problems in new ways that sustainably deliver value
to employees, capital providers and customers. Over-promising the scope of
change created by technology and the possibilities of business and finance to a
new generation will lead only to disaffection as these promises falter. All
those new investors and crypto owners may nurse a grudge against capitalism,
rather than understand the perverse world they were born into.
The end of
magical thinking is upon us as cryptocurrencies and valuations are collapsing —
and that is good news. Vested interests will resist that trend by continuing to
propagate fictions. But rising rates and a return to more routine business
cycles will continue to provide the rude awakening that began in 2022.
What comes
next? Hopefully, a revitalization of that great American tradition of
pragmatism will follow. Speculative assets without any economic function should
be worth nothing. Existing institutions, flawed as they are, should be improved
upon rather than being displaced. Risk and return are inevitably linked.
Corporations
are valuable socially because they solve problems and generate wealth. But they
should not be trusted as arbiters of progress and should be balanced by a state
that mediates political questions. Trade-offs are everywhere and inescapable.
Navigating these trade-offs, rather than ignoring them, is the recipe for a
good life.
Mihir A.
Desai is a professor at Harvard Business School and Harvard Law School and the
author of “How Finance Works and The Wisdom of Finance.”
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