The Economist - USA (2022-01-22)

66 Finance & economics The Economist January 22nd 2022

themostsince2008.

Easymoneyalsohelpedfuela bonanza

incompany­financingactivity.Thepaceof

dealmaking and initial public offerings

(ipos)hasbeenalmostbewildering.Global

ipos raisedthemammothsumof$600bn

incapitalin2021,comparedwitharound

$200bnin2019.Tradingandcorporatefi­

nancehavetogethergeneratedextraordi­

naryprofitsforWallStreetfirms.Globalin­

vestment­bankingrevenuesamountedto

$129bnin2021,a 40%increaseoverthose

oftheyearbefore,accordingtoDealogic,a

dataprovider.

Butnow,asinflationhotsupandmone­

tarypolicyshifts, theperiodofbumper

profitsthatbanksenjoyedsincethemid­

dleof 2020 maybecomingtoanend.A

look at the profits for the final three

months of 2021 suggests that theslow­

down may have already begun. Trading

revenues dropped by 11% at JPMorgan,

comparedwiththesameperioda yearear­

lier(althoughrevenueswerestill6%above

theirlevelin2019).

Considering that bank bosses have

beenwarningformonthsthattradingand

dealmakingrevenueswouldeventuallyre­

turntopre­pandemiclevels,theirimmi­

nentnormalisationshould,perhaps,have

notcomeasasurprisetoinvestors.The

fact that share prices have fallen,then,

couldhintata lurkingfear.Thearrivalof

extraordinarystimuluspromptedanun­

usual periodofprofitability forbankers.

Perhapspuntersareworriedthatthere­

moval of such stimulus could prove

unusuallydismal.n

Ethereumanditsrivals

Battle of the blockchains

T

o believers, open,public blockchains

provide  a  second  chance  at  building  a

digital economy. The fact that the applica­

tions  built  on  top  of  such  blockchains  all

work  with  each  other,  and  that  the  infor­

mation  they  store  is  visible  to  all,  harks

back to the idealism of the internet’s early

architects, before most users embraced the

walled  gardens  offered  by  the  tech  giants.

The idea that a new kind of “decentralised”

digital  economy  might  be  possible  has

been bolstered over the past year as the nu­

merous applications being built on top of

various  blockchains  have  boomed  in  size

and functionality. 

Perhaps  the  most  significant  part  of

that  economy  has  been  decentralised­fi­

nance  (DeFi)  applications,  which  enable

users  to  trade  assets,  get  loans  and  store

deposits.  Now  an  intensifying  battle  for

market  share  is  breaking  out  in  this  area.

Crucially, Ethereum, the leading DeFi plat­

form, seems to be losing its near­monopo­

ly. The struggle shows how DeFi is subject

to the standards wars that have broken out

in  other  emerging  technologies—think  of

Sony  Betamax  versus  vhsvideo  cassettes

in  the  1970s—and  illustrates  how  DeFi

technology is improving lightning­fast.

The  idea  behind  DeFi  is  that  block­

chains—databases  distributed  over  many

computers  and  kept  secure  by  cryptogra­

phy—can  help  replace  centralised  inter­

mediaries  like  banks  and  tech  platforms.

The  value  of  assets  stored  in  this  nascent

financial  system  has  climbed  from  less

than $1bn at the start of 2020 to more than

$200bn today (see chart on next page).

Until recently the Ethereum blockchain

was the undisputed host of all this activity.

It  was  created  in  2015  as  a  more  general­

purpose version of Bitcoin. Bitcoin’s data­

base  stores  information  about  transac­

tions  in  the  associated  cryptocurrency,

providing  proof  of  who  owns  what  at  any

time.  Ethereum  stores  more  information,

such as lines of computer code. An applica­

tion  that  can  be  programmed  in  code  can

be guaranteed to operate as written, there­

by removing the need for an intermediary.

But  just  as  Ethereum  improved  upon  Bit­

coin, it too is now being usurped by newer,

better  technology.  The  fight  resembles

competition  between  operating  systems

for  computers,  says  Jeremy  Allaire,  the

boss of Circle, a firm that issues usd Coin, a

popular crypto­token. 

Current blockchain technology is clun­

ky. Both Bitcoin and Ethereum use a mech­

anism  called  “proof  of  work”,  where  com­

puters  race  to  solve  mathematical  pro­

blems to verify transactions, in return for a

reward. This slows the networks down and

limits  capacity.  Bitcoin  can  process  only

seven  transactions  per  second;  Ethereum

can handle only 15. At busy times transac­

tions  are  either  very  slow  or  very  costly

(and  sometimes  both).  When  demand  to

complete transactions on Ethereum’s net­

work is high, the fees paid to the comput­

ers  that  verify  them  climb  and  settlement

times  grow.  Your  correspondent  has  paid

as much as $70 to convert $500 into ether

and waited for several minutes for a trans­

fer  from  one  crypto­wallet  to  another  to

take place. 

Developers have long been trying to im­

prove  Ethereum’s  capacity.  One  prong  of

that is, in effect, rewiring it. Plans are afoot

to shift Ethereum to a more easily scalable

mechanism  called  “proof  of  stake”  later

this year. Another idea is to split the block­

chain up, through a process called “shard­

ing”.  The  shards  will  share  the  load,  ex­

panding capacity. Some developers are al­

so  working  on  ways  to  bundle  transac­

tions,  reducing  the  number  of  them  that

must be directly verified.

The  problem  is  that  each  advance

comes  with  costs.  DeFi’s  supporters  tout

The race to dominate the DeFi ecosystem is on