Today is quite the day for those of us who follow markets in general and the financial sector specifically. Over the past few days it became clear that today would also be the day that Coinbase (COIN) would make its debut as a publicly traded company. But before COIN could open for trading, a piece of inevitable but still unexpected news crossed the wires: convicted fraudster Bernard Madoff died in prison.
I’ve been trying to figure out the existential convergence of Madoff dying on the same day that COIN began trading. To the many, the direct public offering of COIN is another key step in the legitimization of cryptocurrency. Many forget that the history of cryptocurrency in general, and bitcoin in particular, has been fraught with pitfalls and outright fraud and theft. Bear in mind that many of the early adopters of bitcoin were using it to purchase illegal goods and services on dark web markets like Silk Road. The sagas of Mt. Gox, Bitfinex, and QuadrigaCX involve loss or outright theft. For those unfamiliar, Mt. Gox closed abruptly in 2014 after losing about 850,000 of its customers’ and its own bitcoins, largely because of theft. Bitfinex, which still exists, had 119,756 bitcoins stolen from customer accounts in 2016. In 2018, about C$250 million in bitcoin and cash disappeared when the founder of QuadrigaCX died. Apparently he was the only one with the password to the digital wallet, though there have been several lawsuits alleging other fraud and seeking and exhumation as proof that the founder actually died. Against that backdrop, is there any doubt that Coinbase satisfies a customer desire for ease and legitimacy in the crypto market?
Yet despite those setbacks and more, the true believers never lost their faith in bitcoin and other cryptocurrencies. For starters, bitcoin is proof of concept of the viability of blockchain, the distributed financial ledger that could have profound and tangible applications across a wide range of industries. I have thought that blockchain is the real “killer app”, not the cryptocurrencies that utilize it. Some blockchain evangelists see it as a potential game-changer, much like the internet. I don’t fully share that enthusiasm, though. Blockchain is not as user-friendly as the internet, and while I have heard about intriguing potential applications for blockchain in securities clearing and supply-chain management, the real-world adoption seems far slower than that of the internet. Less than 10 years after the development of the World Wide Web in 1990 we were fully immersed in the internet bubble (though the pace is slower if we date the internet’s birth to the first message in 1969 or the adoption of TCP/IP in 1983).
In stark contrast to the concept that the Coinbase represents a key step to legitimizing a business with shady beginnings, Bernard Madoff created a shady criminal enterprise built on a carefully constructed façade of legitimacy. Though he started his business as a penny-stock trading firm, it grew into one of the largest market-makers on NASDAQ. Madoff became prominent enough to serve on the board of governors and eventually chairman of the National Association of Securities Dealers (NASD, the original sponsor of NASDAQ and now known as FINRA). During a Bloomberg radio interview today, I heard the former head of the Securities and Exchange Commission (SEC), Arthur Levitt, say that the SEC regularly consulted with Madoff before adopting rule changes. It made sense then, though it sounds insane to modern ears – like asking a bank robber about the best safe to use for a vault. Madoff was a pioneer in exploiting rule 19c3 to trade listed shares over-the-counter and offering financial incentives for brokers to route their order flow to him. Like it or not, much of modern market architecture – multiple exchange listings and payment for order flow – date to Madoff’s business practices.
The veneer of legitimacy allowed Madoff to avoid proper scrutiny of his “asset management business” for over a decade. We now know that regulatory inquiries were ignored or thwarted because of his industry stature. During my father-in-law’s visits from Boca Raton, Florida, he would frequently ask me about Madoff because a friend frequently touted his wonderful investments with Madoff. I was always skeptical, remembering the difficulties I had during dealings with Madoff Securities when I was a NASDAQ market maker and on the Cincinnati Exchange, which was run by Peter Madoff. During various discussions, I relayed that I had no idea that Madoff managed money, let alone in the sums they did, and that there was no evidence that its self-described “split-strike conversion” strategy was being done on options exchanges or even feasible. Fortunately my father-in-law also had a skeptical streak and never invested in the Ponzi scheme. Sadly, his friend’s retirement was ruined.
The financial world came full circle today. Madoff turned financial legitimacy into a criminal enterprise. Coinbase attempts to bring much-needed legitimacy to a financial product whose initial adoption was rooted in illicit enterprises. Quite the existential convergence indeed.
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