If you want to take down the world’s most powerful industry, you call someone who’s done it before.
If you haven’t already, read part 1 here.
If you build it…
Alexander Mashinksky’s exploration of VOIP and observations of how the technology developed informed the design of the Celsius Network app. You bypass the established infrastructure, cut out the bloat and just deliver the best value possible. A single outstanding product can change whole industries very quickly if it sets a widely adopted benchmark.
Anyone reading this can almost certainly remember the days when expensive international calls were the norm, and you had to count every minute on the phone. Now the same thing can be completely free, minus the cost of the Internet connection – in most places at least. In some countries, the phone companies successfully lobbied their way back into the arrangement as unnecessary middlemen. But either way, the ongoing communication revolution would not have happened if phone companies were left to their own devices.
“It’s about just opening the doors and letting the light in,” Mashinksky says. “Now everyone says ‘oh, it’s daytime outside, why are we sitting in this shitty room and letting everyone steal our money from us?’”
“We, me and my co-founder Daniel, worked on the idea and thought about it hard. How can we structure it as a win-win, where the only guys that lose are the banks? How can we create a solution? What I compare it to is Costco. So, Costco is an amazing company. You pay a membership fee once a year. And then you walk into this giant warehouse and everything is half the price. And you’re like ‘Jesus, why was I paying full price all this time?’ And you take a cart, and you fill it up as much as you can because you can’t wait to take all of these benefits.”
It may be worth noting at this point that Mashinksky is extremely wealthy from his VOIP days and other ventures, and certainly doesn’t need to hit Costco for the bargains. It seems getting a good deal is its own reward.
“So we’re like Costco for financial services. We’re going to put the best products in the warehouse – in the wallet that we guard, we’re going to make sure that no one is cheating you and no one is stealing from you, and no one is acting not in your best interest. And then we’re going to give it to you. And right now, membership fees are one CEL token. That’s 10 cents. That’s our membership fee. It’s a pretty good deal.”
“But it’s also a pretty good deal for us. Because we get to keep 20%. We don’t charge any fees, we don’t charge initiation fees, or termination fees, or early withdrawal fees or penalties… we have 65,000 members, and you’re not gonna find a single person that will tell you ‘Celsius charged me a fee.’ If we make income, and we give 80% to the community, then we get to keep 20%. Right, so it’s a win-win for the community. It’s a win-win for us.”
Of course, it’s still a matter of trust.
Mashinksky maintains that he doesn’t need the money, and that his motivations aren’t commercial in nature. But he also concedes that if everything goes to plan, Celsius Network could end up being ludicrously valuable.
As a free service WhatsApp essentially gives 100% back to its users, he points out. And yet Facebook still paid around $20 billion for it.
“So obviously, Facebook looked at the community, at the WhatsApp community, and said ‘wow, this is a very valuable asset.’ Celsius is trying to do exactly the same thing,” Mashinksky explains. “Celsius is saying that whoever is going to want to come into banking is going to need a community [they trust] with their assets. And if we build that first, if we’re the first guys to give 80% back…”
“WhatsApp gives 100% back. Think about it that way. So we’re giving 80% – we’re not giving enough! We should be giving more!”
How do you kill an industry?
With a killer app, of course.
If you believe there’s a fintech revolution coming, building a trusting community around a genuinely great-value service is still one of the most profit-minded things you can do. Ponzi schemes might make a quick buck, but they don’t capture even a fraction of the value that legitimate businesses will in this space. Also, they’ll get you arrested.
Just like communication, financial services are a human necessity, and anyone who can find a way of delivering it at zero direct cost to customers will set the benchmark and win an enormous community for their platform, which can then drive commercial value in other ways.
It doesn’t have to be anything like selling user data or advertising either. Picture a marketplace of all kinds of third party financial services and other products, all jostling around an app-based community bank that pays users interest on their digital currency savings accounts, and skims a barely-noticeable cut of the fees users pay for those services.
Purchasing all your financial products from the same monolithic profit-driven institution is so passé.
If the development of cryptocurrency follows similar patterns as VOIP, the ultimate winners in the new era of consumer finance are the platforms that accrue the most users by paying their users the most. But this will also mean eliminating almost everything except the activities which drive value to depositors.
Mashinksky is at peace with that idea though.
“We don’t want to be a bank, because then we’d need 10,000 employees just through compliance and audits and all that stuff,” Mashinksky shrugs. “What I want to do is do only the things that create value for our depositors, and none of the things that cost all the money, that banks have to provide… we don’t want to be a bank. Celsius is not a bank.”
“The model is beautiful. My coworkers… they’re always saying, ‘Alex, there’s gotta be a downside here, you must have missed something.’ I’m like, ‘no, this is a beautiful model. It’s perfect! Don’t mess with the baby!’”
Messing with the baby
The most obvious downside to this is probably that compliance, audits and regulations exist for a reason, and most financial advisers (even if they’re not working for a bank) probably wouldn’t advise putting all your financial eggs into one unregulated basket.
So, what are you as a consumer missing out on by stepping into an unregulated space?
Deposit insurance schemes come to mind, which ensure that customers don’t lose everything if their bank goes under.
However, on closer inspection, in Australia, the deposit insurance scheme hasn’t paid out since 1931 and keeps costing banks 0.7% to 1.5% a year depending on their credit rating. That’s a cost which is apparently being predominantly passed on to the depositors it’s protecting, rather than the shareholders.
And while it’s paid out more in the USA, the usual pattern is still for the deposit insurance scheme to just get periodically wiped out every time the banks collectively belly flop after trying to impress their shareholders by doing a cool backflip off the diving board, metaphorically speaking.
The insurance scheme, headed up by the Federal Deposit Insurance Corporation, was conceived and tested in the Great Depression of the 1930s after a lot of people had their life savings wiped out. The deposit insurance scheme then got wiped out in the savings and loan crisis of the 80s and then got wiped out again in the 2008 financial crisis.
And while the FDIC is definitely still protecting consumers from the USA’s many failed banks, the usual procedure for doing so is to facilitate the sale of a defunct bank to a larger one. In the long run, this aids the consolidation of the industry and just kicks the can down the road until the next big crash, rather than solving some of the underlying issues.
It’s also worth noting that the FDIC’s reserve ratio is about 1.35%. This means the FDIC has enough reserve funds to cover 1.35% of the amount insured under the scheme. At the same time, a bank that’s “only” leveraged 10 to 1 is considered well-capitalised by the FDIC.
Part of the underlying issue is banks are leveraged to the gills, Mashinksky says, and that they are incentivised to stretch that leverage themselves as far as possible.
“20 to 1… that means for every dollar of deposit - you give them $1, they create out of thin air $20. And they lend it out. So if something goes wrong with that $20, your dollar is fucked.”
“If you’re leveraged 20 to 1, and you lose 5%, you just lost all of your assets. That’s what happened to Lehman in 2008. They were leveraged 50 to 1. So they lost 2% of their value in a day, and they disappeared. A $600 billion company went to zero overnight because they lost 2% of their balance sheet. So that’s how much risk banks take with our money. Because we flip a coin. If it lands on heads and they get giant bonuses, and if it lands on tails we bail them out.”
Celsius Network, and many other cryptocurrency loan platforms, go to the opposite side of the spectrum and end up being under-leveraged.
“We require $2 for every dollar we lend you,” Mashinksky explains. “So you give me two Bitcoin, and I give you one Bitcoin worth of dollars. So let’s say Bitcoin drops 20%. I give you a margin call. I’m like 'hey, put more dollars in or give me more coins, or let me sell some of your coins to cover your loan… We have plenty of safety, right? How much safety does a bank have when they give you a loan? Negative.”
That blockchain transparency helps here. You can see how much cryptocurrency is going into a lending platform and how many stablecoins are coming out.
“What we tried to create is a fully transparent institution that acts in your best interest,” Mashinksky says. "It’s not just us saying that. Even if you’re not a Celsius customer, you should be able to go to the blockchain and say ‘how much did Celsius actually get in deposits?’ Because you can see the coins coming in.
“‘How much did Celsius issue in loans? Do they have negative leverage? Do they have more loans than deposits? No? Okay, good. How much did they collect in interest? Okay, good. Did they actually give 80% to the community? Did they distribute to all these wallets, to 65,000 wallets? I want to see that trail.’ Right? So when we do that we’ll be the first institution in the history of mankind to do that.”
Banks are less transparent. The FDIC isn’t in a position to audit every single bit and piece of every bank, and so primarily has to take bank reports as a matter of trust, while we the consumers then have to take the FDIC reports as a matter of trust.
Both the 1980s savings and loan crisis, and the 2008 global financial crisis, were both exacerbated because some banks were outright lying about their true capitalisation, and the FDIC was just as surprised as everyone else that the banks were bankrupt.
What’s in it for you anyway?
So what’s the upside? How do you as a consumer benefit from the banks being over-leveraged? There are probably some ineffable benefits, in that the modern world was financed by all this pretend money being created out of thin air, and the modern world is a pretty nice place to live. Plus, there’s the fact that at least some of that over-leverage is finding its way back to you in the form of savings account interest, share dividends and the taxes banks pay.
But as we’ve seen most of the benefits are siphoned to the top of the wealth pyramid, and the consequences of the periodic economic implosions that accompany this system disproportionately impact the least-wealthy.
And how about the other bank costs? AML/KYC compliance is a big one. In the most cynical of nutshells, AML/KYC can be described as a system that makes sure the bad guys have to pay higher margins on money transmission services than the good guys.
Of course, Celsius Network doesn’t dispose of AML/KYC. But it might be able to keep costs down relative to banks by sticking to a straightforward range of consumer finance.
The largest known money laundering schemes, such as the case of the $80 billion “Laundromat” which encompassed dozens of banks in 96 different countries, or the $230 billion of dirty money moved through just one branch of just one bank, will often take the guise of various business transactions.
Plus, at the end of the day for the end customer, AML/KYC regulations largely come down to profitability regardless of what form they take.
On one side financial institutions spend a certain amount of money on AML/KYC costs, and on the other side, they either knowingly or unknowingly make a certain amount of profit from serving criminals. The costs of compliance and the profits of unintentional money laundering both boil down to numbers on the balance sheet in the end. In the end, it’s still a question of how to more fairly distribute earnings, regardless of compliance expenditure.
You could also make the argument that financial institutions which aren’t beholden to shareholders have less incentive to take the risk of money laundering, and will be less likely to risk turning a blind eye to it.
A matter of trust
But none of that touches the biggest hurdle of all. Are you seriously going to just give your money to some largely unregulated app? Celsius Network doesn’t have any of the signs of trustworthiness of major Australian financial institutions, such as pictures of farmers and advertising at sporting events. Add to that, it deals in cryptocurrency, a field where everyone is conditioned to trust no one and see scams everywhere.
And yet, people do trust it. That might be one of the most incredible things about it.
Celsius Network issued more than $1.2 billion in crypto-backed loans in its first year of existence, while its own projections were for $100 million by fall 2019. By any measure, it’s way ahead of schedule.
“Earning everybody’s trust seemed impossible,” Mashinksky says. “When people looked at our project, they said ‘no one’s going to trust you, who’s going to give you money?’ But the reality is that people are so fed up with the banks.”
“I’m running around saying bad things about banks every day. But most people are just not crazy enough. I just don’t need the job, you know? I’m already a very rich guy… I just want to help several hundred million people, right? And people are saying ‘nah, there must be a secret agenda here.’”
The transparency offered by Celsius will go a long way towards building that trust. And while many bank financials are ostensibly transparent, there’s a huge difference between the kind of transparency you get from a potentially fudged financial report and what you’ll find on the blockchain.
But that’s the easy part. The banks didn’t get where they were overnight. It was a gradual process of consolidation and rate-cutting and finding ever-more ambitious ways of siphoning money away from customers and towards shareholders. And while Mashinksky probably doesn’t need any extra cash, you probably can’t say the same for everybody who will ever work on the network. What if subsequent generations reduce the amount given to the community from 80% top 79%, and then just keep going from there?
Or what if Celsius Network succeeds beyond anyone’s wildest dreams, and subsequent generations use the network’s clout in pursuit of other profits at the expense of users? As Mashinksky said, this is exactly how the banks got to where they were today.
Setting an example
Mashinksky has given the issue some thought.
The first line of defense is a governance system, where depositors get 65% of the vote and the Celsius Network organisation itself gets 35%. The balance is designed to prevent the network from turning against the wishes of its community, but also to prevent 51% of the community from making a bad decision.
“We’re there to guard the community from doing something suicidal and stupid, right, but otherwise, once a year everybody can submit their ideas, and we take the best ideas and we implement them,” Mashinksky explained. “The challenge is what’s going to happen 20 years from now. Is this company still going to be the same? I hope that I’m instilling in this company the norms and standards, but if you hire a bad manager to replace me… you know.”
But even if it comes to it, Mashinsky is optimistic that if Celsius slides downhill over time, competitors will come along and replace it, using the same tricks laid out by the young Celsius Network’s playbook.
By doing everything the best way it can (according to Mashinksky at least), and showing that there are business merits to putting users before immediate profits, Celsius aims to set an example not only for today’s financial institutions but also so competitors can defenestrate it later if needed.
If you want to change the world, you need to think long term.