Derivatives in finance are so dumb

I’ve spent my entire professional career in financial services. First in investment banking (which is horribly named, we didn’t do any investing; It should be called “advisory banking” or something) and now I write about “finance” for CoinDesk.

I really write about bitcoin, but sometimes I’ll write about other economic-y and finance-y things (like stocks and bonds and interest rates and about how inflation is bad for you). Today I am mad about derivatives.

Derivatives are financial contracts between two (or more, somehow) parties whose value is dependent on an underlying asset. To put that in real-life English, here’s an example of a derivative: Let’s say I think the price of my house is going to go up by next year and I want to bet on that outcome. So I come to you and tell you: “Say, friend. Would you be so kind as to open a derivatives contract with me regarding the value of my house? If it goes up, you pay me some money and if it goes down I pay you some money?”

Naturally your first response is probably: “Heck yeah, friend! There’s nothing I’d more rather be doing with my friend than drafting up derivatives contracts. I’ve always said this.” And then we go on our merry way, eventually one of us will be paid out.

Obviously the financial industry just had to come in and ruin a perfectly good thing among friends. In the industry, derivatives contracts are written up in all kinds of crazy ways betting that the price of a certain stock will be above a certain value by a certain date or that a certain mortgage will be yielding a certain value by a certain date or that the interest rate of a certain country will be a certain value by a certain date. With its eternal wisdom, the financial industry decided that it was cool to then start trading those derivatives on an open market. And then someone even smarter starting making derivatives of those derivatives.

Yes. Someone was like: “Hey that guy over there made a bet with that gal over there about the price of his house. We should make a bet about who is going to win.” As if that is normal behavior. The best part is that people think that this is growth. This is the growth of the financial industry they say. How great! Obviously this is growth, but only from a financial perspective.

I don’t have the energy to describe what that means today, but here’s your takeaway:

This thing called the “financialization of everything” and the financialization of everything is bad.

So today the dude who ran the Enron bankruptcy (the famous bankruptcy of an energy company that was the best in the business because they figured out a way to trade energy derivatives instead of, say, making energy. Also they did some fraud, but whatever.) wrote that a bankruptcy he’s working on in the crypto space is the “[worst thing he’s ever seen in his 40 year restructuring career].”

First off, wow that’s a long career my man, congrats on that. Second off, this crypto thing he’s working on was an exchange that dealt primarily in derivatives. I’m not saying that derivatives will always lead to collapse (nor does this post even remotely try to prove that), but it sure looks like they do.

‘Til next time.

P.S.: No one edited or proofread this. It wasn’t even edited or proofread by me.