This article is a short outline of what I see as the macroeconomic effects of a possible continuation of weakness in crypto financial markets. The direct effects would be small, although weakness in crypto is interleaved with the fortunes of the tech sector. It is certainly possible that all risk assets will be under pressure if the economic situation deteriorates, so crypto might be akin to the canary in the coal mine — a signal of other dangers.Bond Economics
I end with a discussion of so-called “stable coins.”...
Macro Effects Of A Hypothetical Crypto Crash?
Brian Romanchuk
8 comments:
So Brian thinks Fed monetary policy reducing the value of bank system regulatory assets by 100Bs doesn’t matter because “what about the rest of the economy?” but thinks these pissant coins that nobody uses “could reduce the value of all risk assets”
Huh ??????
Bitcoin’s Plunge Exposes Idea of Uncorrelated Asset as ‘Big Lie’
So, not only is it rat poison squared...
Warren Buffett Says He Wouldn't Take All the Bitcoin in the World for $25
Crypto reflexivity and the ultimate stablecoin reading list
https://the-blindspot.com/crypto-reflexivity-and-the-ultimate-stablecoin-reading-list/
Why financial engineering has gone full circle with Terra
https://the-blindspot.com/why-financial-engineering-has-gone-full-circle-with-terra/
"One question: if I buy tether, my cash was supposedly going into a short term dollar asset (asset side of tethers balance sheet). But if I bought luna or terra ust, where would my cash go? You know that?"
"This is the question isn’t it. In theory this was structured like a synthetic ETF. So the issuers could use the proceeds however they saw fit to “defend the peg”. The logical thing to do from a risk mgmt perspective was invest in dollar securities.
But the issue with MMFs/Stablecoins is that simply matching things one to one is an incredibly low margin exercise. If not negative margin exercise. It’s also subject to slippage risk. The way MMFs compensate for this is by charging fees.
But if you charge fees in the hyper competitive world of crypto you will lose market share. So the incentive has always been to play the “delta one” game. I.e. take the proceeds and invest them in assets that will OUTPERFORM the dollar.
You then get to pocket any outperformance for yourself while returning the par value dollar return to the customer. The least risky way to do this is to invest in higher yielding “safe assets” that are highly correlated to the dollar.
But in crypto, the preference was to take a lot more risk by investing in almost everything — including your own asset creation via your own loan-making business — and simply mark it to market all the time. "
" This essentially transformed these stablecoins into shadow investment banks and even in some cases de facto commercial shadow banks.
When a bank’s loan book sours, or its assets need to be written down, this has a direct impact on the equity value of a bank. The same applies to the investments of these stablecoins.
If you think of short-term bank liabilities to depositors as the equivalent of “stablecoins” that banks issue, you can think of bank equity as the supporting investor equity that backs the capacity of banks to defend those liabilities.
This is a similar relationship to what Terra had with Luna. Think of Terra as the short-term depositor liability, and the Luna as the bank equity.
Now imagine if a bank could control for the stability of its “money liabilities” not via a liquidity guarantee from the central bank, but by being able to continuously tap the market for its own equity whenever it needed a top up?
That’s essentially how the “arbitrage mechanism” at the heart of Terra/Luna operated. Like a permanent rights issue to the market. And as long as the “bank equity” was supported by the market, it could fund the liabilities. "
A key thing not well understood about stablecoins is that unless their business models’ incorporate a fee structure (and most of them do not), they can’t really make enterprise profits. The only way they can generate profit aside from charging fees is by taking undue risk with the funding they receive from depositors.
These are important considerations for the Terra debacle.
What the Terra founders de facto created was a system wherein the par value of Terra liabilities was supported by an ETF-style arbitrage mechanism linked to the value of its own equity — as represented by the price of Luna cryptocoins. The crypto community viewed this as genius financial engineering equivalent to alchemy itself.
"What it really was, however, was an explicit commitment to the market that Luna’s stock-market value would always be used as a cushion to defend the price stability of the system’s “money like” liabilities.As Bloomberg’s Matt Levine describes the arbitrage at the heart of the arrangement (TBS’ emphasis):
One UST is supposed to be worth one US dollar, and one UST can always be exchanged for a floating quantity of Luna with a market value of $1. If a UST is trading at $0.99, you can buy it for $0.99 and then exchange it for $1 worth of Luna, making an instant profit. If it is trading at $1.01, you can buy $1 worth of Luna (for $1) and use it to buy a UST worth $1.01, making an instant profit. Because of this arbitrage relationship, while the price of Luna can fluctuate, the price of Terra should always be $1: If it trades above or below $1, people will exchange Terra for Luna or Luna for Terra until the price of Terra gets back to $1.
But another way to phrase the above is as a promise from Luna Foundation that it will always be prepared to use its own “money like” liabilities to buyback its own shares from the market when it feels they are undervalued in relative terms. This undervaluation occurs when its capacity to “debt finance” is uninhibited (and thus super cheap) because it is being inundated with inflows into Terra — possibly to the point that it risks breaking par value to the upside.Rather than break par in this way (and return the imbalance to its own customers) the system always has an incentive to return the positive slippage to its primary insiders and investors. On the flip side, the commitment extends to a promise to always issue more stock to the market at a discount if it feels its stock has become overvalued relative to its capacity to manage redemptions. (Which is to say, in the event it can no longer raise debt financing as cheaply as it can raise equity financing).
Terra was “different” in that it was allegedly backed by an algorithm. But this of course was always pure marketing. It wasn’t really backed by an algo. It was backed by an arbitrage which emulated a perpetual value-creation motion machine. The problem is, that perpetual motion machine was illusory, and entirely dependent on constant liquidity in Terra and its value-skimming counterpart Luna.
Being dependent on “liquidity”, however, is also just a euphemism for being dependent on there always being as many people in the market wanting to buy your asset as there are wanting to sell it. Liquidity disappears when there is a big imbalance either way. This is a known known risk. The fact that anyone could have been dumb enough to think you can algorithmically control for it speaks volumes about the naiviety underlying the stablecoin market"
https://the-blindspot.com/in-the-blind-spot-terra-diesel-cartels/
In some respects, the shakeout is probably a good thing. We need to see these aspiring systems fail in controlled ways to understand the scope of their potential contagion if they were ever to get huge and thus too systemic. Now is the time for learning.
Terra Luna / US Dollar
https://tradingeconomics.com/lunusd:cur
From the comment section .......
"Now that the worlds of crypto and finance have now collided in such a way that we can finally expose everyone engaged in arbitrage hunting, from Paulson to Soros, as nothing more than a hacker ”
"My SWAG. Satoshi Nakamoto circa 2008 set out to improve computer insecurity by fostering the community for online trading of bitcoin with incentives built in for crypto and finance to collide. We can expect Nakamoto was terribly disappointed that people preferred to hold rather than trade, defeating the carefully thought out design.
Yet, behind the scenes financial traders hacked to fix this flaw by creating stable coins, and some unstable ones. Nakamoto will love this Lehman moment for crypto, because to improve trusted online computer trading, there is more work to do. Solving CBDC’s privacy problem post by R3 gives a glimpse"
https://www.r3.com/blog/solving-cbdcs-privacy-problem/
Stable coins are regulated securities…
Utility coins (Bitcoin etc) are not regulated…
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