central banks

CRYPTO: Can Stablecoins jumpstart the digital economy?


We are bummed with the SEC's rejection of pretty much every effort to launch a Bitcoin ETF, which is at the top of the wish-list for normalizing crypto currencies and assets. The investment management value chain is now caught in a weird race: (1) either crypto custody will become regulated and build tendrils to plug into existing infrastructure, or (2) a regulated wrapper, like an ETF, must contain underlying crypto assets, and then travel along into asset allocations of regular investors. Neither is going to change the mood of the market tomorrow. So instead of focusing on financial progress, could the crypto economy show some economic progress? 

A recurring thesis for spurring on that economic activity, supported by continued investment from crypto funds and ICOs, is the emergence of stablecoins. The argument goes that if you have a virtual currency that stays pegged to the US dollar, for example, then the currency can be used to buy and sell goods without the fear of volatility (or capital gains on buying a sandwich). It can also work as a unit of account in which other assets are traded. And if we can figure out how to dampen volatility in the markets, perhaps that will also be seen as a positive by the SEC. A lot of ink has been spilled on how different projects are different -- but at the core, this is an automated macro banking algorithm that must maintain price parity, backed by assets, leverage, or fraud. One that can be manipulated or broken (e.g. below, Nubits).

We see stablecoins as incrementally helpful, but not sufficient. You still need a fiat/crypto equilibrium mechanism, and if a stablecoin becomes large enough to maintain a digital economy, it comes into direct competition with the United States government, its monetary policy, and its police force. It is highly unlikely that the US will let a decentralized or private actor print the equivalent of dollars. Who knows, maybe a central bank issued coin is still a reality -- take for example,Thailand, which is working with R3 on interbank transfers. While this isn't what most Bitcoin enthusiasts would want, the USD is the best peg to USD. Let's just get people to hold it in a Bitcoin wallet -- which is why rounding your change into crypto using Revolut, or getting a blockchain-native phone once it's out, could be so meaningful.


Source: Medium (Nathan Sexer on Stablecoins), WSJ  (SEC rejection), CoinDesk (Thailand bank coin)

REGULATION: Convergent Evolution of Financial Standards

Source: IMF

Source: IMF

Convergent evolution in nature is a fascinating phenomenon. Organisms that have entirely different histories can develop similar solutions to a recurring problem in the environment. For example, take the flight skills of birds and bats, or the eyes of mammals and cephalopods. Natural selection has a way of chiseling away at wetware until we get a serviceable answer. In a similar vein, we expect to see similar governance outcomes in the traditional financial services industry and the crypto economy. And we don’t mean the vanilla stuff, like the regulator presence, or industry boards that create standards. Instead, we are pointing to two different phenomena that should have the same effect: (1) the Dodd Frank legislation requiring capital standards from banks (and especially the FSB rules for Globally Significant Banks), and (2) the steady move in several public blockchains towards Proof of Stake.

Let’s back up. In traditional finance, sentiment and impression of financial stability is key to the functioning of the system. The simple reason is that banks are massively levered, especially when involved in capital markets activities, like trading and investment banking. And even in the case of the depository bank, the bank lends out the deposits it collects from clients. A run on the bank occurs when all the clients try to pull funds out at the same time, learning that the funds aren’t there, and causing further panic. Thus things like government insurance (FDIC). And in complicated cases like 2008, the run was on the banks by the banks themselves. When Wall Street thought Lehman couldn’t pay its overnight commercial paper because it was insolvent, credit dried up. And so did Lehman.

Which brings us to capital requirements. In brief, this is a regulation that forces financial institutions to hold a certain amount of assets on its books, rather than circulating out there in the markets earning a return. Instead of being 30x levered, you may only do 15x or 20x, depending on how important you are and what assets you hold. Having cash on the books is better than a bunch of junk bonds, and so on. When a confidence crisis happens, the institution – so goes the theory – will have enough buffer to absorb a shock, and no government insurance is needed. In the abstract, that means that today’s banks all hold assets in order to participate in the financial system as players (and take their economic rents). But remember the refrain – banks supposedly manufacture trust, trust in the economic system, in the presence of cash, in payments, in commerce. This capital is the government’s (and if we believe in effective representative democracy, it is our) way of putting institutional “skin in the game”, which scales with importance to the industry.

If you know your crypto consensus mechanisms, you may know where we are going. Today’s Bitcoin and Ethereum chains are secured by a computationally expensive method called “Proof of Work”, where the “Work” is the burning of electricity to power processors good at solving arbitrary math. Various groups are unhappy with this power consumption, and the centralization of mining power it has caused whispered complaints. Different consensus algorithms exist, as do controversies about them. But generally speaking, approaches like Proof of Stake, or EOS’ Delegated Proof of Stake, will work of crypto resources instead of physical ones. Your “stake” is the capital you hold, that may be committed to participating in the system and manufacturing trust, through voting or forging or something else depending on the project. Built into the economics of committing such capital to validate blocks is a probabilistic rewards, which looks a lot like interest on average.

Source: Cointelegraph

Source: Cointelegraph

What this means is that crypto and banking have converged on the same solution. Some central authority declares the guidelines of the system, and how much capital is required to be committed to keep it humming along. Then, parties that manufacture trust put this capital aside as table stakes to be in the rent-taking business. And, by the nature of the beast, scale efficiencies of running such operations lead to consolidation and some form of global oligopoly A large bank today may find such a system to be pretty familiar and comfortable – and they certainly have the capital to deploy. Goodbye crypto utopia!

CRYPTO: Economic Rent-seeking is Universal

Source: American Institute for Economic Research

Source: American Institute for Economic Research

The post-AI and post-crypto world will reconfigure many of our basic economic assumptions and requires a bit of philosophizing. So forgive our attempt, but we need to talk about economic rent-seeking and wealth creation. The Peter Thiel definition of building a successful company is to discover a piece of information around which a monopoly can be built. Building a monopoly is the primary reason that supports the venture capital industry model of rushing to massive unprofitable scale fist, and then creating moats and extracting value (i.e., economic rents from the monopoly/oligopoly position). See Amazon, which has leveraged not-caring about profitability into an unshakeable bedrock of retail. And once you have rent-seeking monopolies in place, they grow tendrils into media, politics, and customers -- and are very hard to remove. This snowballs and leads to extreme inequality, which is exacerbated by the power laws of software and the attention economy.

In the crypto world, there is a techno-utopia story that posits that a decentralized open technology ecosystem will be the antidote to centralized institutions that are controlled by questionable interests.  A key argument by bitcoin maximalists is that central banks print fiat money at will (often at the behest of bailing out Wall Street), which represents debt that erodes regular people's hard-earned savings through inflation. The argument goes that Bitcoin, on the other hand, has a fixed supply of currency and therefore cannot be manipulated to enrich some particular hegemonic party. This view is unsurprisingly contentious and only tells some of the story. We may be upset with instances when governments, which are to some extent accountable to citizens, use sovereign power to lower our purchasing power. But does that mean anyone and everyone else should be able to do the same?

Crypto currency and tokens issued by projects, through ICOs or reverse ICOs or airdrops or forks, are all a version of money printing. Mature capital markets do this all the time, through the issuance of debt and equity that time-shift financial resources to enable productive use. We allow and regulate such activity to encourage economic growth -- but may rightly be concerned that oligopolies have captured the process and are taking economic rents by being closest to the river of money. But does that imply that any individual at any time should be able to issue personal currency in billions of flavors? And that those most enriched by this process are those with the highest control of the attention economy -- i.e., the armies of bots pushing the latest altcoin, the ICOs with the best bounty programs, the biggest celebrities, the largest pump and dump Telegram groups? Disagreeing with central bank policy execution does not imply a right to be a Bernie Madoff.

While the stated motivation for much of the crypto movement has been to solve economic rent seeking by traditional finance and governments, we are now at a place in the industry where crypto is full of rent-seekers. Crypto investors have focused on owning the protocols of the new world. That means owning the highways on which information travels and taking a toll (through capital appreciation) any time someone uses the highway. Is that a productive outcome for global wealth distribution? Look at the blockchain name game and the reverse ICO phenomenon. Telegram is aiming to raise $2 billion for which it will give out no equity, with 52% of the tokens will accrue to the company owned by the founders. Looks like a self-minting of billionaires - a massive economic rent on controlling a popular messaging platform that dilutes the ecosystem. And that's not to mention the self-enrichment from premining in forks like Bitcoin Gold

But the traditional system is catching on! See Japan's largest bank, Mitsubishi UFJ Financial Group, which plans to launch its own coin in 2018. If it is okay for tech firms to extract this type of value, then those who are most familiar with the money printing process will do it too. As another data point, Bank of America has more blockchain patents than IBM, trying to create intellectual property control over a resource that is meant to be open source and free. We need only look at the sideways journey of the web -- with the loss of net neutrality and the walled gardens of Facebook and its newsfeed algorithm -- to understand the danger of unabridged rent-seeking behavior on public goods.

So after all that, what is the answer? We don't have many. But we know at least to (1) highlight that rent-seeking is a universal human trait that exists in all types of communities, and (2) avoid cultish beliefs that are allergic to evidence. Penny for your thoughts?

FINTECH: Behold Production Blockchain!


With public crypto funding at $700 million in November alone, it is easy to forget that anything else matters. But let's check in on the progress of sovereigns and incumbents in capturing and controlling blockchain technology. Take for example, the Australian Stock Exchange working with Digital Asset Holdings ($115 million in venture raised) on replacing the entire trading chassis with a proprietary "Distributed Ledger Technology", i.e., a private blockchain with the attributes of confidentiality and scalability.  ASX is moving forward with DLT as a production system, which is a big deal. For context, the sum of market capitalizations on ASX is $1.5 trillion, or 3 to 5 times larger than all of crypto. Which of course raises the question of how private and public chains will interact. For that, see AionPolkadotBlocknetWanchain, and various others.


Another development is the growing progress towards sovereign digital currency. Certainly the US Federal Reserve is flirting with the idea, especially after Russia has indicated strong interest in building the crypto ruble. Also surprising is the news that Venezuela, famous for putting people in jail for Bitcoin mining, is going to launch its own cryptocurrency. The planned offering sounds like an ICO of the country's national resources. If you can't beat them, join them.

The silliest data point we've seen is this. Bulgaria, a country with a $60 billion GDP and $16 billion of national debt realized it owns on $3 billion of Bitcoin, which was seized in a law enforcement action earlier in the year. 5% accidental GDP growth (or 20% national debt repayment) is nothing to sneeze at. Will Bulgaria go long BTC or hedge out some of that risk using CME futures? Or, manipulate public opinion with some soverign propaganda bots to impact the price?

Source: Australian Stock ExchangeDigital Asset Holdings