🏦⚔️🔐 Banking system vs. crypto
I decided to try to summarize the most important things in points, so maybe this post, which promises to be long, will be shorter and more readable. Let's get started...
- The main tasks of a bank:
receiving / "storing" capital
placement of loans/investments
making payments/transfers, i.e. transactions.
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Banking system based on partial reserves = the banks approx. They can invest 10 times more money than they actually keep. Most of their capital is depositors' money, only approx. 10% is the bank's equity.
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Banks carry out maturity and interest rate transformation ("financial alchemy"):
The interest rate and term of their deposits differ from the interest rate and term of the assets they purchase or the loans they take out. This is how they generate revenue.
Think of our own capital held in banks, the management of which we specifically pay, but at least - in theory - we can withdraw it at any time (= it has no expiration date). Banks invest this money in longer-term and higher-interest assets.
So an approx. They make approx. 0% deposit that can be released immediately. Fixed capital with 1-5% interest, longer spread.
And in the meantime, they still manage to make it look like we have access to our money at any time. -
But the "magic" only works as long as people believe it: if everyone wanted to withdraw their money at the same time (= bankrun), then the banks would immediately go bankrupt.
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Banks must purchase and hold equity instruments to insure themselves. However, their value is only a fraction of the capital invested by depositors.
In other words, "they are too leveraged". If the customers' money is stolen, they can only repay a fraction of it out of their own pockets. -
That is why banks and the money deposited with them are "insured" by states / state organizations (of course with taxpayers' money), but e.g. in America only up to the value limit of 250,000 dollars.
One such American insurer is the FDIC. These organizations, however, are severely underfunded: the FDIC is said to be able to insure only 1-1.5% of deposits. (!!!) -
The Silicon Valley bank was among the banks that took more risks, because:
funded start-up tech companies, i.e. startups,
and their depositors were startups that invested money received from venture capital investors (see: fund raise, seed round), and these amounts in many cases exceed the 250,000 mark, i.e. they are not insured by the state,
in addition, the assets purchased by SVB were also among the riskier ones, with maturities of several years (but in return with a higher expected return - at least in "peacetime").
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They invested in these instruments despite the fact that their yield and therefore their value is threatened by the FED's interest rate hike, which was already predictable back then. In other words: they bet against the interest rate hike and/or were convinced that somehow they would get through it. At the time of the purchase of the assets, "money printing" was going on due to the "epidemic crisis", and the depositors also "flooded" the SVB with their deposits. To such an extent that SVB hardly knew where to put the huge amount of money.
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The FED, on the other hand, started raising interest rates aggressively at the end of 2021, which in our case means that investors are being diverted from long-term investments to short-term government securities: the yield on the latter will begin to exceed the yield on longer-term instruments. In addition, due to the short maturity, these instruments are also less risky. So, those who have the brains and the ability will switch to short-term assets in this case, and because of this, the value of long-term assets decreases, since there is less demand for them.
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The result:
After the series of interest rate hikes in 2022, the value of SVB's own assets practically fell to zero (!!!). Of course, this was an unrealized loss. Had they survived this period, they would have been able to hold on to these assets until their multi-year maturities expired.
(interest: even the central bank itself, the FED, holds such securities, but unlike banks, they are able to hold them until the end of the term - and they probably know this exactly) -
About the capital of SVB's depositors:
From the point of view of depositors looking for investments, the bank is only one option. So-called money market funds compete with banks, for example. And their yield also started to be more attractive to investors, so more and more people decided to transfer their capital from banks to such instruments. -
And the impact of the listed factors: banks (especially those taking on greater risk, like SVB) started to find themselves in a difficult situation. And SVB itself could not withstand the onslaught of investors who wanted to escape their money.
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And this is a problem because a significant part of the amount of money circulating in the world is debt: loans issued by banks that far exceed their real capital. Home loans, student loans, business development loans, loans issued for infrastructure development and construction, etc. etc...
(and let's not forget that the US dollar is actually a "debt note": the US government owes a company called the FED for every single dollar!) -
So: if the banks collapse, the entire capitalist/central bank balloon system collapses.
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In the "bail-in" post, I wrote about what solutions the "authorities" are thinking about. (link in comment)
According to them, SVB was not considered a bank of "high importance", so the FED, the US Treasury and the FDIC chose the solution that:
1.) that he does not bail out the bank, and that he compensates the depositors not from the depositors' money (= bail-in), but from "his own pocket" (= from the taxpayers' money),
2.) and signals to the market with a new package of measures that there is no reason to panic, thus preventing further bank runs.
(As far as I know, they cannot deal with the fact that money market funds and other alternatives are more attractive to investors than the deposit interest rates offered by banks...)
In the picture shared with the two in the post before this, you can see this "measure pack" and it contains some absolutely amazing stuff:
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The value of the banks' equity assets must be determined based on the future (!) sale value, along with the expected returns until then (par value) - that is, it doesn't matter that they are worth less now (or possibly nothing); banks can therefore continue to operate and issue loans, because they have capital on paper. This is what I call the latest version of printing money from scratch.
(while interest rate hikes are necessary because of the latest "money printing", right) -
The FED, the Treasury and the FDIC assure everyone that, one way or another, all troubled banks and/or depositors will be "rescued".
(I ask: 1.) so can banks take on more risk? 2.) what will they be saved from?)
In this case, what I mentioned in the bail-in post happened:
the troubled, unimportant SVB is bought by a larger bank for pennies (its English subsidiary was bought by the HSBC bank for £1(!!). In other words, after each such bankruptcy, the system is further centralized.
(One of the suggestions at the end of the mentioned post is to keep our capital in smaller banks, but what will happen if there are no more smaller banks?)
It is also worth noting that the failed centralized "crypto" companies essentially did the same thing as the banks: they invested depositors' money. The only difference is that they did not have the legal authority to do so, and they are not rescued by state organizations when there is a problem. If it's all done by banks, then there's nothing wrong with that, right...
[ A Signature and SigNet ]
Signature was supposedly not in nearly as much trouble as SVB, yet it was shut down. (see my post listing the history, also in the comments) And this is interesting because they operated SigNet, which was a 24/7 working transfer network that connected crypto exchanges and banks - similarly to the also "mowed down" to Silvergate bank's network called SEN. (practically, it can also be understood as a side-chain connected to blockchains)
And by shutting down the networks, the infrastructure was suddenly pulled out from under the centralized part of the crypto-world. Or not?
SigNet is said to be still operational, which means that it is operated by the FDIC itself, since they "seized" it. In other words: the US government's own company currently operates a 24/7 crypto transfer system. :O
It is even more interesting if we add that the FED plans to launch its own 24/7 instant transfer solution: FEDNOW within 1-2 months. Maybe I don't need to add anything else to this. You understand. ;)
[ The Circle and the USDC ]
In the whole story, perhaps the USDC de-peg was the least interesting and dangerous. (according to the news, e.g. Vitalik also bought it at $0.88! :O)
Circle stored only a small part of the USDC collateral at SVB, and even alone, but with the help of BlackRock, they could have saved themselves.
On the other hand, the main reason for the exchange rate discrepancy was that Circle stopped redeeming USDC (citing panic and the fact that the banking system is down on weekends, right). That is, arbitrage traders hunting for exchange rate differences did not have the opportunity to buy cheaper and exchange USDC for null, thereby restoring the exchange rate. So, in fact, Circle itself can make sure that de-peg has happened.(!)
But what is even more interesting: a significant part of the USDC collateral is with the "veteran bank" BNY Mellon, and the amount stored at SVB is also transferred here. And BNY is a "too big to fail" bank, that is, they are too big for the state to let them fail. "High-risk/high-risk", right?
In other words: the USDC is "insured" by the American state itself, including with the newly adopted package of bank protection measures.
Until now, the USDC may have seemed more like the "Trojan horse of Wall Street", but in the light of the events, we can even say that the largest stablecoin in the crypto world managed to get so close to the fire that it can only collapse if the banking system itself collapses.
Not bad. :D
If you missed the opportunity, don't regret it. It is certain that the rest of the year will be busy. ;) I didn't dare risk it either - even though I didn't know the above - that's why I didn't post about it in more detail. I didn't want to influence anyone.
I'm sure I didn't write everything I wanted to, but it still got pretty long. The rest will be in the comments... ;)
Referring back to the address:
Bitcoin was born after the previous financial crisis, and now the crypto market is facing a similar period for the first time. As the banking system will appear more and more risky, crypto will become more and more attractive to investors. And from the example of money market funds, we can see what effect it can have on the banking system if people turn to other forms of investment. The banks have exceeded their "leverage principle", that is, it is enough if only a small part of the depositors withdraw their money, and they will already collapse.
The director of the IMF is neither wrong nor exaggerating when he says that crypto is a threat to the stability of the traditional monetary system. It's just that it's not crypto's fault, but the fractional reserve banking system.
Image: the "consolidation" of American banks since 1990 (= the big fish eats the small fish)
Source: twitter.com/coryklippsten/status/1634252297860706305
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