3 Questions to ask about our Collateral Hungry world
We just celebrated the Swiss National Holiday on August 1st and Swiss banks are offering for the first time (positive) yields for Euro accounts (albeit for minimum sizes in the hundred thousands). We still can’t celebrate the eradication of yield hunger but some crumbs are being served here and there.
In my financial mind, there are two main types of hunger: (a) yield hunger, and (b) collateral hunger. And isn’t it ironic that these types of hunger are also very present in the DeFi world but contrary to the complex and opaque traditional financial system, the blockchain infrastructure could offer full transparency and nearly real-time monitoring of collateral? This, of course, requires a collective intention to allow this to happen. You would think that permissionless connectivity to all L1, L2, and Dapps would be a given, and voila a dashboard could be assembled with flows, counterparties, and collaterals. But this is not the case because of the growth of CeFi and hybrid DeFi which means we are still in a world of Plug & Play with APIs, similar to the traditional world that can only work via permissioned APIs.
I am exaggerating here to make the point between the original — BHAG — Big Hairy Audacious Goal / vision of Web3.0 and Open Finance, Open Business built on Web 2.0. Think Square or Stripe developers versus Ethereum and Polkadot developers. Nobody needs permission to build on Ethereum and Polkadot but the nature of the ecosystem built on these gets `distorted` as permissions are introduced and then at some granularity, it looks no different than Stripe and Square.
`It has been two full years now that it is not science fiction anymore in my mind, that we could build a dashboard showing real-time global cash flows in a knowledge graph format. Of course, there are several reasons that this may not happen but nonetheless, from a methodological point of view, it is plausible. One of the main reasons that it won’t happen is that we cannot agree who will control this dashboard because we have the mindset that somebody must control. This is a dashboard much like the ones on Star Trek.
The issuers of the four almighty existing reserve currencies, the USD, the Euro, the Yen, the Pound and the outsider, the Renminbi pegged to the USD for now, will never arrive at a consensus for who will be the Jean Luc Picard of a dashboard of cash flows counterparties and collateral.
Cash flows and liquidity nightmares in the banking system have surfaced again recently as madness hit the dollar repo market in September. It brought shivers to many old timers as we are old enough to remember so well the 2007 precursor of the subprime crisis.
The Fed intervened to calm the extreme interest rate spikes in the repo market. Matt Levine reported on September 18 wild swings in these wholesale market interest rates between 9% and five point 29%. This volatility is happening in a market with the Fed funds rate around 2.25%.
This is a cardiac episode caused by the lack of liquidity in U.S. dollars, on a historical base it looks like a cardiac unrest. This situation seems an extraordinary global macro event that needs to be put into perspective as the new normal is `abnormal spikes and volatility.`
This is an excerpt from an Oct 2019 article I wrote on Daily Fintech Category 5 hurricane in cash markets — Dollars and Bitcoins.
If we look at the Fed funds rate (set by the Fed as a guideline but the interbank market will always reflect the lending/borrowing conditions) to date, we see the spike in the Fall of 2019 and how the cardiogram since looks very smooth and calm. A stark reminder of how central interventions from some lender of last resort (whose ability to intervene is not doubted to date, even though it is criticized by many) does work at some level.
The federal funds rate refers to the interest rate that banks charge other institutions for lending excess cash to them from their reserves on an overnight basis
The consequences, however, of such interventions are naturally mispricings. As a result, high-quality liquid assets — HQLA — are so much in demand as collateral for the reserves of the commercial banks and for any other lending/borrowing needs; that we end up with the last 3+ yrs. of negative sovereign yields becoming the norm
We have lived for too long in a Collateral hungry state which has hugely distorted the prices of financial `high quality` liquid assets like government bonds and more. Ironically, this Global Collateral Hunger led to the Global Yield Hunger crisis which trickled down to the retail level. As a result, even traditional `real assets or fixed assets` like land or houses or any property became mispriced albeit not liquid. Even though the technology exists to tokenize fixed or tangible such assets, we haven’t executed on this because of several reasons (this needs another article to explain it). So, these non-liquid high-quality fixed assets haven’t moved up the liquidity spectrum and remain stuck. This beckons the question, what digital or natively tokenized asset could act as better collateral than physical properties?
We all admit that the way we phrase a question affects the answer because it opens or blocks possibilities.
So, let me try a few variations of the question:
- Physical properties are not liquid collateral. Assuming natively digital properties are more liquid, then which digital properties can be good collateral for lenders?
- Some cryptocurrencies like Bitcoin, are digital properties and very liquid for the most part. Can they be better collateral than the fixed physical but illiquid properties? And if so, what is the multiple LTV (loan to value) compared to that in the traditional banking system using fixed properties as collateral?
- The current market failures have taught us that AMMs (automated market makers) will accelerate flash crashes and liquidity crises. I think of these events as the new kind of mispricings that don’t last as long as in traditional markets. However, the ripple effect is different (compared to the central intervening architecture) and has a lasting impact.
3. The other digital properties that could be considered as a collateral, is our data. The question here I think should be: What kind of data from my personal and business activities, could become better collateral than the piece of fixed property I may own?
- If all my life is digitized on a dashboard which is updated real time, what is useful data and insights that can become collateral for a loan?
The world will remain Collateral Hungry but the nature of the Collateral will change dramatically. Smart networks and integrations will make access to certain data sets better collateral than any traditional physical asset.
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