New money, old habits
DeFi lender Celcius stopped customer withdrawals on Sunday. The email to customers was reminiscent of the Lehman Brothers collapse:
The carefully chosen wording about honouring withdrawals “over time” caused the Celsius token to fall as low as 14 cents, down more than 95% in a year. It also caused significant selling pressure on bitcoin because the company has large BTC reserves which it is now dumping to shore up its financial position.
This story is older than time. Once the run on the bank starts, it doesn’t stop. If you stop withdrawals “for customer protection” then it’s pretty much over.
The lesson here is clear: You cannot have yield and 100% liquidity. By definition, yield implies that your assets, or a portion of them, have been loaned out for a productive purpose and you cannot immediately have them back. If everyone demands payment, the bank collapses. This is also true in the traditional financial sector.
The recreation of the fractional reserve provider (a bank) is the antithesis of what the sector really stands for. Celsius built a traditional financial system with new assets and none of the traditional protections.
Right across the DeFi sector, the liquidation cascade this has caused continues. Each provider holds their reserves in bitcoin, which they continue to sell as their strategy of last resort.
With a fund that holds 80% bitcoin, what do we do now?
Nothing. Bitcoin is doing what we always thought it would. It is the uber-collateral of our sector and distressed businesses and investors are selling it because they invested with leverage or through DeFi protocols that cannot now pay them. It’s not pretty to watch, but watch it we will.
It is exactly the kind of brutal clean out that did not happen in traditional finance in 2008. They now limp along under the weight of indebtedness, while in our sector you go bankrupt and don’t get bailed out. Good. If you run a fractional reserve, or use leverage and something goes wrong; you die.
For bitcoin, every 10 minutes, blocks keep coming. Hash rates are at all-time highs. No press releases, no scandals, no excuses.
Of course, all the sages that didn’t buy bitcoin at $200 or $2,000 aren’t buying it at $20,000 either. They told you so. They knew ‘this’ would happen but perhaps they don’t know what is about to happen. We shall see.
One little discussed matter about investing is maintenance costs. They are obvious in some investments, like housing. Strata fees, land taxes, and general upkeep. It is an unending fight against entropy and something that eats into returns. You might budget 1.5% per year for property.
For equities, it is different. There is apparently no maintenance cost but in fact that is not true. You might consider the management team of a listed company and the listing costs themselves as maintenance costs. For a good steer on how much these are costing you, add the corporate costs line in the P&L to the cost of the management share scheme and that is a good guide.
As an investor in a public company, you are in a fight with management who will try and enrich themselves at your expense. I need more incentive or more salary; I need more expensive travel allowances, etc. They are all maintenance costs and they consume a large amount of shareholder return.
The best assets from a maintenance perspective are bonds and bitcoin. Basically, zero for both. Regular readers know what I prefer.
How many assets are there that have zero maintenance costs and asymmetric upside? Very few. You might consider improvements to your brain power as providing some asymmetric features with no ongoing cost (like learning a language). It is harder to think of widely investable ones though.
Perhaps uniquely, bitcoin provides exactly this opportunity. It costs nothing to hold in perpetuity. Nobody is eating it from the inside with share schemes and salary costs. Its roof will not need repairing.
Zero maintenance cost and asymmetric upside. Is there another?
Until the 80s, bearer bonds were a big feature in financial markets. The essence of a bearer bond is if you hold the piece of paper, then you hold the claim. They were essentially as good as money and anonymous.
Those bonds are now making a comeback through bitcoin. They are printed in the same way as banknotes today but include an NFC chip. The user generates an encryption key that combines with a local encrypted key built within the note. Every note also has an expiry date after which point only the user generated encryption key can access the bitcoin.
It’s actually simpler than it sounds. Bitcoin is a bearer instrument anyway. This idea allows that instrument to be represented physically by inserting a small chip in the paper with a private key in it.
A lot of people struggle to conceptualise bitcoin because it essentially lives in the ether. This physical representation might go a long way to addressing this issue.
It will face hurdles of course. The notes will be anonymous but as bank notes are phased out across the world there will be a huge market for this.
The bearer bond might remind people that buying things anonymously is not illegal. It used to be and should still be the default.
Not one week after announcing the end of Quantitative Easing in the Eurozone, the ECB convened an emergency meeting. Unfortunately, the market had reacted rather badly to the news Christine wouldn’t be buying anymore bonds. The basic message being “we won’t be buying any either, particularly those rather plentiful Italian ones”.
Bond yields across the Eurozone started diverging which is the precursor to a crisis. Hence le réunion urgente.
Post the meeting, the narrative moved from the end of Quantitative Easing to the introduction of a new ‘anti-fragmentation tool’.
I would speculate the anti-fragmentation tool will work like this: the ECB will be able to intervene in the market if the spread between two eurozone bonds is greater than n basis points. In effect the tool will permit permanent QE, forever. It won’t be QE though, it will be the “prudent use of our new anti-fragmentation rule”.
It’s a remarkable position Europe finds itself in. The bond market is sustained only by the enormous buying by the central bank, without which it is certain to collapse under its own weight. The ECB will spend any amount of money to sustain the euro project in the belief that the currency binds the continent together. “This commitment has no limits”. Indeed, why wouldn’t it? The ECB can print any amount of currency it wishes, and it will.
Sadly, it is much more likely now that it will be the euro that pulls Europe apart rather than binds it together. Germany cannot be expected to subsidise the borrowing of the Southern states forever. Their tolerance will be much lower now they are paying astronomical prices for energy and almost everything else.
The bond market in Europe is broken. The only way out long-term is huge population growth. That isn’t coming.
The world is looking the wrong way. Equities are collapsing, bitcoin is collapsing, but the cause of both things is the unlimited action to prevent the collapse of the bond market.
Before that emergency meeting, we got the announcement that bond purchases will stop and interest rates will rise. As usual they sent out an explanatory set of cartoons so that primary school children across Europe could be as confused as the rest of us are:
“Inflation is much higher than we want and will stay high for some time”
Europe has now become an agricultural economy. Mobile phones no longer work, everyone is map reading again. Planes are flying low over cities to taunt us because we can’t afford to fly anymore.
“The economy will grow more slowly in the near future”
We have forgotten how to make things. Confused citizens can barely operate trolleys any longer. Pictures of the war in the Ukraine and the Chernobyl disaster hang in the empty warehouse to remind workers how lucky they are.
“We are taking further steps in normalising our policy”
Christine Lagarde turns the European economy off.
“We are also starting on a gradual but sustained path of interest rate rises”
A man carries interest rates up a ladder to the sky to warn Europeans of the Weimar economy that awaits them.
Most satisfyingly though. Diseased pigs will soon be ruling Europe and your shopping trolley will be full again. You will push your trolley with one hand, chest pumped forth in triumph as the porcine overlords look down and smile.
Animal Farm readers will know exactly where we are going. Have a lovely weekend.