TLDR: Financial stability is not just about the number of users. Financial stability is based on reducing systemic risks. How to reduce the systemic risks? Hint: this can be achieved by introducing financial concepts from TradFi.
Many crypto gurus say we can achieve financial stability by increasing BTC hodlers 10+ million. Is this so? Is this really that we achieve financial stability by increasing user numbers or will this just amplify the systemic risks?
Let’s walk through it. The reasons crypto is lacking financial stability (i.e. has high systemic risks) are:
1. **Paper BTC**. CeFi exchanges can sell you paper BTC (i.e., these are IOUs that exist only in their platform and are backup up only with their promise to pay). But, there is no way to find out if you got paper or real BTC in the CeFi exchanges. OK, bigger exchanges publish their transparency reports, but they only publish the reserves. They do not publish their liabilities …
2. **Shorting client funds.** The more customer funds CeFi exchanges have, the more shorting CeFi exchanges can offer to their hedge fund clients (i.e., borrow Bitcoin, sell it and repurchase it at the dips. And keep doing this very long time).
3. **Undercollateralization**. CeFi lenders provided uncollateralized or under-collateralized loans to hedge funds, who were then shorting these assets. This lending would have been un-possible in TradFi – no one is lending in TradFi without 200% collateral to the hedge funds …
4. **Asset liability maturity mismatch**. CeFi/DeFi platforms have continuous maturity mismatches between lenders’ loan durations and borrowers’ loan durations. Why is asset-liability mismatch dangerous? Well, just one word here – LUNA. If all depositors want to withdraw simultaneously, but the funds are not available immediately, then we have an asset-liability mismatch.
**How to reduce current systemic risks?**
1. Take your funds out of CeFi trading exchanges. If CeFi exchanges have fewer deposits, it’s too high risk for them to sell you paper BTC.
2. Take your funds out of CeFi lending platforms so that CeFi lending platforms cannot offer uncollateralized loans to hedge funds, who will then be shorting your assets.
3. Take your funds out of CeFi/Defi lending companies that don’t have maturity matching.
4. Evaluate possibilities to use fixed-income instead of money-market funds
**What can CeFi/DeFi industry do?**
1. For exchanges: Implement the uptick rule, i.e., sell order submission will be possible only after the buy order (like in TradFi).
2. For exchanges and lending platforms: Implement transparency on the OTC lending contracts to the hedge funds
3. For all platforms: Implement CeFi/DeFi maturity matching dashboard (asset-liability duration matching dashboard).
It’s more than just the number of users or holders which guarantees the crypto industry’s stability.
It’s about introducing financial concepts which will reduce systemic risks in the industry:
* Reduce paper BTC
* Reduce shorting of client funds
* Introduce more transparency, especially for lending contracts
* Implement asset-liability maturity matching
* How did CeFi lending take down your BTC: [
* BTC doesn’t have any yield? How did CeFi lending platforms paid interest for your BTC? [
3 thoughts on “What is required for systemic financial stability in crypto?”
The biggest thing this article is missing is that in order for Crypto to be stable a more meaningful economy has to sit on top of it. That is true for some coins. But for a lot of them, it’s completely false.
All of the other stuff you listed creates liquidity, but liquidity can go both ways no matter how many rules you try to place on it to force a price that isn’t consistent with value created. This is true of Crypto or any currency for that matter.
Was telling a friend a similar thing this week. Rather than using some of these CEXs and their crypto payment options, use self custody and transfer to the party you want to pay. The CEXs are using IOUs and paper BTC. With a wallet agnostic payment option that merchants can integrate, it’s better to use self custody wallets.
For any currency, crypto or otherwise, to be stable, it needs to be backed by stable value.
The US dollar, for instance, is backed by the US government, which is in turn backed by US taxpayers. As long as the world believes in US innovation, they will lend to the US (through dollar buying).
Similarly, there will need to be some concrete backing, like if you promise to exchange one token for one barrel of crude oil, at any time. Then, stability would only depend on user trust in you and your ability to keep your promises.